22 July 2008

How Mae and Mac jacked up the US debt by 50% overnight [updated]

Once upon a time, the US government set up three agencies to provide home loans to people.

The Federal National Mortgage Association (FNMA) was founded by FDR to improve the liquidity of the mortgage market. It sits in between the mortgage borrower and the lender. Its job is to assume the risk of mortgage default, in return for a fee. In the 1960s, part of it was removed from the federal balance sheet by spinning it off into a private corporation. It was replaced by…

The Government National Mortgage Association (GNMA), part of the Department of Housing and Urban Development (HUD). GNMA bundles mortgages into securities which it guarantees even if the mortgages default, and then sells them on to big investors. It handles mortgages for veterans and native Americans.

The Federal Home Loan Mortgage Corporation (FHLMC) was set up in 1970. It basically does the same job as the FNMA, and was set up to provide competition for that organization.

In addition, the The Federal Agricultural Mortgage Corporation (FAMC) provides loans for agricultural real estate and rural housing.

Finally, the Student Loan Marketing Association (SLM) was set up to provide federal student loans.

Before long, people working in the housing industry came up with names that were easier to say and remember than the abbreviations the government used. FNMA became known as Fannie Mae, after the candy company Fannie May. GNMA became known as Ginnie Mae, and someone came up with Freddie Mac for FHLMC, presumably because the H is silent.

By the mid 80s, all the government agencies were called Mae or Mac; the FAMC became known as Farmer Mac and SLM became known as Sallie Mae.

Once the slang names became sufficiently entrenched, several of the organizations decided to officially change their names to the slang versions. Hence, FNMA’s logo officially says FannieMae, and FHLMC’s says Freddie Mac.

Before long, some private corporations worked out that they could suggest that they were big government-backed outfits by naming themselves something ending in “Mae” or “Mac”, without technically lying to customers. Hence a bank in Pasadena called itself IndyMac, and one in Brea called itself ResMae.

Fannie Mae and Freddie Mac have ended up guaranteeing almost half of the mortgages in the US, for a total of around $5.3 trillion. Since they were officially run as private corporations, they were able to spend a lot of money ensuring that they remained unregulated and able to invest in subprime mortgages–i.e. mortgages that the borrowers would never be able to pay back, in quantities large enough to ensure that the CEOs and shareholders of the lending companies would get rich.

So as the housing bubble has started to collapse, so has Fannie Mae’s stock price. (Check the 1 year or 5 year graph.) Freddie Mac’s stock price has been just as ugly.

Now, as already mentioned, Fannie Mae is (strictly speaking) a private corporation. However, over the years they have bent the rules and implied that the US government backs their loans. It wasn’t true, but by lending unwisely they’ve become so big that the government now thinks it can’t afford to let them fail. So last weekend, the the Treasury Department and Federal Reserve announced that they would make funds available as necessary to keep Fannie Mae and Freddy Mac solvent.

In other words, last weekend the US government effectively added up to $5.3 trillion to the national debt, which is an increase of 50%.

So ironically, by a year or two ago the situation had become so dire that IndyMac and ResMae found themselves with names that had negative connotations. ResMae collapsed last year, and now IndyMac has collapsed.

Now, in the event of a US bank’s collapse, individual consumers are protected by the Federal Deposit Insurance Corporation or FDIC. Basically, the government guarantees your money won’t disappear if the bank collapses, up to a limit of $100,000 per person.

Unfortunately, the FDIC doesn’t actually have enough money to bail out all the banks that are expected to crash. In fact, before IndyMac crashed they had funds to cover just 1.19% of the total insured deposits. After IndyMac, they dropped below the legal mandatory minimum of 1.15% coverage.

Theoretically, the FDIC gets its money by charging premiums to banks who wish to assure investors that they are FDIC guaranteed. So the problem of bailing out the FDIC will be passed on to the average taxpayer, in the form of higher bank fees. And if that fails, the taxpayer will be forced to bail out FDIC directly.

Some analysts are now comparing the fiasco to ENRON. Except this time, it’s an ENRON where the taxpayer has to bail out the crooks. So, another great victory for reduced government regulation and the free market.

Update:

On 2008-09-08, the US government formally took FNMA and FHLMC into public ownership making the bailout official. While not every loan is going to be defaulted on, the taxpayer is potentially on the hook for the entire amount; it’s on the balance sheet as a liability.

© mathew 2017