Tuesday, June 21, 2016

A Palace For Fannie (Mae)—–Why The Imperial City Must Be Sacked - by David Stockman

To hear the establishment media tell it, you would think that Attila the Hun was fixing to sack the Imperial City. Would that Donald Trump were that bold or dangerous.
Then again, he is a showman of no mean talents. So if there is a maquette of Fannie Mae’s planned new $770 million headquarters somewhere around Washington DC, he could start the sacking right there. Hopefully, he would not hesitate to shatter it with a fusillade of tweets—-or even take a jackhammer to it while wearing a Trump hard hat.
Fannie Mae is surely a monument to crony capitalist corruption, and living proof that massive state intervention in credit markets is a recipe for disaster. But rather than shut it down after it helped bring the nation’s financial system to the edge of ruin, the beltway pols have come up with an altogether different idea.
To wit, they plan to move Fannie from her already luxurious NW Washington headquarters to this hideous new glass palace to be built in the heart of Washington DC. Could there be a bigger insult to the 15 million families who lost their homes to foreclosure owing to the crash of the giant housing bubble that Fannie Mae and the crony capitalist crooks who ran it helped perpetuate?
And that’s to say nothing of the $180 billion of taxpayer money that was pumped into Fannie Mae and the other GSE’s after the house of cards came tumbling down in August 2008. In fact, while the politicians on Capitol Hill have dawdled for eight years without any statutory changes or mandates for even minor reforms, Fannie Mae’s management and its phalanx of K-Street lobbies showed exactly who rules in the Imperial City.
It is the larcenous rule of these syndicates of beltway racketeers, in fact, that has put Donald Trump’s name on the Presidential ballot.
So let it be granted that his manners and policy knowledge appear to be on the meager side. Yet it is malodorous tales like that of Fannie Mae’s swank new palace which demonstrate why a disrupter on horseback is exactly what the Imperial City deserves.
In truth, the government housing guarantee programs at Fannie Mae and Freddie Mac have been an abomination from the very beginning.
Not only did they inappropriately subsidize home mortgages by upwards of $60 billion annually—–most of which went to affluent middle-class households not entitled to taxpayer help in the first place—-but they were also based on the kind of Washington artifice upon which today’s rampant crony capitalism thrives. Namely, the specious claim that the GSEs are unique, creative “public-private partnerships” that enable a “secondary market” for home mortgages, and thereby remedy the alleged failure of the free market to provide cheap 30-year housing loans to the public.
In fact, the so-called secondary market for mortgages was no such thing. Freddie and Fannie have always been a de facto branch office of the US Treasury and their securities have been just another variant of treasury bonds. That finally became official when the U.S. Treasury threw them a $180 billion lifeline on the eve of the financial crisis.
The reason that became necessary, of course, is that the GSE’s had been minting fabulous book profits over several decades by drastically under-reserving for losses, confident that Uncle Sam would bail them out if a crisis ever came.
In fact, when the mortgage meltdown did come, Freddie and Fannie had virtually no accumulated reserves and capital and would have exposed investors to tens of billions of losses. Needless to say, the implicit “call” on the US Treasury that had always been embedded in the below market rates on Freddie/Fannie paper was instantly exercised by Wall Street’s then plenipotentiary in Washington, former Goldman CEO and US Treasury Secretary Hank Paulson.
To be sure, the proper course would have been to force investors ranging from the sovereign wealth fund of China to Norwegian fishing villages and Wall Street hedge funds to take their lumps for not reading the indentures (which contained no legal US guarantee), and to prosecute Freddie and Fannie and their executives for blatant and monumental accounting fraud.
But the accounting fraud was never even acknowledged, let alone prosecuted,  owing to the beltway fiction that the GSE’s are “off-budget” public-private partnerships.
This convenient scam was first invented by Lyndon Johnson to magically shrink his “guns and butter” fiscal deficits. But since then it has metastasized into a giant business fairy tale—namely, that behind the imposing brick façade of Fannie Mae’s soon to be superseded headquarters, as pictured below, there is a real company generating value-added services that are the source of its reported profits.
In fact, there is nothing behind those walls except a stamping machine that embosses the signature of the American taxpayer on every billion dollar package of securitized mortgages it guarantees and on all the bonds it issues to fund a giant portfolio of mortgages and securities from which it strips the interest.
That’s right. It is the unwitting taxpayers of America’s flyover zone who underwrite Fannie’s balance sheet and enable the racketeers who run it and fed off its massive money shuffling operations to live high on the hog.
Here’s how the scam works. Fannie and Freddie typically booked 90% gross profit margins owing to the fact that they have essentially no cost of production beyond the trivial expenses of their automated underwriting systems and highly computerized back-office operations. Their real cost of goods would be the large accounting provisions for future losses that would be required were they not wholly guaranteed by the US Treasury.
Indeed, the pointlessness of their faux financial statements can be easily demonstrated by the counterfactual. That is if we wanted to have honest socialist mortgage finance, a handful of GS-14s could run Freddie and Fannie out of the U.S. Treasury building.
Civil servants could emboss the taxpayers’ guarantee on every family’s home mortgage just as proficiently as the make-believe business executives who populate Fannie Mae and the other GSEs today; and in the process we could dispense with the sheer waste involved in applying GAAP accounting to the operations of a mere government bureau.
I laid this out more fully in The Great Deformation, yet the mythology about Fannie and Freddie is virtually immune to these obvious truths. Indeed, the beltway discourse has been so corrupted that a whole new raid on the treasury has been launched by speculators who bought up their worthless securities after the 2008 collapse and subsequent bailout. And now they are pounding the table for a bailout of the remnants of the last bailout.
To its credit, the Obama administration had previously recognized that absent Uncle Sam’s bailout of the roughly $6 trillion of Freddie/Fannie mortgage guarantees and debentures, the junior equity securities in their capital structures (preferred and common stock) would have been worthless.
In fact, at the time the GSEs were essentially nationalized by the Bush Administration in September 2008, the thin layer of equity represented by their shares had been leveraged at approximately 100X, and would have been obliterated in a proper bankruptcy.
Accordingly, the Obama folks had simply decided to treat the remnants of Freddie/Fannie as a wholly owned government investment fund and swept back to the US Treasury 100% of the  phony “book profits” posted each quarter.
What that amounted to, of course, was just an off-budget scam. The US Treasury loaned its credit card to the GSEs and then booked the resulting profits as income. Needless to say, it did not enter any off-setting liability for the risk being incurred.
This maneuver has resulted in more than $200 billion of phony deficit reduction since 2009, but something even worse. Namely, a huge lobbying campaign by Wall Street speculators demanding an end to the Treasury profits sweep so that they can capture an estimated $40 billion windfall gain on the worthless stock they bought for pennies on the dollar.
This stinks to high heaven, but it did not slow down the crony capitalist hucksters led by hedge fund operatives Bruce Berkowitz and Bill Ackman one wit.  During the peak of their recent lobbying campaign, the even postured themselves as the benefactor of America’s middle-class homeowners.
There is no viable alternative,” to Fannie Mae and Freddie Mac, Ackman said today in a Bloomberg Television interview with Stephanie Ruhle after the Sohn presentation. “Preserving the 30-year prepayable fixed-rate mortgage — it’s like the bedrock of the housing system — is critical. We think the only way to do it is by preserving Fannie and Freddie…… Ackman said mortgage rates would jump without the government-sponsored enterprises.
Oh, puleeze!
If evidence was ever needed that massive statist interventions like Washington’s subventions for homeownership end up generating random income distributions and windfalls to the politically mobilized, the recent hedge fund campaign to “rescue” Fannie and Freddie is surely it.
In an alternative political universe not corrupted by crony capitalist mythology about the elixir of homeownership, of course, there would be no need for a Treasury Bureau of Home Mortgage Finance. The decision to own or rent would be made by 115 million American households based on their best lights, not the inducements and favors of the state.
Markets would clear the interest price of mortgage debt and set credit terms and maturities consistent with the risks involved. Undoubtedly, rates would be a few hundred basis points higher and 30-year fixed rates mortgages quite rare.
And like in the seemingly prosperous precincts of Germany, the home-ownership rate might be 55% or any other number not selected by pandering politicians of the type who pinned the disastrous 70% ownership goal on the wall during the Clinton-Bush era.
At the end of the day, having 40 million renter households and 25 million mortgage-free owner-households provide (in their capacity as taxpayers) trillions of subsidized credit to upwards of 50 million mortgage-encumbered households is absurd.
To be sure, this perverse arrangement could be dismissed as just another expression of the capricious and random shuffling of income among American citizens that is the tradecraft of the Washington puzzle palace.
Unfortunately, as underscored by this latest attempted hedge fund raid on the treasury, the reality is not so anodyne. In order to hide this random redistribution mischief, what amounts to the Treasury Bureau of Home Mortgage Finance has been gussied-up to form the simulacrum of a profit-making enterprise.
In that posture, the GSEs have been repeatedly plundered by insiders like Franklin Rains, the 90 million dollar man who drove Fannie off the cliff; and by fast money stock speculators who managed to drive the combined market cap of Freddie and Fannie to the lunatic level of $140 billion during their heyday at the turn of the century; and by the Wall Street dealers and so-called fund managers who inventoried trillions of GSE debt securities in order to scalp profits from the economically pointless spread between regular treasury bonds and the GSE variant of the same thing.
All of these hundreds of billions were pocketed by adept cronies and speculators in the various debt, equity and preferred securities of the GSEs during the decades culminating in the 2008 financial crisis. Given the trauma of those events, Secretary Paulson’s desperate and ill-disguised nationalization of Freddie and Fannie should have put an end to the plunder.
But it hasn’t because there is no end to the zero cost-of-goods carry trades by which speculators scoop up and fund financial assets—busted and not—during the Fed’s money printing marathons. That’s what has been happening since the Fed went all-in on ZIRP and QE in 2009, and this play on the busted securities of Fannie and Freddie is a perfect example.
Likewise, there is no end to crony capitalist marauders like Berkowitz, who have the temerity to demand make-wholes from the state. Nor is there any shortage of K-Street hirelings—lawyers, accountants, and consultants— who are skilled at the manufacture of specious public policy rationalizations for outright thievery.
So two years ago came the patented crony capitalist rush. At the peak of the speculation, the equity shares of Freddie and Fannie had risen from 10 cents to $6, and the preferreds had erupted from $0.25 per share to $12, meaning that some speculators had garnered paper returns of 45-60X.
And why did this revival miracle transpire?
Quite simply because Berkowitz’s Fairholme Capital and his posse of punters—-John Paulson, Perry Capital, and Pershing Square, among others—have taken turns bidding up the paper, and then laying the legal and political groundwork for overturning the Obama Administrations correct decision to sweep the profits.
Yes, they had a fig leaf of rationalization for their raid on the treasury. Berkowitz and his sharpies blather that Freddie and Fannie have now returned $230 billion to the US Treasury, thereby repaying the original $180 billion drawdowns, with some change to spare.
But what hay wagon do they think even the clueless officialdom of Washington rides upon?
Roughly $50 billion of that was for writing up a “tax asset” that had earlier been written down seven years ago, owing to the fact that absent nationalization the GSEs had no prospect of booking even accounting income in the future.
And the remaining $170 billion represents dividends paid to the Treasury since 2009 based on using Uncle Sam’s credit card to issue the bonds and guarantees which fund the assets from which these so-called GSE profits and dividends are scalped.
Awhile back, a courageous US District judge threw a monkey wrench into the works—at least on the judicial front. But the hedge funds are not done, and will now surely revive a legislative drive to accomplish their egregious plunder of America’s innocent and unaware taxpayers.
During the peak of their campaign to fleece the nation’s taxpayers for the second time around, the leader of the hedge fund gang, Bruce Berkowitz, appeared on CNBC demanding that Washington exercises its “fiduciary responsibility” to distribute billions in paper profits that have not been earned and are not owed.
Indeed, so shameless are Wall Street’s princes of plunder that Berkowitz told a skeptical CNBC questioner that “we’ve helped before with AIG”, and that he now merely seeks a “win-win” to “help with jobs, help with the economy, help with the dream of homeownership”!
In short, the purportedly well-mannered and knowledgeable politicians of the beltway have sat on their hands for eight years while Wall Street bandits have been launching the blatant raid described above, and while Fannie’s management has been fixing to build and occupy the glass palace also shown above.
Hopefully, someone will sack the Imperial City, mannered or not.