Slowly working its way through Congress is the “reform” of Fannie Mae and Freddie Mac – the government-sponsored enterprises (GSEs) that subsidize the home mortgage industry. Whether the federal government should be involved in mortgages and to what level headline the debate. But lurking beneath the surface is another fight with arguably more important consequences.
The specific dispute is about whether investors in Fannie and Freddie stock should receive compensation or be zeroed out. But the real issue is whether the federal government should keep its promise that these stocks were safe investments or whether the principle of pure expediency – rampant in the Obama administration – will triumph yet again, with the federal government welshing on its promises.
In this debate the federal government is taking advantage of the confusing nature of these shares. The public thinks shares in Fannie and Freddie are like any other stock. For example, if you buy Alcoa, you are well aware you are taking a risk. Alcoa could go up, go down, way up or way down – and you are on the hook. But, Fannie and Freddie were not normal shares. The federal government provided an implied guarantee to the shares.
This implied guarantee was more than a nod and a wink. Financial institutions across the country held preferred shares as part of their core capital structure. The fact that federal regulators approved and even encouraged these investments was a loud and clear signal to all investors that the equity in Fannie and Freddie was backstopped. In contrast with an Alcoa, where no federal regulator would have ever allowed Alcoa to be part of a bank’s core capital.
For the Treasury Department and the Obama administration to now lead people to think Fannie and Freddie shares are just like any other stock, is disingenuous at best. More accurately, it is an outright promise-breaking fraud. Make no mistake; Fannie and Freddie were undeniably a rat’s nest of bipartisan corruption and double-dealing for years. But no bureaucrat or politician from either side of the aisle told local banks and investors they could not rely on the stock.
And, there have been real costs beyond investor losses. Research conducted by Federal Reserve staff admits that arbitrarily wiping out the value of these shares cost over $8 billion in direct losses and caused the failure of 15 community banks. Additionally, in the just the first three months after the takeover, an estimated $4 billion in lending was not conducted solely due to weakened capital structure.
What has this arbitrary decision ultimately cost the economy in lost jobs and output? It could easily be in the tens of billions.
But what does the Obama Treasury Department care? People fail to understand the real ideology behind the Obama administration is one of pure expediency and political advantage. Rules only exist to serve the administration’s ends. When the rules become inconvenient, change them or ignore them. Wiping out individual investors, community bank capital and undermining faith in the financial markets simply doesn’t matter if the administration can grab profits to help mask the runaway federal deficit.
What the Obama administration does not realize (or doesn’t care about) is how much of an insidious thing the principle of expediency is. When you do it once, it gets easier and easier to do it again. Is this what we are going to accept from our government? A government where the rules only apply until it’s convenient to ignore them?
It’s easy, and profitable at first. But the decay to the economic and political system builds and builds. If you want to see an endpoint, just consider what the Peronist cult of personality, expediency, and clientilism has done to Argentina.
Decay and decline start one step at a time. But recovery and restoration also start one step at a time. Congress should step up and force the Obama administration and Treasury to keep the promises made to banks and investors and not zero out Fannie and Freddie shares. The alternate is to continue the corrupt policy of expediency.
We should, however, consider the bright side of this mess. The Obama administration is providing us all with an important teachable moment: You can never trust the federal government.
[Disclosure Note: The author has not owned and currently does not own any shares of Fannie Mae or Freddie Mac.]