David Dayen: Hedgies Bet on Fannie/Freddie Status Quo

By David Dayen, a lapsed blogger, now a freelance writer based in Los Angeles, CA. Follow him on Twitter @ddayen

The new CBO budget projections showing debt stabilization over the next decade and a reduction of the expected FY 2013 deficit to $642 billion hasn’t been deemed by Washington as a “scandal,” although falling deficits amid high unemployment and below-trend growth is actually, you know, a bit scandalous. But even more unremarked upon is one of the primary reasons for this near-term deficit drop, mentioned in passing by CBO on page 1:

CBO’s estimate of the deficit for this year is about $200 billion below the estimate that it produced in February 2013, mostly as a result of higher-than-expected
revenues and an increase in payments to the Treasury by Fannie Mae and Freddie Mac.

In fact, CBO estimates those payments at $95 billion for the entire fiscal year, almost half of the entire reduction in the estimate between February and May. And of that sum, the lion’s share comes from the recent lump payment of nearly $60 billion by Fannie, which results basically from some borrowing-by-extension. Basically, Fannie wrote down the deferred tax value of its assets after the bubble collapse, and due to the recovery, they wrote the assets back up (Freddie’s likely to do this as well, though the lump sum will wind up smaller). It’s essentially a benefit based on taxes that Fannie won’t pay in the future. It’s not like Fannie HAD $60 billion sitting around, but under HERA, the law governing the conservatorship, they must turn over that realized gain to the Treasury. But they’re doing it through borrowing the money. James Hamilton has a good writeup of how this all works, and Steven Pearlstein goes so far as to call it an Enron-style off-balance sheet accounting play. It’s hard to argue with him.

We know that Fannie and Freddie’s profits are coming directly from monetary policy keeping mortgage rates low (subsequently giving them a massive spread on their lending), and their dominance in the marketplace, with the GSEs involved in 9 out of every 10 new mortgages in the country. But they’re “helping” federal finances so much that it’s just incredibly unlikely to see this gravy train end for some time, and everybody knows it. GSE dividend payments have already pushed back the distasteful debt limit fight and halved deficit projections. No way the Administration (the “proudest lil’ deficit hawks in Washington”) or Congress gives that up, at least not until they “make back” all $188 billion sunk into the GSEs (they’re at $132 billion or so now). Just as a side note, the GSEs may not be hedging interest rate risk in such a way that protects them from a potential spike down the road, suggesting that the walls could come down on this money-making machine sooner than anyone thinks. But that’s certainly not on anyone’s minds in DC. They just have dollar signs in their eyes.

And that’s where the vultures come in.

Some of the hedge funds that made fortunes in the housing-market crash are now betting on the recovery of Fannie Mae and Freddie Mac, the government-controlled mortgage giants.

Paulson & Co. and Perry Capital LLC are among a handful of hedge-fund firms that have bought so-called preferred shares in Fannie and Freddie, which collapsed in value in 2008 after the companies were taken over by the federal government.

These firms are hoping Fannie and Freddie’s recent return to profitability on the back of a recovering housing market will lead the companies eventually to make payments to preferred shareholders.

Hedgies win here if the government sells its preferred shares on the market, essentially keeping the GSEs the same and privatizing the profits. In the short and possibly medium term, government balance sheets will look stronger post-sale, and the private investors will take all the subsequent dividend profits and none of the tail risk.

The report claims that recapitalization is a “nonstarter,” but of course, the shares are going up now even without the dividends to investors, and the forced inertia to not mess with what is perceived as a “good thing” will be incredibly strong. This will cement our Government Mortgage future. Why would private investors shoulder risk on mortgage backed securities when they can just latch on to Fannie and Freddie? Moreover, the hedgies have rolled out their lobbying strategy:

Preferred shareholders may need to persuade Congress or the courts to revisit the current structure if they hope to recoup the full value of the shares. Paulson, Perry and others have been circulating plans before lawmakers that Fannie and Freddie should be restructured or privatized in some form, according to people familiar with the matter.

Hedge funds have stepped up their lobbying of Congress to encourage the sale of the government’s stake in the firms, said Sen. David Vitter (R., La.) at a hearing on Capitol Hill last month. “And to some extent, investors are already speculating that the companies will be returned to the marketplace.”

Those preferred shares are going to be worth something very soon. And while a few in Congress (including the aforementioned Vitter, actually) have legislation at the ready to prevent the cash grab, the temptation is going to be very great. And regardless of whether we just continue in this conservatorship limbo or return to the public/private past, you’re going to keep taxpayers at risk for more bailouts ahead.

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About David Dayen

David is a contributing writer to Salon.com. He has been writing about politics since 2004. He spent three years writing for the FireDogLake News Desk; he’s also written for The New Republic, The American Prospect, The Guardian (UK), The Huffington Post, The Washington Monthly, Alternet, Democracy Journal and Pacific Standard, as well as multiple well-trafficked progressive blogs and websites. His has been a guest on MSNBC, CNN, Aljazeera, Russia Today, NPR, Pacifica Radio and Air America Radio. He has contributed to two anthology books, one about the Wisconsin labor uprising and another on the fight against the Stop Online Piracy Act in Congress. Prior to writing about politics he worked for two decades as a television producer and editor. You can follow him on Twitter at @ddayen.


  1. Pedro Hisquale

    ‘GSE dividend payments have already pushed’ the plutocracy away from pushing austersity since the gravy train is delivering. Well that’s nice. Aren’t the taxpayers on the hook for things like the F35? My gosh, we have to protect those taxpayers too.

  2. washunate

    David, do you think ‘serious people’ are at least privately concerned about what happens when kicking the can stops working (even if the Confidence Fairie prevents them from saying so out loud)?

    Between fraud and wage stagnation, we know that current prices for items bought with debt are unsustainable. The entire ‘markets’ for housing, higher education, and automobiles are backed by the government.

    This CBO report feels a bit like Enron financial statements about 1999. Great, if you don’t pay attention to why exactly they’re doing great. That’s not the CBO’s fault of course; their job is to extrapolate current trends, but it does speak very poorly of the pundit class.

    Wait, sorry, that assumes there is value in the DC Punditocracy. Never mind.

    1. Jackson Bane

      Kicking the can is making people rich, isn’t it? What’s with the idea the Gov’mint is “over there”, and then everything else is “over here”? People use the expression kicking the can when they argue for more wrath against the teeming masses.
      Meanwhile, another quaint idea was that the employer of last resort is the Government, but look at Rust and multiply that 1000s fold. The half assed clean up job is handed off to friends of friends who hook up to the taxpayer ATM. How many leading fortune 500, defense contractin’ corps absolutely depend on the Gov’mint for their profit? They make money the old fashioned way, by playing a game of keep away, slaves on one side, “job creators” on the other.

      1. washunate

        When I say kicking the can, I am referencing the federal government’s 12 month budgetary cycle. Since USFG uses cash based accounting (rather than accrual based), liabilities (promises) extended today are not expensed today; they are expensed when the cash flow actually exits.

        Thus, via the magic of accounting, we can promise to backstop Fannie/Freddie/TBTF/whatever ‘in the future’ with no current budgetary impact. At some point, this can kicking stops working, and the bill comes due ‘now’ (EESA, etc.).

        This haphazard policy making then rachets up a new higher minimum required support level; thus, we have the bizarro world where ’emergency’ actions continue indefinitely (loan backing, too big to jail, etc.), and the old ‘normal’ bad policies can’t even be touched (tax loopholes, bankruptcy rules, etc.).

        I mean, imagine what would happen if the government said it would only back mortgages where the prospective borrower had a minimum of 20% equity in the property and income at least 33% of the sale price, or implemented bankruptcy processes where natural persons could shed debt as easily as corporate persons shed debt? Even such basic, minimalist, noncontroversial notions would blow up the whole thing.

  3. Adam Eran

    Worth remembering: Fannie and Freddie began as public institutions, and LBJ privatized them to pay for the Vietnam war… Yet another reminder that government “debt” really stems primarily from war.

  4. Robert Waldmann

    Theoretically the Federal Government could just keep Fannie and Freddie as government agencies. I don’t see why they should’t be hugely profitable. the US Federal Government has much higher risk bearing capacity than any other Earth based entity. It should be able to make huge profits by issuing Treasury securities and buying mortgages.

    Of course it won’t happen. That’s what lobbyists are for. Also it would be socialism and we can’t have that. But I don’t see an economic as opposed to ideological problem.

    1. psychohistorian

      Absolutely correct and as noted right above, Fannie and Freddie use to be part of our socialistic govt and they were doing too good and we needed more war.

      But then the US motto use to be E Pluribus Unum instead of In Inheritance We Trust.

    2. washunate

      I’m a little late coming back to this thread, but can you flesh out what you mean by hugely profitable? The combination of fraud and wage stagnation made them so hugely unprofitable that they had to be bailed out by the government.

      The Cost of Stuff (dare I say, ‘inflation’) is simply too high for current wages to make meaningful lending profitable. That’s why the only major lending out there is government-backed (housing, student loans, auto industry).

  5. CapVandal

    This is a fascinating issue.

    In my opinion, taking cash out of Fannie Mae is the worst possible thing that could happen to hedgies betting on the Preferred.

    A quick look at their 10k clarifies some things. Fannie Mae has essentially zero capital. They really don’t need it, since their balance sheet is guaranteed by the Government.

    To privatize it now, as a complete entity, would require a significant capital infusion. Per the 10k, that would be in the neighborhood of $150 billion. (“Accordingly, our deficiency of core capital over statutory minimum capital on a pro forma basis as of March 31, 2013, adjusted for the dividend to be paid by June 30, 2013, is $147.7 billion.) If it was simply IPO’ed, the proceeds would likely be less than required capital.

    The near paranoia about ‘Enron’ style accounting is misplaced. The Federal Government doesn’t pretend to have anything like a GAAP balance sheet. The Grand Canyon isn’t on any balance sheet (as well as liabilities for future entitlements).

    The major point is that they are running a $3 trillion balance sheet with zero net capital, which now includes $50 billion of intangible capital and -$50 billion in tangible capital.

    The tax asset is pretty vanilla GAAP accounting. A GAAP balance sheet with $0 capital is inherently odd.


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