UPDATE: 09-11-08 IT IS IRONIC THAT JAMES LOCKHART STILL HAS A JOB

According to Reuters ...

"James Lockhart, director of the Federal Housing Finance Agency, told lawmakers that he had found 'significant and critical weaknesses across the board' by August when the government was mulling how it might stabilize the companies, which are critical to the U.S. housing market."

"Deepening anxiety about the housing market and soured mortgage investments have damaged global credit markets in recent weeks. Lawmakers are now hammering out details of a rescue plan that would see Washington buy up to $700 billion in troubled assets. Lockhart said that Fannie Mae and Freddie Mac may choose to shed some of their mortgage securities under that plan. 'In theory, some of their securities could be purchased as part of this program,' Lockhart said. 'They will have the ability, like other people, to participate.'"

"When asked what would be fair compensation for the chief executives of Fannie Mae and Freddie Mac, Lockhart said the current chiefs should receive compensation somewhat in line with the heads of other financial services companies. 'I would expect to pay them over a million dollars a year,' Lockhart said." <Source: GSE nationalization was unavoidable: regulator | Reuters.com>

According to my research, the GSE's engaged in accounting tricks to hide their true condition from Lockhart and that it was Morgan Stanley that discovered the real issues and problems. Second, Lockhart does not seem to get the fact that Fannie and Freddie are not like other people -- they are now government agencies." And as for compensation, why the hell should we pay the heads of government agencies more than the President of the United States or the Secretary of Defense -- both of whom have far greater authority and responsibility? 

It is my opinion that Lockhart should be replaced as soon as possible. Other than issue press releases. I cannot find a single outstanding accomplishment relating to the regulation of the GSEs which would justify his continued existence as the head of the FHFA (Federal Housing Finance Agency). 

UPDATE: 09-11-08 WHAT WERE MORGAN STANLEY'S FINDINGS

Although the Morgan Stanley report was said to be confidential, rumor has it that at least one of the two GSEs, Fannie Mae and/or Freddie Mac may have used a legal  accounting trick to mitigate their reported losses and when they computed their capital requirements. Some people are saying that it is possible that agressive accounting treatment of deferred tax assets (tax-deductible losses carried forward from prior periods which could be used to reduce future tax liabilities) may have been used in the capital requirements calculation. Thus giving a legal, but somewhat flawed view of the financial condition of the GSE.

I continue to wonder why Bush crony James Lockhart continues to head the FHFA (Federal Housing Finance Agency) when his material misstatements to the public regarding the GSE's core capital requirements and overall soundness were so blatant as to make me wonder if this is just another Bush crony in the Alphonso Jackson or Alberto Gonzales mode: personally loyal to the President rather than to the institutions which they head? I have very little faith in Lockhart's ability to solve the GSE situation -- whether they are a government agency, a quasi-public entity or will be totally privatized. In this situation, I would probably ask Representative Barney Frank for an assessments of Lockhart's current ability to lead the agency in a transition period.

It is believed that everything is now on hold for both the Administration and Congress -- with all parties willing to leave it to the incoming Administration and a new session of Congress.

UPDATE: 09-08-08 A GLIMPSE INTO THE FUTURE?

• It appears that Fannie Mae's and Freddie Mac's stock were in a freefall and it appears that it will be delisted from the New York Stock Exchange since they are now "penny stocks."
• In addition, it appears that the Treasury's action is a stop-gap until the matter is more fully resolved by the incoming Administration and Congress after January's inauguration.
• It is unknown, at the time, whether or not Fannie's and Freddy's extensive lobbying activities have ceased and the departments scheduled to be discarded. Look for heavy special interest lobbying when Congress resumes next year.
• The major political players promise to be  Fed Chairman Ben Bernanke, Senators Chuck Schumer, Christopher Dodd and Richard Shelby; Representatives  Barney Frank and  Spencer Bachus.
• It appears that a McCain Administration could have additional insight since McCain's former national finance chairman in 2000, Herb Allison, is now the de facto CEO of Fannie Mae. A handoff from the Bush Administration to the McCain Administration? Allison was tipped to be on the short list as Treasury Secretary in a 2000 McCain Administration; thus pointing out his financial expertise and political influence.
• It is still possible that the Fannie and Freddie will be broken up into smaller units and sold as independent non-government entities as per Alan Greenspan's suggestion to reduce systemic risk to our national economy and the mortgage industry. However, considering the large sums of money that are flowing through Fannie and Freddie, look for Congress to attempt to rob the piggybank for their socially-engineered "community" housing activities before letting loose of the golden goose.

UPDATE: 09-07-08 THE QUESTION "WHY NOW" MAY BE ANSWERED

According to Bloomberg News ...

"Treasury Secretary Henry Paulson decided to take control of Fannie Mae and Freddie Mac after a review found the beleaguered mortgage-finance companies used accounting methods that inflated their capital, according to people with knowledge of the decision."

"Morgan Stanley, hired by the Treasury to probe the companies' finances, concluded the accounting, while legal, enabled Freddie, and to a lesser extent Fannie, to overstate the value of their reserves, according to the people who declined to be identified because the findings are confidential."

And we were all wondering why Morgan Stanley would accept a government contract to perform the services essentially for free, charging only $95,o00 for expenses, and why Hank Paulson, did not choose his old firm, Goldman Sachs to provide the same services?

Original Blog Entry ...

Why did the government take over Fannie Mae and Freddie Mac?

In a last ditch effort to prevent the current housing and mortgage crisis from further spiraling into a true economic depression, Henry Paulson’s Treasury Department and Ben Bernanke’s Federal Reserve have apparently worked out a method that they hope will save the economy.

Who are Fannie Mae and Freddie Mac and what do they do?

Both Fannie Mae and Freddie Mac are considered Government Sponsored Enterprises. That is they have a special status with the government which allows them to borrow money at preferential rates and then make money on the spread between the borrowed rate and the rate of return they generate on their operations. They are quasi-governmental in that they can act like a private organization, making a profit, selling stock to raise capital, pay dividends … but are responsible to Congressional mandates and government oversight. For a complete explanation of the nature of Fannie Mae and Freddie Mac, we suggest that you click on each of the enabled links which will take you to a comprehensive Wikipedia entry.

For those who do not know Fannie Mae and Freddie Mac, their activities, while extremely technical and complex, are fairly easy to understand. First, they provide a secondary market that purchases mortgages from lenders in order to allow the lender to use the capital from the mortgage sale to offer more loans to the public. Second, they bundle these loans together and sell them to investors who then earn a specific rate of return on these mortgages as the borrower continues to pay both interest and principal on their loans. And third, the act as a guarantor of mortgages. Somewhat like a large insurance company that insures your car against loss for the benefit of your car loan lender.

In this capacity, Fannie Mae and Freddie Mac insures about half of all the mortgage loans in the United States, to a tune of about $5.3 TRILLION dollars. Unfortunately, due to managerial malfeasance and market circumstances, the mandated “core capital requirements” needed to provide an actuarially sound financial underpinning of these guarantees is woefully deficient.

Unsound condition …

As with most banks which fail to maintain their legislatively and administratively mandated core capital requirements, they are judged to be in “unsound condition” and are thus involuntarily into a Conservatorship. Appointed managers will thus take over the organization’s management functions and seek the required capital to return the entity to soundness. In the process, the interim management will also undertake a restructuring of the enterprise, often removing board members, executives, department heads and others who have caused the problem or represent non-productive elements of a newly structured enterprise.

What’s next?

While we could recount the historical problems of both Fannie Mae and Freddie Mac and the recent malfeasance of their management, what may happen is purely speculative and up to the various decision-making entitites. You can be sure that the Treasury Department, The Federal Reserve, the traditional GSE oversight regulators will play major roles. And, of course, where big money is involved, the individual members of Congress and their committees will be sure to add their proverbial two cents.

With this much uncertainty, it may be useful for you to read the official announcements from each of the agencies involved. This represents the current official viewpoint of all parties concerns.

The basic outline is that the newly constituted Federal Housing Finance Agency (FHFA)  regulator headed by James Lockhart who headed the old GSE regulator, OFHEO (Office of Federal Housing Enterprise Oversight) will assume the Conservatorship of the GSEs.

As per the Treasury Department, the government will buy $1 BILLION worth of stock from each company. The stock is said to be senior preferred stock which takes precedence over all other stockholders should the enterprises be liquidated. The stock will yield a 10% return to the treasury, quarterly dividend payments and is issued along with warrants that would allow the government to assume a 79.9% stake in each enterprise. All dividends that would normally be paid  to existing stockholders would cease. The government will also have the right to purchase an additional $100 BILLION in preferred stock (probably representing the remaining portion of each enterprise) should the need arise.

Note: James Lockhart allegedly failed to do his job when he headed OFHEO. And in the past months has assured the public that the GSEs were in solid financial condition and are meeting their core capital requirements. Therefore, what the government says and does may be two divergent and separate things.

In a perfect world, someone would be charged with making false and misleading statements to the public to shore up their stock. I wonder if such statements by Lockhart are actionable under SEC rules and regulations or if he gets a pass due to the fact that he works for the government?

The FHFA has announced that they will be removing the CEO’s of Fannie Mae, Daniel Mudd, and Freddie Mac, Richard Syron. Both are staying for a transitional period and both have received multi-million dollar compensation packages while their organizations have posted BILLION dollar losses. It remains to be seen exactly what goodies are contained in their golden-handshake severance deals.

Now comes an unpleasant surprise. It seems that the former Vice President of Merrill Lynch and Company, Herb Allison, will step in as the CEO of Fannie and the former Vice Chairman of US Bancorp, David Moffett, will assume a similar post at Freddie Mac. What angers me is that selecting someone from Merrill Lynch is tantamount to handing the henhouse over to the fox since Merrill’s activities were so intertwined with the subprime crisis and all that occurred.

Update:  A more accurate description of Herb Allison's resume ... Herbert Monroe Allison, Jr. (born August 24, 1943) was chairman, president and CEO of TIAA-CREF from November 2002 to 2008. Previously, he had been with Merrill Lynch from 1971 to 1999, where he was president and COO during the latter part of his tenure.

In addition to providing a direct capital infusion into the enterprises, the government will also be purchasing an unspecified number of mortgage-backed securities on the open market, to be managed by, as yet to be appointed, independent asset managers. I only wonder where such managers can be found: people with the industry expertise to manage such large sums of money and who have relatively clean hands when it comes to the overt and covert manipulation of securities which has resulted in this ongoing financial crisis? For those of you who may be as cynical as I am, this appears to be a ginormous government-run hedge fund – and we can’t wait to see what these managers are actually paid. Probably more than the President of the United States is my guess… as will the heads of the GSEs.

What about the banks?

We know that the FDIC has recently said that the number of banks on their watchlist moved up from 90 to 117 in the previous quarter. According to anonymous sources, there appear to be at least four large banks on this list. While we could speculate on which banks might top the list, we would be playing into the Chuck Schumer “bank run creation scenario”  named for Senator Chuck Schumer who was associated with a publicly-released letter to now-failed IndyMac’s regulator questioning their soundness. The resulting bank run by depositors pushed the bank into an “unsound condition” in which FDIC (Federal Deposit Insurance Corporation) was appointed as the conservator. So add to the GSE amount, something for the banks which are said to be close to being ruled as being in an “unsound” condition. Likewise, some of the politically-connected brokerages and possible, perish the thought, some hedge funds. An open raid on our Treasury by the Wall Street Wizards, the politicians and their special interest friends.

Who said what …

• Treasury Department, Henry Paulson’s Remarks
• Treasury Department, Preferred Stock Purchase Agreement
• Treasury Department, MBS Purchase Program
• Treasury GSE Credit Facility
• FHFA, James Lockhart’s Remarks
• FHFA Fact Sheet on Conservatorship
• Federal Reserve, Ben Bernanke’s Comments
• The Federal Banking Regulatory Agency’s Comments

Bottom line …

As with most government initiatives, they start with loft intentions and degenerate into something other than advertised. It remains to be seen on Monday (9/8/08) how this might affect the stock market, especially in relation to Fannie Mae (FNMA) and Freddie Mac (FRE) whose values have recently plummeted from a 52-week high of $68.60 and $65.88 respectively according to a quarter-end closing quote on 8/29/08.

The rest of the financial industry will wait, somewhat impatiently, for more details to leak or be announced.

What actually has happened is that the GSE’s which were created to keep their guarantees from impacting the Federal deficit and National Debt have now transferred their net losses and operational costs back onto the government’s books – and thus the citizens of the United States will, once again bail out politically-connected entities whose management exhibited poor judgement all the while lobbying Congress for relaxed capital requirements and ever larger loan caps.

Que Sera, Sera (What will be, will be)

-- steve

FANNIE MAE & FREDDIE MAC: A CONSPIRACY THEORY EMERGES (Updated)