Playful agencies Fannie Mae and Freddie Mac returned under state protection

In late July, the U.S. federal government passed a law that allowed for an increase in its maximum borrowing from $800 billion to $10.7 trillion. This will save the guarantee agencies Fannie Mae and Freddie Mac from complete collapse and, it is assumed, stabilize the market.

Written by: Vanja Figenvald

On Sunday, September 7 of this year, a new page was written in the history of American, and thus world capitalism. On that day, Treasury Secretary Henry Paulson announced the government’s plan to take over the two financial agencies that have been at the center of the subprime mortgage crisis from the beginning, Fannie Mae and Freddie Mac. These two agencies with comic book names derived from the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation were established in 1938 and 1970, respectively, as part of the U.S. government’s fight against poverty, with the aim of facilitating access to housing loans for the poorer segments of the population.

According to the basic concept, Fannie Mae is a shareholder corporation authorized to issue loans and credit guarantees. It is the central entity of the subprime market tasked with ‘filling’ the market with the necessary money for mortgages. Freddie Mac was created as a private corporation to end Fannie Mae’s monopoly in the same market. At the beginning of this year, these two agencies covered about half of the entire U.S. mortgage market, valued at $12 trillion, but with the departure of most other players from the market due to the recent crisis, their influence in that market now accounts for about 80 percent of new mortgages made this year.

The legal form was satisfied by placing the two unfortunate entities under the so-called conservatorship of the Federal Housing Finance Agency, thereby the government de facto takes over their management. Accordingly, the leading figures Richard Sayron and Daniel Mudd were dismissed, and seasoned veterans of the financial sector Herb Allison, former vice president of Merrill Lynch, and David Moffet, vice president and CFO of US Bancorp, were brought in to replace them.

How to profit from intermediation

It is a significant event for the banner of laissez-faire capitalism in which the state is merely a night watchman, someone who observes the market from the corner and does not meddle too much in it. However, this is not the first time Americans have resorted to state interventionism, which they generally lump together with the socialism they despise, to ironically save their capitalism. The celebrated New Deal of Franklin Roosevelt, within which Fannie Mae was established, utilized the model of large infrastructure projects, work actions, and a somewhat more generous social policy to save America from economic collapse during the interwar period. This is not the only similarity. In those years of the legendary collapse of the New York Stock Exchange, American financiers got too playful and inflated the bubble so much that it had to burst.

Further irony lies in the fact that Fannie Mae was supposed to stimulate liquidity in a completely dormant market, and now it urgently needs money itself, after finding itself in a deficit of about $5.5 billion in combination with Freddie Mac. A similar scenario, under somewhat altered conditions, occurred this time when banks uncontrollably issued loans and mortgages to an economy that could not service them. Somewhere around 1968, the U.S. government grew tired of Fannie Mae and decided to ‘detach’ it completely from the state cradle and turn it into a private corporation. The agency thus ceased to be a guarantor of state mortgages and entered the waters of the financial sector. Its business consisted of buying and ‘repackaging’ loans for further resale through mortgage-backed securities, providing banks and other financial institutions with a constant influx of fresh money for issuing new loans and mortgages.

Simply put, to reduce the risk of approving and financing a mortgage loan, a bank sold bonds to third parties whose mortgages were precisely their guarantee, i.e., to investors. This is where Fannie Mae steps in, paying the bondholder the money that the borrower did not pay or the difference for a price lower than the value of the loan when the given property is sold. They, in turn, secure themselves by ‘picking’ part of the monthly payments that they save as a reserve and guarantee for such scenarios in which the borrower fails to service the loan. For this reason, the investor, or the owner of the mortgage bond, believes that there is no risk for him unless the two agencies go bankrupt.

The financial monster has slipped out of control

After some time, Fannie Mae and Freddie Mac warmed up to the whole story and expanded their business to buying the very bonds they guaranteed, using borrowed money and earning on the difference in interest rates between the bonds and what must be paid for the loan. Somewhere in that turmoil, when the money began to smell everywhere, banks started selling bonds without the guarantees of Fannie Mae and Freddie Mac. And then last year the well dried up, money disappeared, and the house of cards began to collapse, and people slowly began to realize that the government guarantees they were convinced existed – did not. They were not there, although a large number of people, even market players, simply did not understand this, while on the other hand, these agencies had a range of benefits and were exempt from taxes and other obligations that allowed them strong growth.

Of course, the U.S. government is not entirely without responsibility for the crisis that has arisen, as it has long encouraged the development and strengthening of these agencies in an effort to facilitate access to housing loans for broad segments of the population, but it forgot to monitor its monster more carefully. This example vividly illustrates how much the financial monster grew and slipped out of control at one point, as too many players and intermediaries began to appear, the game grew out of control, and everyone acted as if there was no risk. Far more concerning is the fact that this is just a smaller segment of a much more branched and imaginative financial playground on which the whole world plays and in which there are a number of even more sophisticated mechanisms with only one goal – to reap as much fictitious money as possible, (here it is evident how such a system is unaware of the real economy) and supposedly secure their investment.

Such insurance simply does not exist. The decline of the economy and payment capabilities must also reflect on the operations of the financial sector, which still does not exist in its own world separate from reality. On the other hand, it is not entirely crazy to assume how aware various brokers and little managers are of the fact that the ordinary person, the eternal taxpayer, ultimately has to pay for their playing with other people’s money, whether he wants to or not. The law of July 30 of this year allowed for an increase in the federal government’s maximum borrowing from $800 billion to $10.7 trillion precisely to provide the government with greater opportunities to save the market.