Talking Fannie (Really Poorly)
Thanks seedz, very helpful. I’ve been spreading this to all those who, like toddlers at a funeral, have a vague sense that something really big and important and bad is going on but don’t know what or why.
Can you explain what it means for Fannie Mae to use “credits against future taxes as money”? Sounds fun!
I was Gchatting with a pal and she said I should tumbl about Fannie Mae and how the government used a Communist Bazooka to blast it into nationalized smithereens, the kinds of smithereens usually seen in Venezuela or Russia.
Without checking any of the facts, I offer here a abridged and confused history of Fannie (I would include Freddie too except it was created in the 70s to do mainly the same thing as Fannie so just for simplicity I’m only talking Fannie here). In around the late 1930s in response to the Great Depression the government decided it would be a good idea to help people own houses. So they made a mortgage entity that would buy mortgages from banks, ensuring banks continued to have enough money to keep lending for more mortgages. The banks would then use the money Fannie gave them to keep lending money to other homebuyers. So Fannie is basically a big receptacle for a bunch of mortgage loans where banks could toss their mortgages and take back money.
Then Fannie on the other side would transfer the loanership of mortgages to someone else, like an investor, who would buy the mortgages in the form of a bond and receive a fixed income (the interest rate on the mortgage) in return. Fannie would take a little money off the top for the service of packaging and guaranteeing the mortgage I guess. (That is, Fannie would sell the thing and tell the investor “Don’t worry, if the borrower defaults, I’ll pay you back myself with all this money I’m getting by skimming off the top of the income you’re making off the mortgage.”)
Fannie had help doing this by being allowed to borrow at a lower rate than most banks (I think this is because of its role as a facilitator of American homeownership). Fannie was a weird corporation for this reason. It was guaranteeing mortgage debt with the implicit backing of the government, while turning over its profits to private shareholders.
In other words, Fannie would let the people that bought its stock have money, but if it were ever to lose a ton of money so that it went bankrupt, taxpayers would be the ones holding the bag (hint: that’s what happened on Sunday).
All of this worked really well for everyone as long as most people were able to keep paying for their houses. Most of the time it even was still okay when people weren’t able to pay for their houses, because the houses would be worth more than the mortgages by the time people defaulted, so banks could just take the houses, and didn’t really lose anything because the house would be worth more than the initial mortgage anyway.
Then in the early 2000’s Fannie had bad (fraudulent) accounting of whether or not it was making money. (This is only somewhat related to what would happen now, in 2008; we’ll talk about that in a couple paragraphs.)
So that was really awful for management but after the government got wind of the shenanegans Fannie got some new guys — one of whom was actually literally named Mudd — in there to “clean house,” and then Fannie went back to securitizing mortgages. Only here’s the thing: Mortgages for a while were not good things to buy because people were a) later not going to be able to pay for them or b) going to realize that when their homes went down in price their mortgages would basically be asking them to pay more for their houses than they were worth, so they would just decide not to pay them.
[Aside: I think home prices went down because around 2005 or so people got a great idea that real estate was the place to put all their money, meaning a ton of homebuilding happened in places like Florida and California and Nevada. Well, eventually there were too many houses everywhere and no one to buy them, which meant that home prices began to decline. That’s why situation *b) happened above.]
Situation *b) was a big deal because when home prices were appreciating banks could just take over houses without having a big loss over the money they originally lent for the house. The underlying asset had increased in value, so if the homeowners didn’t want to pay for it, it was profitable for the bank to take it over.
So Fannie and Freddie in around July 2007 started to make it apparent that there were some serious issues surrounding all this mortgage debt they were buying and selling (i.e., people weren’t paying for their houses anymore). And then other people realized it, too. And so a lot of the mortgages they had bought from banks were suddenly worth bunko, and mortgage debt they were selling was likewise bunko.
And, whoops, that debt came to a little more than $5 trillion.
But wait: it got worse.
Banks had invested in that mortgage debt Fannie was selling. So when the debt went bubkis, so did the balance sheets of a great number of financial institutions. The government realized over the weekend of September 6 and 7 that Fannie would never have enough money to make good on its guarantees of the debt and would therefore have a pretty tough time ever providing more liquidity to banks, who had understandably become more hesitant to make loans after homeowners stopped paying them back.
So the government came in and said, “Alright Fannie, here’s the deal. We’re going to guarantee all that mortgage debt so banks don’t all die just because they bought these mortgages from you. We’re also going to keep straight-up giving you money so you don’t go belly-up on anybody. In return, we are going to make all the money from this business model in the future, which means your stock is worth, oh let’s say, $0.”
This was great because $5 trillion is a big number to kiss goodbye, even for a robust economy like the United States. The one problem was that a lot of banks also owned Fannie stock, which means that they will be in a lot of pain as a result of the nationalization of Fannie Mae, because on Monday shares of Fannie and Freddie each went down more than 85%.
It’s still not clear how poorly capitalized Fannie was because they were using weird credits against future taxes as money, which is pretty much an accounting fake-out (something Fannie’s used to if the early 2000’s are any indication).
So that sucks a lot, but many experts agree it’s better the government came in and started using taxpayer dollars to pay for taxpayers’ defaults on loans. But taxpayers don’t really know where their money goes anyways so they probably won’t get too sad about that unless the government loses its credit rating and places like China start calling back their loans to the government. In fact, it might have been the Chinese that pressured the U.S. government into making Fannie and Freddie Communist. At least, that’s what a guy I talked to today at work was saying.
And that is a poorly researched report on what happened with Fannie. Freddie is mainly the very same idea with some sort of distinction that I don’t know.
If anybody knows any facts here that are wrong or need clarification I would love to know that. Because I have only the most nonexistent grasp of this situation ever.
