Resources: Newsletter Articles: Freddie and Fannie

Freddie Mac and Fannie Mae have been in the news lately... including a $24 million golden parachute for an exiting CEO, and an SEC investigation. What are these organizations, and what do they mean to you? Fannie Mae and Freddie Mac own or guarantee more than a third of the home mortgages in America. They are government-sponsored enterprises established by federal law in 1968 and 1970. They act as financial intermediaries, raising funds in the capital markets and channeling the proceeds to lenders, who in turn provide financing for their customers.

Running The Numbers

Despite the fact that they are owned by private investors to whom they have a fiduciary responsibility, Fannie Mae and Freddie Mac receive three distinct benefits from their sponsored status: 1) tax exemptions reduce their operating costs; 2) they are exempt from registration and disclosure requirements imposed by the Securities and Exchange Commission (SEC) on all other large privately owned issuers of publicly traded securities; and, 3) their treatment under federal law is interpreted by investors as implying that the credit risk of their debt is comparable to U.S. Treasury debt, regarded as the least risky debt in the financial markets.

According to the Congressional Budget Office, their exemptions include $1 billion worth of local taxes and securities fees, and an additional $9 billion a year thanks to an "implicit subsidy": the ability to borrow money cheaply because of the widespread assumption that the federal government will cover losses, even though not legally obligated to do so. The Congressional Budget Office estimates that $6 billion of these annual subsidies are passed along to homeowners as lower interest rates, leaving $4 billion to be divided among the shareholders and employees of Fannie Mae and Freddie Mac.

Untouchable?

Freddie Mac and Fannie Mae are two of the largest and most profitable companies on Wall Street. They recruit government veterans from both political parties as executives, and manage what they call "political risk" as much as theyÊmanage the financial risks of their portfolios. The chairman of the House subcommittee that oversees the companies says they "have unlimited financial resources [and] good personnel who maintain good relations with many members of Congress... they're tactical, and they're everywhere". Last year, they employed over 40 lobbying firms on their behalf.

When Freddie Mac recently replaced its top management during an internal inquiry of its accounting practices, outside investigations were announced by federal prosecutors, regulators, and lawmakers. Freddie Mac and Fannie Mae argue that their importance to homeowners and the housing industry justifies their privileges; they also claim that their profits are the result of good management.

Critics seek improved oversight, citing the enormous potential public costs for taxpayers should either company make the wrong bets when buying and selling mortgages.

If you have any questions or comments about this article, please let me know!

sherrybenninger@grubbco.com

The GRUBB Co., 1960 Mountain Blvd., Oakland, CA 94611

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