What You Are Missing

Reader comment on: Fannie Mae and Property Rights

Submitted by John Carney (United States), Feb 23, 2015 10:42

I do think you are missing something. We're in agreement that property rights are property rights, and that the profitability of a certain piece of property doesn't diminish the rights of the holders.

The question with respect to Fannie Mae, however, is about whether the net profit sweep was a one-sided deal in which Treasury got a right to future profits in exchange for nothing at all. The government's argument all along has been that the company did, in fact, get something in exchange: namely, the right to pay a lower dividend on the government's stake when profits are slim.

In the past, when profits were inadequate to pay a quarterly installment of the 10% of Fannie's dividend, the company was obliged to draw additional funds from the Treasury's commitment. This happened a number of times prior to the summer of 2012, when the deal was changed. Each draw made further dividends more difficult to pay, since they added to the aggregate draw and therefore the amount due under the 10%.

What's more, each draw brought the company closer to hitting the limit on the Treasury's commitment. That is, closer to the point where no new money was available to bail out the company. Sometime before they hit that limit, there certainly would have been a market crisis, as no one would purchase the securities issued by the companies if they believed they might lack the capital to support them. Since the company's capital is almost exclusively the government backstop, keeping that at a healthy level is the key to its survival.

The 2012 deal preserved the backstop from being eaten away by the need to draw down to pay the 10% dividend. It means that rather than taxpayers always receiving 10% from the company, taxpayers can receive less when profits fall short. In exchange for accepting the risk of lower payments in tough times, the Treasury gets potentially higher payments in good times.

The enormous accounting driven profits of 2013 obscured this reality. Many believed the companies were now so profitable that there was no chance they would ever fall short of being able to pay the 10% dividend. If that were true, the deal would indeed seem one-sided.

The fourth-quarter results show that this was an illusion. We had a relatively healthy housing market, where prices remained steady and defaults remained low, yet both Fannie and Freddie's profits fell short of 10% of their draws from the Treasury. So this quarter they are paying the government less than they would have owed under the original deal.

That proves both that there is a benefit to the company to the net worth sweep and that the short-fall of profits is more than a theoretical possibility. It is has happned and it is something that is very likely to happen again in the future.

There are huge differences between Fannie Mae and any other publicly held company. First, Fannie was chartered by the federal government. Second, the government was authorized by a Congressional statute to bailout the company and to put it into conservatorship or receivership. Third, Fannie still enjoys a multi-billion dollar line of credit from the U.S. Treasury. Fourth, no one would buy a dime's worth of Fannie's paper without that line of credit.

If any other company found itself in a similar situation, dependent on an explicit government backstop for its ongoing operations, then I would expect that shareholders would also receive nothing. All of the equity of Fannie was wiped out in the crisis. All that remains are the shares, which trade despite being fundamentally worhtless. None of the current holders of the pre-crisis shares contributed new captital to the company. That all came from Treasury. So the government's equtiy and backstop is responsible for all of the profits of Fannie. No one else has a claim on those profits.

I hope that clarifies why the fourth quarter results severely undercuts the argument that this is expropriation.

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Other reader comments on this item

Title By Date
⇒ What You Are Missing [661 words]John CarneyFeb 23, 2015 10:42
Bailout [433 words]AdamFeb 23, 2015 11:20
Disagree with Carney [95 words]JC criticFeb 23, 2015 16:33

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