Government Takes Over Fannie Mae and Freddie Mac.

The AP reports a federal takeover of Fannie Mae and Freddie Mac:

Government assumes control over mortgage giants Fannie Mae and Freddie Mac

WASHINGTON (AP) — The Bush administration, acting to avert the potential for major financial turmoil, announced Sunday that the federal government was taking control of mortgage giants Fannie Mae and Freddie Mac.

Officials announced that the executives and board of directors of both institutions had been replaced. Herb Allison, a former vice chairman of Merrill Lynch, was selected to head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp, was picked to head Freddie Mac.

Treasury Secretary Henry Paulson says the historic actions were being taken because "Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe."

The huge potential liabilities facing each company, as a result of soaring mortgage defaults, could cost taxpayers tens of billions of dollars, but Paulson stressed that the financial impacts if the two companies had been allowed to fail would be far more serious. . . .

Both companies were placed into a government conservatorship that will be run by the Federal Housing Finance Agency, the new agency created by Congress this summer to regulate Fannie and Freddie. . . .

Paulson said that it would be up to Congress and the next president to figure out the two companies' ultimate structure. . . .

The companies own or guarantee about $5 trillion in home loans, about half the nation's total. . . .

Lockhart said in order to conserve about $2 billion in capital the dividend payments on both common and preferred stock would be eliminated. He said that all lobbying activities of both companies would stop immediately. Both companies over the years made extensive efforts to lobby members of Congress in an effort to keep the benefits they enjoyed as government-sponsored enterprises.

The transcript of the official statement is here. Several regulatory changes are announced.

UPDATE: As a reminder, Fannie Mae was involved in a lot more than "lobbying." There was the Enron-style accounting and the thuggish behavior.

KenB (mail):
It's about time. I'm a strong advocate of private profit, but not with socialized risk.
9.7.2008 3:00pm
Obvious (mail):
Interesting question for financial market types: What effect will this have on the stock market Monday?
9.7.2008 3:01pm
Houston Lawyer:
I'm interested in knowing how the government will run these entities. The objective should be to maximize collections on mortgages owned. In the wrong hands, it could become a candy shop for various interest groups.
9.7.2008 3:05pm
Curt Fischer:
Did anyone else see this gem from Sec. Paulson?

I attribute the need for today's action primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction. GSE managements and their Boards are responsible for neither.

Well WTF were the management and Boards responsible for then?
9.7.2008 3:05pm
Cornellian (mail):
I attribute the need for today's action primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction. GSE managements and their Boards are responsible for neither.

i.e. GSE management / board membership appears to be nice work if you can get it.
9.7.2008 3:07pm
What makes my blood boil is the sketchy accounting that helped set this up. Fannie and Freddie were caught a few years ago using what tricks they could to manipulate stock prices to the advantage of their exceedingly well-paid executives (e.g., Raines). They got little more than slaps on their wrists, which they largely brushed off. There was not greatly heightened scrutiny of their operations by regulators afterwards, and it seems they continued with the shadey bookkeeping, including failure to mark to market the securities they hold, making their capital reserves appear greater than they truly are. So, the hugely bad investment bets they made along with the other financial institutions that couldn't get enough of the toxic mortgages, which might be viewed as incredibly stupid but arguably "innocent," were compounded by the not so innocent misleading of regulators and investors.

If there is evidence of punishable wrongdoing, I earnestly hope it will be pursued.
9.7.2008 3:15pm
James Lindgren (mail):
When it was leaked after 4pm on Friday that a takeover would almost certainly happen this weekend, Fannie and Freddie stock plummeted (it may be worthless now, it's hard for me to tell from the news release).

US stock index futures went up strongly, however, on the leaked news.

So the likeliest outcome on Monday is market UP, but one never knows. Certainly, that's the way I bet on Friday afternoon before the market close.
9.7.2008 3:20pm
byomtov (mail):
Well WTF were the management and Boards responsible for then?

Cashing their paychecks, I suppose.

Paulson's absolution of mgt is really hard to understand. If you're in the business of lending money against collateral, isn't it important to make sure the collateral is good?

If the whole operation is so mechanical that they couldn't do anything about it, why is it necessary to pay millions to get someone capable of running it. There are lots of capable administrators in the world who could do that for a fraction of what the CEO's got paid.
9.7.2008 3:33pm
anon234324211 (mail):
What law authorizes the gov's seizure?
9.7.2008 3:55pm
anon, doesn't this seizure smack of fascism? I know that term is overused today, but this seizures smack of fascism to me.
9.7.2008 4:00pm
anon, doesn't this seizure smack of fascism? I know that term is overused today, but this seizures smack of fascism to me.
You have a truly singular notion of what constitutes "fascism," if you think it covers the government stepping in to take control of these two entities originally created by Congress, which have gotten themselves into such profound financial straits that they threaten our national economy, and the world economy too. To label this "fascism" would not be to overuse the term, it would be to apply it to that which bears no more resemblence to than it does to just about any 'ism you might imagine.
9.7.2008 4:19pm
vinnie (mail):
It's about time. I'm a strong advocate of private profit, but not with socialized risk.

I'm not with it either, let them fail. Don't take my tax money to save stupid people.
9.7.2008 4:27pm
Two observations: One of the best comments I read basically say that, come Monday, if the market collapses a la Oct '87, or worse, then we will know with a fair, but not complete degree of accuracy that the market forces work, but there's that whole recession/depression thing that it would kick off. On the other hand, if the market goes up tomorrow, then we have pretty conclusive evidence that the market is completely un-connected to what most people know as economic laws, and the stock market is merely a massive, public ponzi scheme. The repercussions might be even worse than the first alternative.

Second, I just have a sense that when the historians of the future look back at the 'Post-empire era of the United States', September 8th, 2008 (or maybe the 6th) will be one of those dates that freshmen have to memorize for their history exam.
9.7.2008 4:28pm
"On the other hand, if the market goes up tomorrow, then we have pretty conclusive evidence that the market is completely un-connected to what most people know as economic laws"

I'd be interested in knowing what "economic laws" you are talking about. What about this law: "All economists that can predict the market ahead of time are billionaires."
9.7.2008 4:56pm
It's really miserable. Shows a total Goldman (Democrat really) take-over of the financial helm of government. These are really not guys that you want running things. Leave them to colluding with CEOs on how to create agency effects. LEave them to churning portfolios. Put keep them the hell away from the till.

Best thing ever was when Rubin called O'Neal to get him to bail out Enron and he said no. And he let the thing fail. And the world did not melt down.

Now, we have bail out after bailout. Disgusting.
9.7.2008 4:59pm
This is a sort of "takes a Nixon to go to China" where we would be better off with a minority but energized Republican party in Congress, and lacked control of the White House. If this sort of thing were going down from Carter, we would have so much kerfuffle and scream that it would be stopped. But the Republicans who are willing to bend any principle to keep their seats are desperately scared of being equated to Hooever. And they are actually caving faster than a Democrat would.
9.7.2008 5:02pm
A. Zarkov (mail):
" ... and the stock market is merely a massive, public ponzi scheme."

Bingo. Give that man 10 silver dollars. When you read the bio of Charles Ponzi, you get the feeling he was the founder of modern finance. It's all there: 1. arbitrage as in his International Postal Reply scam; 2. bank fraud; 3. Florida real estate scams. How modern can you get?

We really have no means to put a value on a stock sold in the secondary markets. The Gordon Dividend discount model looks good except stocks that don't pay dividends should have a zero price and they don't. You buy a stock because you hope someone will buy it from you at a higher price in the future. Or you hope the company will do a buy back of its shares or another company will buy your shares.
9.7.2008 5:13pm
Curt Fischer:
I don't understand a lot about finance. I remember questioning the need for the Bear Stearns bailout at the time, but I was probably not in a position to appreciate all the nuances of the finance industry.

Here, the "bailout" makes more sense to me. It certainly seems as if non-preferred shareholders will lose mostly everthing. And, the plan calls for a reduction in the assets of either FM over many years--it seems today's "buyout" is the first step in unwinding (or at least shrinking) the GSEs. I can't understand why TCO is so "miserable" about this situation. What would have been a better outcome?
9.7.2008 5:17pm
How about getting the Fed out of this business, and letting more transparent and accountable state outfits take up the slack?
Could their existence be challenged under the 10th Amendment?
9.7.2008 5:21pm
one of many:
Not certain about TCO but I would have preferred a statement that the US was not going to stand behind them and if you foolishly believed an 'implied' guarantee that you got what was coming to you. I'm glad of this announcement and it surpasses my expectations of what was politically feasible, Fannie and Freddie have spent a lot of money and carried water for so many congresscritters that it was optimistic to expect anything this good.
9.7.2008 5:27pm
I suspect that a fair fraction of the US financial executive cadre ought to be jailed. Plus much of the federal government cadre, naturally.
9.7.2008 5:34pm
Curt Fischer:

Not certain about TCO but I would have preferred a statement that the US was not going to stand behind them and if you foolishly believed an 'implied' guarantee that you got what was coming to you.

This would have essentially ended the capacity of the US economy to provide mortgages to its citizens, at least as I understand things. Of course, in the wake of the FM explosions I'm sure eventually new mortgagers would appear and old ones would gain a lot of market share. But wouldn't it be bad if the capacity to finance mortgages to US citizens disappeared for a few months (or at least shrank considerably)?

Maybe not. I'm no economist, so maybe there's a good reason why such concerns are overblown. If so, I'd love to hear it.
9.7.2008 5:38pm

What law authorizes the gov's seizure?

You don't expect neocons to obey the law, do ya?
9.7.2008 5:39pm
one of many:
Yes it would Curt, and it would have tanked the world economy too, there are lot of Fannie and Freddie bonds out there and an enormous number of financial instruments based upon them. It also would require a time machine since the US government has converted the implied guarantee to an explicit one. Sometimes though to live up to your principles you have to break a few eggs. I'm not saying the results on the economy of a repudiation of Fannie and Freddie would have been good, just that the enforcement of the principle would have been worth it (in my political worldview). I suspect only a few die hard libertarians would agree with me, heck I'm not sure I would even agree with me if there was a snowball's chance of it actually happening, but it is nice to dream.
9.7.2008 5:47pm
RPT (mail):
No wonder George Will doesn't ask the "are you better off" question. This just demonstrates that we need four more years of a Republican executive.
9.7.2008 6:09pm
vinnie (mail):
For us uninitiated: What exactly does the government guarantee? I mean who gets how much?
9.7.2008 6:15pm
Moneyrunner43 (www):
Some comments here strike me as semi-unhinged. Why would the market have to go down Monday to prove to XON that the market isn't a Ponzi scheme?

For those who are interested, I have prepared a summary of what's happened, including quoting and linking to Jim Lindgren's earlier post.
9.7.2008 6:22pm
To clear up some facts that have been confused in previous comments:

(1) The GSE's don't loan money to anyone. They buy loans other people make, guarantee their performance, and resell them to investors.

(2) The GSE's didn't create their business model with it's dual purposes, Congress did. That's why Paulson said it's not the GSE's fault.

(3) the old chestnut that the GSE's represented "private profit/socialized risk" is a crock -- the private profit part (i.e.: the shareholders) were just wiped out. Some private profit. Paulson just private-profitted me out of $5k.

(4) there is no law authorizing the government to seize private companies like this, and yes, it is fascist.
9.7.2008 6:42pm
karl newman:
It is amazing how big this government is getting under a Republican president. It appears that the real socialists are in the White House now. Prescription drugs, massive increase in DOD, now this. Where will it end? What next? Why couldn't they let Bear Stearns fail again? GM is next in line, probably will take them over to win Michigan for McCain.

For what was once a libertarian blog there are a lot of big government conservatives posting for four more years of this mess.
9.7.2008 7:26pm
Curt Fischer:

Thanks for the clarification that the GSEs do not make loans themselves, but rather simply guarantee them. I for one was unclear on that point.

Regarding your other points though:

2 and 3. The FM issue is definitely a big mess and I'm sorry to hear your investments went sour. That's never any fun for anyone. But was it really Paulson who private-profitted you out of $5k? For example, what board members did you vote for at the last shareholder meeting, or the meetings before that? Or, do you share Paulson's view that the Board and the management of your particular FM weren't responsible for anything? My point is, sure there was private profit available in the FMs, right up until today (or whenever the deal goes through). It's not clear to me that anyone's gain or loss is Paulson's responsibility. Wouldn't it be the companies'?

4. What about the law that Paulson mentioned in his statement today? The specific authorization that Congress gave him? He and others seem to be convinced that that law is enough. It also doesn't sound like this move has anything to do with fascism, at least as I understand its definition.
9.7.2008 7:42pm
Quarterly Prophet (mail):
So we finally figured out what it would take for Jim Lindgren to stop talking about the election.
9.7.2008 9:01pm
A. Zarkov (mail):
Calculated Risk has some cogent comments about the Fannie and Freddie takeover.
9.7.2008 9:14pm
Benjamin Davis (mail):
This is not fascism, this is welfare for the rich one more time. Always done in the name of protecting the poor or middle class and "the economy." The cynical financial wizards who created all this bad debt are just laughing their way to the bank. Privatize the profits and socialize the losses - that's the game.
9.7.2008 9:56pm
I would have preferred to let bond haolders take their haircut. Unwind the mothers. And then shut them down. They're really not needed anyhow. People can secrutize without conflating a government gaurantee. Mortgages would have been perfectly obtainable without Freddie or Fanny. Money in search of a return will seek out people needing credit. The market and risk and all that will determine what interest is charged.
9.7.2008 10:10pm
I was recently at a meeting where credit for commercial airplanes was discussed. The market is just fine. It was said that this is a relatively easy asset to underwrite. For one thing, it's a hard asset. Real estate is NOT hard to underwrite. It may cost a little more (and it should based on defaults, and also perhaps some stickiness in prices still needing to descend). But loans can get worked out by the market.
9.7.2008 10:15pm
Houston Lawyer:
I suppose all of those against bailing out Fannie Mae and Freddie Mac also oppose the FDIC.

There are major repurcussions to allowing financial giants to fail. It took $100 oil for Houston to recover from the loss of Enron and those companies that were damaged when it fell. Of course Sarbanes Oxley didn't help.

Imagine the stupid legislative fixes that we'd get in a world where multi-trillion dollar entities were allowed to fail. If we get out of this with a cost of a couple of hundred million dollars to the taxpayers, we will have done OK. That's a lot less money than was spent to bail out the Savings and Loans 20 years ago.

If Ken Lay deserved jail (and apparently he did), I don't see how this management team should be any different.
9.7.2008 10:52pm
Comments here are unhinged. Freddie Mac and Fannie Mae weren't "seized", they were placed in conservatorship authorized by the foreclosure legislation signed by President Bush on July 30th (the Federal Housing Finance Regulatory Reform Act of 2008 (Public Law 110-289)). The companies cannot be liquidated; essentially their management was replaced so they can be restructured.

While the rationale for these actions is that they are "to big to fail" and the liquidation would cause massive disruption of world financial markets (parenthetically, China is the largest holder of their securities), perhaps what is needed is a "shock to the system" and end the myth that everyone should own a home.
9.7.2008 11:16pm
Moneyrunner43 (www):
Houston Lawyer,

You make a great point. The fact is that banks are in the business of taking in people's depot money and then lending it out to people making used car loans, making a profit on the spread. If you realized that that's how your money is being used would you put your money in CDs without FDIC?

I would love to see the cretins moaning about FRE and FNM lose their savings in their local S&L. Without FDIC I wouldn't allow my checking account to hold more than a thousand dollars.

The political hacks that were in charge of FRE and FNM deserve to quick trip to the slammer. The only thing keeping them out is that most of them were part of previous Democrat administrations and they take care of their own.
9.7.2008 11:22pm
Moneyrunner43 (www):
"depot" should be "deposit"
9.7.2008 11:25pm
KenB (mail):
TCO says:
Now, we have bail out after bailout. Disgusting.
What is the definition of a bailout? I don't claim to know all the details, but the newspaper article I read stated that the shareholders would likely lose everything. The higher-ups will, I hope, lose their jobs. It would be even better if some of them are prosecuted for the accounting shenanigans that would have sent the rest of us to jail were we to have perpetrated them.

If that's what happens, I would not call it a bail out. I lived through the savings and loan crisis in Texas, frequently grimacing when people spoke of the savings and loan bail out. Look around to see how many savings and loans are still around after the "bail out." The depositors, not the savings and loans, were bailed out.

Fannie and Freddie operated with an implicit federal guaranty. They laid down with the devil, and he has come for his due--as in this case he should have. The government's proper role here is an orderly disposition of assets, minimizing losses to others. That's what the RTC did in Texas and elsewhere.

The RTC was ruthless; we regarded the whole process as a second Reconstruction. As with most government activities, it used a meat cleaver when a scalpel would often have done, but it purged the problem, and the economy has moved on. Given that the feds are necessarily involved, that's probably the best outcome we can hope for here. Not that we're guaranteed the best.
9.8.2008 12:29am
They are bailing out the debt holders. And those bitches were LEEEEEEveraged!

I'm actually amazed that people don't understand this. But then again Volokh had no clue what went down in the Hanoi Hilton (so it's good that McCain covered it).
9.8.2008 1:10am
Christopher Cooke (mail):
Prof. Lindgren: Freddie and Fannie's past accounting transgressions were not in the same league as Enron's. Indeed, what they likely did --reserve accounting tricks to smooth out earnings--has been done by almost every major company in the US, from Microsoft (which the SEC sued over reserves accounting gimmicks) to W.R. Grace to --most likely--another famous, marquee-named company that had 26 quarters of always exactly exceeding analysts' expectations by $0.01/share. Freddie and Fannie's CFOs were doing what many in the business world thought was the sign of good management, "managing earnings." It doesn't mean they were correct --they were not--but please let us not grossly distort things.

Now, however, I gather that the rapid decline in the housing market meant that their capital cushions (particularly with respect to subprime mortgages) were seriously overstated. I think Freddie and Fannie were a flawed structure: a government sponsored entity, that got too large to fail, but in which the risk was supposed to be borne by private investors, that was serving a public need. Probably we are much better off to get rid of this type of structure if we are not going to let them fail. Otherwise, we taxpayers wind up assuming the risk but not sharing in the rewards.
9.8.2008 2:20am
vinnie (mail):
Christopher Cooke"
that got too large to fail,

See that is the kind of thinking that will get you in trouble.
The roman empire failed. Herds of Buffalo were stampeded over cliffs. All who followed were meat. Classic fail.
9.8.2008 3:28am
Moneyrunner43 (www):
Christopher Cooke,

I believe that you spoke of "managing earnings" as sort of an innocent thing done by most large companies. I also believe you are referring to General Electric under Jack Welch as using that technique. If you were talking about some other company, let me know.

The end result of Welch's "earnings management" is that GE's stock is now 50% below what is was 8 years ago since Jeff Immelt took over and stopped "managing earnings" a la Welch. I happened to see how this was done on the micro -- not macro -- level and it was simply crooked. Truckloads of goods leaving the factory on the last business day of the quarter, stopping outside the plant gates so that the business unit could book a "sale." The next day the truck returned, with the good still loaded. Then on to "managing" the next quarter.

Then of course there were provisions for returns, provisions for repairs, provisions for etc., etc. etc.

It's wrong, it leads to lies being told on balance sheets, it leads to investors being deceived, and it should lead to fines or jail for those perpetrating this fraud on the markets.

There's no excuse for it even if the juvenile excuse is that "everybody does it." The fact is that everybody does not do it -- and few did it on the scale that FRE and FNM did it, with the exception of Enron and Worldcom. I want to see vigorous prosecution of the people involved, the disgorgement of illegal profits and compensation, and a few more felons to occupy "Club Fed."

And, by the way, I am very much involved in the financial services business and that's why I don't take this as a business-as-usual attitude.

And yes, I think that the government has done the right thing by placing them in receivership. But that is only the first step to making sure this never happens again.
9.8.2008 8:44am
NickM (mail) (www):

Paulson's absolution of mgt is really hard to understand. If you're in the business of lending money against collateral, isn't it important to make sure the collateral is good?

If someone else, who has the resources to do it, is promising to make good on all your bad loans, with no end in sight, no, it's not really important.

Of course, the Freddie Mac and Fannie Mae boards didn't imagine a situation where Uncle Sam tired of being a sugar daddy, kicked them out of the house, and took back all the
things he cosigned for.

9.8.2008 11:32am
K.W. (mail):
A point about GSE failure:

The GSE had capital, loan loss reserves, and debt that was selling at more or less LIBOR rates (the rates that other banks lend to each other, higher than treasury but still low). Failure of the GSEs was in no way imminent. GSEs, in calculating capital, are expected to account for the expected value of all future losses (which is pure guess work, no way around it.) Some of the accounting requires you to use the resale value of securities, even if you expect not to sell it ever, and keep collecting your expected interest payments. My point is that even if the GSEs were negatively valued in their accounting (which they can be by some measures), They won't actually fail until the expected losses actually occur, and may be able to make up for those future losses with future business profits.
9.8.2008 11:48am
K.W. (mail):
"Of course, the Freddie Mac and Fannie Mae boards didn't imagine a situation where Uncle Sam tired of being a sugar daddy, kicked them out of the house, and took back all the
things he cosigned for."

The GSEs, as I understand it, have never used a penny of federal money. They just took advantage of an implicit guarantee that the Feds would continue paying on Agency bonds if the companies ever failed. The agencies have never defaulted on a bond, though. This includes the recent "back-stop"/old "bailout" that opened up the Treasury to the GSEs, which they haven't needed to take advantage of because the sales of GSE debt weren't so bad as to warrant the higher rates on the treasury window.

Actually we can thank OFHEO (now FHFA) for the GSEs owning so much subprime paper, as they required it as part of their affordable housing charter.
9.8.2008 11:54am
Christopher Cooke (mail):
Don't get me wrong: managing earnings is wrong and illegal. But there is a difference between murder and burglary.
9.8.2008 12:12pm