Selling Freddie and Fannie - What's the Real Point?

The Trump administration is in serious discussions to begin selling the government's stake in Freddie and Fannie. Guess who wins… again?

Illustration by Daniel Medina

The Trump Administration is seriously interested in selling 5% to 15% of Freddie Mac and Fannie Mae by the end of this year. Reuters reports all the shares of the two companies could be worth $500 billion.

“Mr. Trump asked bank executives, including Jamie Dimon of JPMorgan, David Solomon of Goldman Sachs, Brian Moynihan of Bank of America and Jane Fraser of Citigroup, to explain how they would execute a deal.” The White House also consulted Wells Fargo.

The underwriting fees will be enormous!

I can just see the figurative boners popping under the table as the bank honchos calculated the stock underwriting fees in their heads from such an endeavor, not to mention also thinking about how to cut one another out of the future deal!

I get a very strong feeling that folks like Howard Lutnick (former head of Cantor Fitzgerald, now Secretary of Commerce), Scott Bessent (former hedge fund manager, now Secretary of the Treasury), and the bank CEOs adapted their strategy. “How can we make a boatload of money with Trump?” transformed into “Let’s pitch selling Fannie and Freddie to Trump!”

Then there’s also this from the Wall Street Journal. Hedge fund managers Bill Ackman and John Paulson have huge stakes in Freddie and Fannie, which have been in government conservatorship since 2008. Ackman has about 10% of the common shares of each. Both endorsed Trump, and the Journal reports Ackman has told investors the likelihood that privatization doesn’t occur during Trump’s administration is near zero.

Two Insurance Companies that became hedge funds

Before 2008, Freddie and Fannie were public companies with an implicit guarantee from the Federal government. They had a small and insignificant regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), that was kept small and insignificant due to Freddie and Fannie’s tremendous and successful lobbying to quash any meaningful attempt at reining in the two behemoth government sponsored enterprises (GSEs).

The initial mission was to protect investors against credit losses in Freddie and Fannie’s mortgage-backed securities (MBS). That started to change in the 1990s. The GSEs became akin to giant, highly-leveraged hedge funds that were able to fund themselves with debt just slightly more expensive than Treasury debt because of the “implicit” guarantee of Uncle Sam. At their height in 2007, Freddie and Fannie managed a $1.6 trillion retained portfolio of MBS.

Brief Story Time

I worked for the Security Sales and Trading Group at Freddie Mac. In 2004, senior management decided to shut down my group. Luckily, if you could spell “mortgage,” there was huge demand for MBS professionals as a number of European banks were diving headfirst into the MBS game. Some colleagues and I ended up going to a large European bank. Just about as soon as we got there in early 2005, the bank underwrote its first subprime bond deal. I had an insurance company client who bought AAA bonds from these deals and was interested in investing. As I was about to send the client the prospectus, I noticed that all the AAA bonds were greyed out, as in not available. I went to the syndicate manager (the person who decides which bond each client gets and how much) and asked him why all the AAA bonds weren’t available.

He told me, “Oh, they’re already spoken for by Freddie Mac. It’s our first deal so we have to give all the AAA bonds to them or they get pissed off.” While I was not that deeply involved with subprime securities, I had looked at the types of loans going into these securities and was puzzled as to how such a large percentage of these huge deals were rated investment grade when the loans in the deal looked like garbage. I had no idea when I was at Freddie that the guys managing the retained portfolio two floors above us were cornering the subprime market! By late 2007 the GSEs held approximately $244 billion of subprime MBS.

Additionally, as I previously discussed in an earlier article here, the GSEs, starting in 1999 right up to the 2008 explosion, insured crappier and crappier mortgages with lower and lower insurance fees (called Guarantor Fees). Between the subprime bonds in their investment portfolios and the crappy mortgages in their insurance book, coupled with a ridiculously small amount of capital given the size of their risks, the GSEs blew up and were put into conservatorship in 2008.

What’s the point in bringing the GSEs public?

Pre-blow up and conservatorship, Freddie and Fannie were public companies with an implicit guarantee from Uncle Sam. That didn’t work. Now, after a mostly successful 17 years in conservatorship — although some would argue against the political control aspect — Trump and Wall Street want to make Freddie and Fannie what they were before, public companies with some sort of guarantee from Uncle Sam.

You think this time it’ll be different? Freddie and Fannie blew up because the number one objective was to juice the bottom line as much as possible while leaving the risk for the makers of the “implicit guarantee” — the U.S. taxpayer.

Those who blame it on things like affordable housing initiatives and the Community Reinvestment Act don’t know what they are talking about.

Seems like quite the circle jerk. How will making the GSEs public companies, with some sort of government guarantee, satisfy the many voices that call for an end to potential taxpayer-funded bailouts like we had in 2008?

Moreover, selling can have negative results for the housing market. Last week, Pacific Investment Management Company warned that selling shares in Fannie and Freddie could lead to higher mortgage rates. “Don’t fix what isn’t broken,” Pimco’s head of public policy, Libby Cantrill, wrote to clients. From a Bloomberg story on what she wrote:

She said that unless the sale can be orchestrated in a way that preserves the government’s commitment to financially support the institutions, investor demand may cool for the mortgage-backed securities that they sell. And this, Cantrill said, would in turn make home loans more expensive for millions of people. Her warning follows a recent estimate by Citigroup Inc. strategists that mortgage rates are likely to rise 0.1 to 0.2 percentage point following privatization. At the upper end, that would equate to roughly $600 a year in extra interest payments for the average borrower.

It seems to me that the only reason for the Trump Administration to do this is really to create an underwriting fee bonanza for Wall Street investment banks and make a few more billion for already-billionaire hedge fund managers.

In other words, business as usual.