Congress Says 'No' to Fannie Mae/Freddie Mac CEO Pay Hike; Misses Big Picture
If there is an issue that has united popular indignation, Left and Right alike, excessive executive compensation surely ranks near or at the top. But the bipartisan opposition to recent pay increases for the CEOs of mortgage conduits Fannie Mae and Freddie Mac, while understandable, misses the larger point. Several months ago, these companies, which account for nearly half the nation’s outstanding home mortgage debt and which since September 2008 have operated as wards of the government, announced plans to raise annual CEO pay from $600,000 to $4 million. Their overseer, the Federal Housing Finance Agency, approved the hikes. Congress has responded with bills to roll them back. Passage and presidential signature are virtually assured. Yet what lawmakers should be doing is allowing these firms to compete, unsubsidized, in the market.
National Legal and Policy Center has visited the travails of these two companies many times over the last few years. The Washington, D.C.-based Federal National Mortgage Association (“Fannie Mae”) and the McLean, Va.-based Federal Home Loan Mortgage Corporation (“Freddie Mac”), founded, respectively, in 1968 and 1970, account for roughly $5 trillion, or close to half, of all outstanding residential mortgage debt in this country (actually, Fannie Mae began as a government agency in 1938, but was re-chartered by Congress as a corporation 30 years later). In recent years, they have bought anywhere from 50 percent to 70 percent of newly-underwritten mortgages. These publicly-traded companies are known as “secondary mortgage lenders.” That is, they do not originate mortgage loans, but instead buy them from institutions that originate them (e.g., banks, savings & loan associations) and eventually package them as bond offerings, known as “mortgage-backed securities,” to outside investors. Fannie Mae and Freddie Mac are what link Main Street and Wall Street. Their job is expanding mortgage lending liquidity. When functioning properly, this arrangement is of great benefit to the supply and demand side. Banks and thrift institutions, having received cash in exchange for unloading long-term debt, gain flexibility in how they manage assets. Investors realize a steady and lucrative stream of income. And borrowers see a reduction in their interest rates of anywhere from 20 to 50 basis points.
But things don’t necessarily go according to script. From their earliest years, Fannie Mae and Freddie Mac have operated as “Government-Sponsored Enterprises,” or GSEs. This gives them several advantages over competitors, including a granting of a $2.25 billion line of credit with the U.S. Treasury (caps in recent years dramatically rising and then being removed altogether) and exemption from state and local taxes. This implicit “too big to fail” federal backing was a key element of a national housing policy that long has promoted homeownership. On one level, this arrangement has succeeded. Roughly two-thirds of all U.S. households are homeowners. But there has been a downside. And its full effects were not realized until less than a decade ago. Armed with GSE status, Fannie Mae and Freddie Mac became an industry duopoly whose top executives and lobbyists enjoyed an unusually cozy relationship with Congress and a series of administrations. Rather than challenge increasingly stringent mandates, they went along, as the money was too good to resist. Yet the mandates were largely responsible for an eventual credit collapse and a sharp upswing in foreclosures.
Back in 1992, Congress, as part of broad housing and community development legislation, laid the groundwork for an expanded role for Fannie Mae and Freddie Mac. The law created a regulator for these corporations, the Office of Federal Housing Enterprise Oversight (OFHEO), part of the U.S. Department of Housing and Urban Development. The law imposed tighter capital standards on the two companies, and at the same time, laid the groundwork for requirements for Fannie Mae/Freddie Mac to reserve a minimum share of purchases of loans going to low-income (i.e., high-risk) borrowers. This quota-driven approach was driven heavily by black and Hispanic civil rights and community activists, and their allies in Congress, who long had been claiming that the financial services industry had been “redlining” minority communities. The industry preferred to see new opportunities for growth rather than the possibility of severe undercapitalization. Cato Institute Senior Fellow Johan Norberg, in his 2009 book, Financial Fiasco: How America’s Infatuation with Homeownership and Easy Money Created the Economic Crisis (Cato), explained:
President (George W.) Bush’s aim was to create an “ownership society” where citizens would be in control of their own lives and wealth through ownership, which would promote both independence and responsibility. But that did not just mean free markets based on private-property rights – it was the expression of a willingness to use the levers of government to treat ownership more favorably than other contractual relationships in the marketplace. One of Bush’s key objectives was to increase the proportion of homeownership, and two of his best friends in that endeavor were Fannie and Freddie.
The growth in housing production and mortgage lending, already well underway since the mid-Nineties, accelerated. Underneath the prosperity was a time bomb in danger of detonating. As more loans went to borrowers who could not (or would not) repay them, Fannie Mae and Freddie Mac – and by implication, bondholders and taxpayers – were exposed. By the end of 2007, the sum of their loans and guaranteed mortgage-backed securities were roughly equal to the national debt. High-risk “subprime” loans now constituted about one-fifth of their combined liability. So long as housing prices were rising, this wasn’t a problem because property values were the primary source of collateral. But in the event of a fall, the reverberations throughout capital markets, here and abroad, could be calamitous.
The price bubble, needless to say, burst. Signs of trouble became evident during 2007. And they would hit with hurricane force in 2008. Fannie Mae and Freddie Mac, operating with only $1.20 for every $100 in guaranteed bonds, faced a meltdown if they failed to satisfy bondholder claims. The entire economy would be in peril. Congress responded in July 2008 with legislation, the Housing and Economic Recovery Act, which among other things, created a new GSE regulator, the Federal Housing Finance Agency (FHFA), to replace OFHEO. President Bush quickly signed the law. But the liquidity crisis would worsen. The investment house of Bear Stearns already had gone under. Merrill Lynch, Lehman Brothers and American International Group (AIG) were on the precipice of eventual collapse. That September, the FHFA, with the strong backing of the Treasury Department and the Federal Reserve Board, seized Fannie Mae and Freddie Mac and placed them under emergency temporary conservatorship.
The GSEs remained corporations, but more in name than in fact. These were now de facto government agencies. Keeping them solvent, at least on the government’s terms, required Treasury Department loan bailouts eventually totaling a combined $187.5 billion. The terms of repayment were punitive. Fannie Mae and Freddie Mac had to hand over shares of senior preferred stock and warrants to their benefactors representing 79.9 percent of equity – and with no opportunity to buy back the shares. Moreover, they had to pay the government a 10 percent annual dividend. Yet around 2011, as the companies were paying back their debts, the unexpected happened: The housing market was coming back. Lenders, having greatly tightened credit standards since 2008 in the face of rising defaults and foreclosures on a scale not seen since the Great Depression, now, if ever so cautiously, were loosening them. Business at Fannie Mae/Freddie Mac was picking up as well.
The Treasury Department had taken note. In August 2012, in an effort to hasten debt collection, the department suddenly changed the terms of repayment. It issued a so-called “sweep” rule forcing Fannie Mae/Freddie Mac to surrender future profits. In the department’s own words, the sweep represented “every dollar of profit that each firm earns going forward.” The action, which superseded the “10 percent” rule, was a blatant breach of contract. Shareholders of already-depressed company stock, unable to realize a return, filed a series of class-action lawsuits. What made the regulation even more unjustifiable was that the balance sheets of Fannie Mae and Freddie Mac were improving. The companies were coming close to repaying what they had borrowed – and then some. By the close of the Second Quarter 2014, the two corporations had forwarded to the Treasury a combined $213.1 billion, more than $25 billion beyond the amount borrowed. Through Second Quarter 2015, this figure had risen to $239 billion. Yet rather than return the corporations to the market with a “You’re on your own” admonition, the federal government has chosen to lock up profits in perpetuity. Fannie Mae and Freddie Mac now aren’t as much companies as they are government-milked cash cows.
The government’s capture of secondary mortgage lending has extended to executive compensation. Part of the bailouts stipulated that Fannie Mae and Freddie Mac CEOs would be paid maximum of $600,000. At the time, the requirement made sense. By the close of 2008, the corporations not only were sustaining enormous losses, but also were still reeling from accounting scandals of a half-decade earlier.
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