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.