Fannie Mae & Freddie Mac: The Steve Forbes Solution

Much has been said and written about Fannie Mae and Freddie Mac, especially today.  Many have hailed the government "rescue" of these companies; others have criticized it.  Some have proposed that they merge.  I recently read a totally different opinion of how to fix it.  This article was published in the August 11, 2008 issue of Forbes Magazine.  In light of today's headlines, I believe his advice is worth heeding.  The government has taken control, but needs to break them up, not merge them or tinker with them

Steve Forbes, editor-in-chief of Forbes Magazine, and former Presidential candidate, believes Fannie Mae and Freddie Mac should be broken up into 10 or 12 new companies.  Why?  He claims this would allow for better competition.  It would also result in companies with better long-term financial soundness, by reducing the current debt-to-equity ratio of 25:1, down to 4:1.  Good idea?  Below you can read his entire editorial.  What do you think?

Bust Up These Beasts

The Treasury/Fed/Congressional Rescue of Fannie Mae and Freddie Mac is only a stopgap.  Unless fundamentally restructured, these two debt-bloated giants will sooner or later blow up.  The once implicit, now explicit, government guarantee for these two quasi-government entities was the reason that they could be leveraged to the hilt, with a debt-to-equity ratio of almost 25-to-1.  Instead of just packaging mortgages and selling them off, the companies kept hundreds of $billions in these instruments in their own portfolios to fatten profits - and enrich their politically connected managers and political allies.  They also went into the junk mortgage business, buying more than $170 billion worth of dodgy paper.

The Bush Administration should vigorously push to have Fannie and Freddie recapitalized and broken up into 10 to 12 new companies, with their ties to the government completely severed.  Yes, this would mean Uncle Sam's pumping in some $300 billion in equity capital and, perhaps taking on some $100 billion in those questionable mortgages.  But such an investment would enable these companies to have a sound debt-to-equity ratio in the vicinity of 4-to-1.  Shares in Fannie and Freddie would then we exchanged for shares of common and preferred stock in the new, solvent firms.  Current shareholders could ultimately recover their losses, and taxpayers could eventually get most, if not all, of their money back.  In fact, Uncle Sam might even make a profit.

One part of the restructuring should mandate that the federal government sell off its equity within, say, a five-year period.

Having 10 to 12 sound private companies competing in the mortgage market will help revive and reinvigorate that sector.  If the Federal Reserve ever learned central banking - i.e., making the dollar stronger and stable - the housing market would quickly snap back.

We are still a mobile nation, and our population is still growing.  The world economy will expand despite occasional road bumps like this one.  Foreigners will want to own hard assets here, including apartments, houses and land.  Once the dollar is stable they will quickly jump in, realizing that the price of such assets will move up again.

What are the odds of such a sensible approach?  Not good.  Why?  Because the two most mammoth political powerhouses in America today are Fannie Mae and Freddie Mac.  Their lobbying muscle makes Arnold Schwarzenegger look like a 90-pound weakling.  Directly and indirectly they employ legions of ex-pols to help them on the Hill.  They hand out largesse of one sort or another to any pol who matters and is willing to take it.  Fannie Mae's "charitable" operations have field people in virtually every congressional district.

These monsters are fiercely resistant to any change affecting their ability to tap Uncle Sam's ATM at will while privatizing profits and socializing losses.  Freddie is considering floating $10 billion of new shares to avoid restructuring.

The Bush Administration has no appetite for such a fight.  Treasury Chief Henry Paulson probably doesn't even realize the need for it.  And, of course, Capitol Hill wants no change.  

One yearns here for an Andrew Jackson.  Our seventh President felt that the Second Bank of the United States - which was chartered by the federal government and combined the powers of today's Federal Reserve and our largest commercial investment banks - was dangerously big and therefore its charter should not be renewed.  But the bank had Fannie/Freddie-like lobbying muscle.  Nonetheless, Jackson destroyed it.  Alas, hedidn't devise a successor entity that would only regulate banks, so we got a banking bubble, which inevitably burst.  But Jackson was correct in principle: No outsize government-created creature should exist. 

Disturbing New Real Estate Trend - Wikipedia-type Sites Can Distort the Truth

A disturbing new trend I’ve seen emerging is the electronic mutation of what I call the “cocktail party CMA.” We have all experienced the real estate conversations that happen at the neighborhood cocktail parties...People exaggerating sales prices or not explaining the real reasons for selling. The internet is really good at distributing information, but not all that information is valid or correct. The Internet can actually accelerate the distribution of false information.

Some real estate websites have now created blogs and “wiki” where consumers can add their personal "facts" regarding sales prices, listing prices, mortgage and appraisals and reasons for such. As many in the industry know, not all information told by buyers, sellers, their neighbors and friends is correct. This will eventually lead to many real estate websites spreading false information. Smart consumers will begin discounting much of the real estate information on many sites, and again start to relying on better sources like real estate professionals and documented records of transactions.

We have already seen this happen in education, where many teachers and schools do not allow their students to use Wikipedia as research source, due to its questionable factual information.