Michael Beitler (pronounced Bite-ler), Ph.D., CPA, is the host of "Free Markets With Dr. Mike Beitler," a libertarian internet-radio talk show, and the author of Rational Individualism: A Moral Argument for Limited Government & Capitalism. Mike was the CFO of a profitable bank for more than ten years.
Originally published at Campaign For Liberty
Fannie Mae reported a loss of $25.2 billion for the fourth quarter of 2008 (losses of $58.7 billion for full-year 2008). Total nonperforming loans were $119.2 billion at year-end. Fannie is requesting additional capital from the U.S Treasury. The other gargantuan government-sponsored enterprise, Freddie Mac is likewise running up billions of dollars in losses. Freddie is preparing to ask for additional capital from the U.S Treasury of $35 billion.
Why should you, the taxpayer, be concerned? Isn't the Federal government using bailout funds allocated by Congress to clean up the mess?
The problem is the Federal government is on the brink of bankruptcy itself. The U.S. government is $11 trillion dollars in debt. (That figure does not include tens of trillions of dollars of off-balance sheet, unfunded liabilities.) Congress has no "money to allocate" to Fannie, Freddie, or anything else. You, the taxpayer, are on the hook for these massive obligations.
Go back to the first paragraph and substitute "additional taxpayer money" for "additional capital."
On September 7, 2008, James Lockhart, director of the Federal Housing Finance Agency (another taxpayer-supported agency), announced that Fannie Mae and Freddie Mac were being placed into conservatorship under his agency. At the time, Fannie and Freddie owned or guaranteed approximately $6 trillion dollars in mortgage loans.
A Brief History
In 1938, the Federal National Mortgage Association (FNMA), better known as Fannie Mae, was added to the Federal Home Mortgage Association (part of FDR's New Deal) to facilitate liquidity in the secondary mortgage market. Fannie was established as a mechanism to make mortgages available to low-income families. The secondary mortgage market is where bankers/lenders sell the mortgages they originate.
By 1968, Fannie Mae was a huge financial institution. The politicians and bureaucrats decided to convert Fannie into a private shareholder-owned corporation. The purpose was to remove Fannie's activities from the Federal government's financial statements and its strained budget.
In 1970, the Federal government created the Federal Home Loan Mortgage Corporation (FHLMC), commonly referred to as Freddie Mac, to compete with Fannie Mae. The stated purpose was to promote a more robust and efficient secondary market for mortgage loans.
The relationship between Fannie and Freddie (both government-sponsored enterprises) and the Federal government itself has always been debated. But investors knew the yield on Fannie Mae and Freddie Mac borrowings (in the form of bonds) was only slightly higher than U.S Treasury bonds. There was an implied guarantee on Fannie and Freddie bonds.
How Did Fannie & Freddie Get So Big?
With an implied Federal government guarantee, mortgage loans as collateral, and a yield (interest rate) higher than U.S Treasury bonds, bankers (like me), insurance companies, and other investors bought Fannie and Freddie bonds without hesitation.
Then with mortgage-backed bonds to sell Fannie and Freddie (with AAA bond ratings) could accelerate their activities in the secondary mortgage market. The number of mortgage loans being originated (and then sold in the secondary market) increased dramatically. Politicians and special-interest groups were delighted.
With Fannie and Freddie "in the game," bankers could originate mortgage loans as fast as possible, sell the loans to Fannie and Freddie, keep the origination fees, and earn servicing fees for the life of the loans. As bankers, we created growing income steams without risk. The risk was shifted to Fannie and Freddie (and ultimately to the taxpayers).
When I'm asked "Why did intelligent bankers make subprime loans?" I give a simple explanation: the bankers could shift the risk to Fannie and Freddie.
Keep in mind, throughout this time bankers were under pressure to make mortgage loans to low-income borrowers for political purposes. Bankers were happy to comply as long as somebody else assumed the risk.
A Little More History
As real estate prices climbed in the 1990s, low-income individuals found it harder to buy homes. The Clinton administration responded by putting more pressure on Fannie, Freddie, and the bankers to make more low-income loans (now called subprime loans). This pressure led to lower lending standards. Fannie, Freddie, and the primary mortgage lenders (the banks) started a race to the bottom. The secondary market, now worldwide, suddenly contained mortgage loans with negative amortization, interest-only payments, layered teaser rates, and floating-rates. Add to that low documentation requirements and you can see the train wreck coming.
George W. Bush got into the act in 2002. Bush signed the Single-Family Affordable Housing Tax Credit Act. The stated purpose was to "renew the dream." In December 2003, Bush signed the American Dream Downpayment Act to provide grants to pay for downpayments and closing costs for low-income borrowers.
By the end of Bush's presidency, "the dream" had become a nightmare; millions of Americans were living in homes they could not afford. Obama's response was to reward irresponsible behavior with taxpayer money. From Wall Street to Main Street, the more irresponsible your behavior the more taxpayer money you received! Can you see a moral hazard here?
To date, not a single politician or bureaucrat has taken any responsibility for the real estate and banking meltdown. The free market has been blamed. Does any part of the story in this article resemble a free market?