Government assumes control over mortgage giants Fannie Mae and Freddie Mac

From the AP:

The Bush administration seized control Sunday of troubled mortgage giants Fannie Mae and Freddie Mac, aiming to stabilize the housing market turmoil that is threatening financial markets and the overall economy.

Treasury Secretary Henry Paulson is betting that providing fresh capital to the two firms will eventually lead to lower mortgage rates, spur homebuying demand and slow the plunge in home prices that has ravaged many areas of the country.

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.

"A failure would affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance," Paulson said.

But more importantly, "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," he added in a televised announcement.

Reaction from the candidates:

Democratic presidential nominee Barack Obama issued a statement agreeing that some form of intervention was necessary, and promised, "I will be reviewing the details of the Treasury plan and monitoring its impact to determine whether it achieves the key benchmarks I believe are necessary to address this crisis."

On Saturday, Republican vice presidential nominee Sarah Palin said Fannie and Freddie "have gotten too big and too expensive to the taxpayers. The McCain-Palin administration will make them smaller and smarter and more effective for homeowners who need help."

The effect on stockholders:

The impact on existing common and preferred shares, which have slumped in value in the last year, will depend on how investors react to Paulson's assertion that they must absorb the cost of further losses first. Under the plan, dividends on both common and preferred stock would be eliminated, saving about $2 billion a year.

I expect the common stockholders will lose 100% of their investment. Preferred shareholders will not see dividends for a long time - perhaps as long as ten years and the value of their investment will approach zero.

Jim Lindgren at Volokh reminds us of the corrupt management of these companies:

In reading this article about Crony Capitalism at Fannie Mae (tip to Instapundit), I noticed that Jamie Gorelick was one of the Fannie executives who benefited from inflated bonuses based on Enron-style accounting. She was Vice Chairman of Fannie Mae from 1997 to 2003 (Fannie’s fraudulent accounting scheme was made public in 2004).
...
The magnitude of Fannie's machinations is stunning, and in two key areas in particular they deserve to be better understood. By improperly delaying the recognition of income, it created a cookie jar of reserves. And by improperly classifying certain derivatives, it was able to spread out losses over many years instead of recognizing them immediately.

In the cookie-jar ploy, Fannie set aside an artificially large cash reserve. And — presto — in any quarter its managers could reach into that jar to compensate for poor results or add to it to dampen good ones. This ploy, according to Ofheo (Office of Federal Housing Enterprise Oversight), gave Fannie "inordinate flexibility" in reporting the amount of income or expenses over reporting periods.

This flexibility also gave Fannie the ability to manipulate earnings to hit — within pennies — target numbers for executive bonuses. Ofheo details an example from 1998, the year the Russian financial crisis sent interest rates tumbling. Lower rates caused a lot of mortgage holders to prepay their existing home mortgages. And Fannie was suddenly facing an estimated expense of $400 million.

Well, in its wisdom, Fannie decided to recognize only $200 million [of losses], deferring the other half. That allowed Fannie's executives — whose bonus plan is linked to earnings-per-share — to meet the target for maximum bonus payouts. The target EPS for maximum payout was $3.23 and Fannie reported exactly . . . $3.2309. This bull's-eye was worth $1.932 million to then-CEO James Johnson, $1.19 million to then-CEO-designate Franklin Raines, and $779,625 to then-Vice Chairman Jamie Gorelick.


As for other losses, they were routinely mischaracterized so that they could be amortized over years, not realized fully as they were supposed to be. By this method, the Fannie Mae management siphoned off millions of dollars in excess compensation to top management, including Gorelick.

Fannie Mae (FNM) & Freddie Mac (FRE) lobbying scandals:

From Open Secrets:

From $3 million to $10 million a year.

This amount seems to understate the actual money spent on influencing Congress.

According to the Washington Post :

FNM spent over $50 million a year in "partnership offices" used for lobbying and $40 million on advertising.

And from the Washington Post of 2006:

Fannie Mae and Freddie Mac last year together spent nearly $23 million on lobbying, as Congress considered legislation to tighten oversight of the two mortgage finance companies in response to their multibillion-dollar accounting scandals.

According to records filed last week with the House of Representatives, the two companies remained among the most prolific corporate spenders on lobbying, despite controversy over their efforts to influence lawmakers.

From USA Today in July 2008:

Over the past decade, both Fannie (FNM) and Freddie (FRE) made the list of Washington's top 20 lobbying spenders. They spent a combined $170 million to cultivate allies during that period, a bit less than the American Medical Association and a bit more than General Electric. At the same time, their executives have consistently led the mortgage-banking sector in campaign giving to members of Congress, contributing a combined $16.2 million since 1997.