Mises Daily Articles
Fannie Mae: Another New Deal Monstrosity
The shortcomings of Fannie Mae have been overlooked on the basis that Fannie plays a critical role in driving the housing sector, and thus the American economy. As Fannie goes, so goes the nation.1 Fannie means housing, and accordingly, Fannie is the conduit that takes one from "inequitable ownership" to the American Dream.2 In a nation where equality is everything, and where advantage need not be earned, but only redistributed, how can anything be more virtuous?
Fannie Mae (FNMA or Federal National Mortgage Association), a government-sponsored enterprise (GSE), finances one of every five home loans in the United States. In 1938 this GSE was founded by the federal government with a mission to increase home ownership across the United States. It is subject to congressional oversight via the Office of Federal Housing Enterprise Oversight (OFHEO). Fannie Mae stock (FNM) is actively traded on the New York Stock Exchange and is part of the Standard & Poor's 500 Composite Stock Price Index.
Fannie Mae may be one of the most ill-fated welfare creations, ever, on the part of the United States government. In the beginning, Fannie Mae's impact was negligible, however, from the outset there were plans to swell Fannie's waistline by expanding her purchasing authority. At about the time the American soldiers were coming home from WWII, Fannie was enabled to purchase loans guaranteed by the Veterans Administration, in addition to the Federal Housing Administration-insured mortgages it was already purchasing. This creation and expansion of a secondary market for mortgages was a vital boost to the supply of lendable money in the United States.
The notion of a "right" to home ownership by means of government subsidies is so firmly entrenched in the American mindset that Fannie could only grow — and grow she did. In 1968, as a part of Lyndon Johnson's societal engineering agenda, Fannie was converted into a private3 corporation and the ability to guarantee government-issued mortgages was switched from Fannie to the federal government's newest creation, Ginnie Mae (Government National Mortgage Association). This meant that Fannie would begin to operate with private capital on a self-sustaining basis. Fannie was growing up, and she was going on to bigger and better things.
In 1970, Richard Nixon authorized Fannie Mae to purchase conventional mortgages, launching a national secondary market for home mortgages. As Fannie's foray into the conventional mortgage market began to surge upward, in the 1980s it began to purchase second mortgages and adjustable-rate mortgages, and it also commenced its mortgage-backed securities scheme.
Fannie Mae advertises itself as "a shareholder-owned company with a public purpose." True to its words, in January of 2000 Fannie introduced its "Mortgage Consumer Bill of Rights" program. This rundown of entitlements promised the consumer the "right" to access credit and the "right" to qualify for the lowest-cost mortgage possible. No de facto private corporation can or will guarantee any consumers' rights whatsoever — that is, unless it has the authority of government behind it to bolster its business model and guarantee its guarantees.
Between Fannie Mae and its "little brother" Freddie Mac (another GSE), you have the largest source of cash for home buying in the United States — they accounted for almost 50% of all mortgage bonds sold through April of 2007, according to Insider Mortgage Finance. Since the beginning of 2006, over fifty mortgage companies have discontinued operations, claimed bankruptcy, or are seeking a buyer. Yet Fannie Mae continues to flourish. Since the end of March 2007, Fannie Mae's stock price has increased by almost 20% whereas the S&P 500 Index has risen only 8.1%.
Remember that corporations are generally chartered by states, and Fannie Mae was a New Deal innovation — created by and for the federal government. The sole purpose of this federally chartered, quasi-private entity was to directly intervene in the housing market while avoiding a more conspicuous regulatory apparatus governed by rules, thus allowing the government to advance and steer the government's progressive entitlement programs while in a semi-mute mode. Meanwhile, Fannie has expanded into mortgage insurance, sub-prime mortgages, and non-mortgage investments, exposing taxpayers to a massive risk of default or bankruptcy.
Fannie is a very willing lender with the power of prominence behind it. Its GSE status allows it to get away with not maintaining the necessary underlying capital and enables Fannie to borrow on more favorable terms than its state-chartered competitors. In addition, Fannie Mae is exempt from paying state or local income taxes and from filing with the Securities & Exchange Commission (SEC).
In February 2004, the Chairman of the Federal Reserve, Alan Greenspan, testified before the Senate Committee on Banking, Housing, and Urban Affairs:
Because Fannie and Freddie can borrow at a subsidized rate, they have been able to pay higher prices to originators for their mortgages than can potential competitors and to gradually but inexorably take over the market for conforming mortgages. This process has provided Fannie and Freddie with a powerful vehicle and incentive for achieving extremely rapid growth of their balance sheets. The resultant scale gives Fannie and Freddie additional advantages that potential private-sector competitors cannot overcome. Importantly, the scale itself has reinforced investors' perceptions that, in the event of a crisis involving Fannie and Freddie, policymakers would have little alternative than to have the taxpayers explicitly stand behind the GSE debt. This view is widespread in the marketplace despite the privatization of Fannie and Freddie and their control by private shareholders, because these institutions continue to have government missions, a line of credit with the Treasury, and other government benefits, which confer upon them a special status in the eyes of many investors.
The perversion here is that the rating agencies, and the financial markets overall, have interpreted the GSE status to mean that there is an implied government backing, and thus their securities have been priced accordingly.
Cooking the Books for Fun Special Favors and Profit
In 2004, Fannie was caught cooking the books.4 The Office of Federal Housing Enterprise Oversight (OFHEO) alleged widespread accounting errors at Fannie Mae. James Lockhart, Director of the OFHEO, commented that "The image of Fannie Mae as one of the lowest-risk and 'best in class' institutions was a façade. Our examination found an environment where the ends justified the means. Senior management manipulated accounting, reaped maximum, undeserved bonuses, and prevented the rest of the world from knowing."5
The latest tally will have Fannie Mae restating its earnings to the tune of $11 billion. Flagrant accounting errors go back to at least the 1990s, when the company was improperly deferring expenses in order to boost reported net income as it paid out huge bonuses to top executives.6 Upon being hit by the scandal in 2004, Fannie Mae stopped filing its financial statements with the SEC. It is interesting to note that past and present Board members of Fannie Mae — some of whom are appointed by the president — have been highly representative of the Beltway elite: a former Reagan chief of staff, lobbyists, a former aide to Nixon, a Reagan Secretary of Labor, a US trade representative, and a top economic advisor to President Bush.7 The company plans to hold its shareholder meeting in December of this year, for the first time in three years.
Maintaining the Momentum
So here we have a company surrounded with much misconception in the financial markets and accused of deceit by its own government overseers. It has chunked away nearly 40% of its profits via restatements of its fraudulent financial statements for recent years. Certainly, then, we can predict the collapse of this mortgage giant due to (1) a lack of audited financials and thus no conveyance of reliable information to the public, (2) an accounting scandal that produced achievements which the OFHEO described as "illusions deliberately and systematically created by the Enterprise's senior management with the aid of inappropriate accounting and improper earnings management," (3) and a collapsing business model in light of a bursting housing bubble, along with an imploding sub-prime mortgage market.
Wait. Not so fast.
Instead we witness a publicly traded company with four high-profile attributes:
- Fannie Mae's financial condition serves as a proxy for Congress's oversight;
- Fannie Mae's "health" serves as a proxy for the health of the housing market;
- Fannie Mae's stock price has an influence on one of the world's most closely watched stock market indexes;
- Leading up to the 2004 Presidential election, President Bush had an aggressive housing agenda to "…dismantle the barriers to homeownership…" with Fannie Mae playing a significant role in "financing" this agenda — and perhaps garnering more than a few votes for Bush and those congressmen who hung on to the coattails of this agenda.
With mortgage defaults on the rise, a financial meltdown at Fannie Mae would certainly demonstrate that foreign policy wasn't President Bush's only major weakness, and it could prove embarrassing for members of Congress aspiring to move into the White House.
Considering the four aforementioned attributes, and the fact that this GSE is deeply mired in scandal, Fannie Mae is no doubt being closely monitored by the Working Group on Financial Markets (a.k.a. the Plunge Protection Team — which reports directly to the President of the United States).8 Accordingly, we would take great pleasure in seeing Ben Bernanke, a member of the working group, asked the following questions — including the supporting commentary — the next time he appears in front of the House Committee on Financial Services.
- After the collapse of the NASDAQ bubble in 2000, and after the shock of 9/11, the Federal Reserve came to believe that the United States was heading into a deep recession. As is typical of any central bank, the prescription to reinvigorate the economy entailed creating more money and granting more credit. By June of 2003, the Fed funds rate had been reduced to 1%. To be sure, this set America's housing market ablaze. And this is exactly what the Federal Reserve desired because it views housing as "…a key channel of monetary policy transmission."
A strategic cog in the monetary transmission mechanism is Fannie Mae. In the four-year period from 2000 to 2003, Fannie Mae's outstanding Mortgage-Backed Securities grew from $706.7 billion to an astounding $1.3 trillion. Moreover, its mortgage portfolio ballooned from $607.7 billion to $901.8 billion. With Fannie Mae financing one in every five home loans in the United States, didn't it ever occur to the Federal Reserve that it should look into this financial institution's accounting, management control, and credit quality systems? If this massive transmitter of money — Fannie Mae — was not up to the task of responsibly lending such vast quantities of money into existence, did it not occur to the Federal Reserve that it may have to clean up the mess it had a hand in making? Does the Federal Reserve have a plan to bail out the second largest financial institution in the United States?
Since the Federal Reserve is so focused on consumer confidence and expectations, wouldn't the share price of Fannie Mae's common stock be of keen interest to the Federal Reserve and the Working Group on Financial Markets? After all, the Federal Reserve engineered the housing bubble, and the health of Fannie Mae may be viewed as a proxy for the health of America's housing market. Interestingly enough, America's housing market is experiencing a significant decline while Fannie Mae's stock price has appreciated by about 50% from its 52-week low, and it recently hit its 52-week high. There seems to be a disconnect here, especially when factoring in rising interest rates and the meltdown in subprime mortgages. In light of this, does the working group exercise any influence on the price of Fannie Mae's stock?
On May 2, 2007, Fannie Mae filed its latest form 10-K with the SEC. One would assume that this 10-K contained Fannie Mae's 12/31/06 audited financial statement. With Fannie Mae's internal accounting nightmare, it turns out that this 10-K contains audited financial information as of 12/31/05. Management hopes to have the 12/31/06 audited financial statement available by next quarter. Since you have a PhD in economics, you must be cognizant of the fact that security analysis begins with examining a publicly held company's fiscal year-end audited financial statement. Does it not strike you as odd that of the 16 Wall Street brokerage houses tracking this security, 9 had "buy" recommendations, 5 were "neutral" and 2 had "sell" recommendations? Considering that the investment community has waited a couple of years to receive any kind of credible financial information, and that the 2006 audited financial statement is still not available, doesn't it seem a bit unethical for any brokerage house (including Bank of America and Morgan Stanley) to recommend buying the stock of a company for which only stale audited financial data exists? Therefore, it begs the question as to what influence the Working Group on Financial Markets is exercising over the powerful Wall Street brokerage houses? Quite candidly, this smacks of a cozy relationship between certain powerful brokerage firms and the working group.
The Chairman of the Securities and Exchange Commission also serves on the Working Group. Have you ever asked him why he hasn't recommended that Fannie Mae's stock be delisted from the New York Stock Exchange? After all, if any other publicly held company hadn't provided an audited financial statement for fiscal-years 2004 and 2005 — until December 6, 2006 and May 2, 2007 respectively — wouldn't such a company have been delisted long ago?
Is the Working Group pressuring Standard & Poor's to keep Fannie Mae in its prestigious S&P 500 Index? How else could Fannie's presence in the S&P 500 Index be sustained?
Fannie Mae is not a free-market entity, nor is it a private body that must compete on the same playing field as its competitors. Fannie Mae is representative of all that's wrong with central planning institutions: it is a government-created conduit for carefully crafted financial and market socialism that the bureaucrats uphold for the purpose of propping up their fantasies for pandemic social engineering.
There's nothing "American" about this dream. In the eyes of the Republic's visionaries, this particular dream has turned into a nightmare.
- 1. Back in the "good old days" when GM had mega-market share and was the nation's corporate powerhouse, the saying was "As GM goes, so goes the nation." With home ownership being the pinnacle of equality nowadays — and thus the focus of government's interventionist policies — perhaps Fannie should be given that honorable distinction.
- 2. In 2001, Fannie Mae introduced its American Dream Commitment (ADC) — a promise to increase home ownership rates through minority ownership initiatives; keep families from losing their homes; and support housing for the chronically homeless.
- 3. The FNMA was partitioned into two separate entities: the GNMA remained a wholly owned corporation of the Department of Housing and Urban Development and Fannie Mae became a "private" corporation by virtue of the government "retiring" its stock in FNMA. The fact that Fannie became shareholder-owned and is therefore "private" is a hoodwink.
- 4. Freddie Mac had its own book-cooking going on. This company misstated earnings by $5 billion and is still trying to figure out how to fix what it did. In spite of that, on the week of June 18, 2007, one brokerage house upgraded Freddie Mac's stock.
- 5. Fannie had to conclude in a management assessment — required by the Sarbanes-Oxley law — that internal controls over financial reporting for both 2004 and 2005 were ineffective. That's putting it lightly.
- 6.  The May 2006 report from the Office of Federal Housing Enterprise Oversight (OFHEO) is truly an eye opener. Yes, it is a government oversight organization, and that's why the report's frankness and vitriol is a refreshing surprise. (The report is available here in PDF.)
- 7. Naming names: Kenneth M. Duberstein, a lobbyist and former chief of staff to President Ronald Reagan; Frederick Malek, an investor and former aide to President Richard Nixon; Ann McLaughlin Korologos, a former secretary of labor under Reagan; Stephen Friedman, formerly President George W. Bush's top economic adviser and former co-chairman of Goldman Sachs with Robert Rubin; Robert Zoellick, US trade representative.
- 8. The Working Group on Financial Markets is not a figment of any one person's imagination, nor is it a twisted conspiracy theory created by "whacko" conspiracy theorists. The mainstream press has, for a long time, been calling this issue to the carpet, with nary a response from its members. <a href="www.lewrockwell.com/decoster/decoster114.html" see="" karen="" and="" eric's="" july="" 2006="" article on the working group and their suspicion regarding GM stock prices. Note that Ron Paul used this article as the basis for questioning Ben Bernanke about the inner workings of the group during a House Financial Committee hearing. Also see the Washington Post on plunge protection.