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On May 21, President Trump said that he was giving “serious consideration” to privatizing the two giant entities that purchase mortgages on the secondary market, Fannie Mae and Freddie Mac. This could revive rampant speculation in the system of securitization of mortgages, which was the primary factor in the financial collapse of 2008. It would create a bonanza for hedge funds and private equity, which have spent nearly two decades setting up a lucrative trade. And despite the supposed “privatization,” the sums of money are so vast that government once again would be on the hook for a bailout, should the speculation cause another collapse.
In announcing the idea in a post on Truth Social, Trump himself let the cat out of the bag. “I am working on TAKING THESE AMAZING COMPANIES PUBLIC [selling them off on the stock market],” he wrote, “but I want to be clear, the U.S. Government will keep its implicit GUARANTEES.”
No! Either companies are private and accountable to markets, or they are part of the government, guaranteed by government and closely supervised by government. But private companies with government guarantees are the worst of both worlds and a bonanza for speculators.
The details get a little wonky, but the story is central to understanding both how deregulation and privatization of finance invites cycles of speculation and collapse, and how Trump is pouring oil on the flames. It epitomizes the corruption that predates Trump, and has intensified under his rule.
Fannie Mae, the nickname for the Federal National Mortgage Association (FNMA), was created in 1938 as part of the New Deal’s efforts to stabilize and revive the nation’s mortgage system. The original FNMA was a public entity. The idea was to set standards for mortgages, and to buy them from banks or savings institutions, in order to replenish their funds to make other mortgages. FNMA itself was financed by the U.S. Treasury. As a pure public institution, the original FNMA was clean, simple, efficient, and scandal-free.
In 1968, with the Vietnam War increasing the national debt, the Johnson administration decided to take Fannie private to get its debt off the government’s books. The tacit government guarantee and the high standards remained—for a while. Fannie, though nominally private, was not a profit maximizer and it did not buy substandard mortgages.
This was also true of the other quasi-public purchaser of mortgages, the Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac), created in 1970 by the Federal Home Loan Bank System to complement Fannie Mae. Both organizations buy mortgages from lenders, package them into securities, and sell them to investors.
Private companies with government guarantees are the worst of both worlds and a bonanza for speculators.
The plain-vanilla prudence from Fannie and Freddie would change. During the housing bubble, more complex mortgage securitizations by private investment bankers were implemented at wide scale. The sleepy secondary mortgage market turned into a big, speculative profit center, with private actors taking on more risk with shakier mortgages. The executives of Fannie, meanwhile, began paying themselves high salaries, and worried about losing their market share. So Fannie emulated the speculators.
By the mid-2000s, Fannie was buying a lot of sketchy securities backed by subprime and other exotic mortgages. As the economy began to totter, Fannie itself was soon underwater.
The authoritative report of the Financial Crisis Inquiry Commission found that in the run-up to the 2008 collapse, Fannie and Freddie were grossly undercapitalized. They owned and guaranteed $5.3 trillion of mortgages, with a capital ratio of less than 2 percent. This would have been risky enough in the plain-vanilla era. But as former Treasury Secretary Hank Paulson testified to the commission, when he was briefed on Fannie and Freddie upon taking office in 2006, he immediately realized that they were “a disaster waiting to happen.”
As private securitizations began to falter, Fannie and Freddie soon became “the only game in town” for secondary mortgage purchases. By 2006, they were guaranteeing about 70 percent of all subprime loans. But instead of shoring up their capital, their executives sought relief from regulatory constraints as a way of making more profits. The two begin incurring large losses in 2007.
Congress passed emergency legislation, the Housing and Economic Recovery Act (HERA), in July 2008. Among many other provisions, HERA established the Federal Housing Finance Agency (FHFA) and authorized it to put Fannie and Freddie into government conservatorship. By September 4, Paulson acted to place the two into conservatorship. The total cost to the government was around $200 billion, but Fannie and Freddie have paid back their earnings to the government since then, compensating well beyond the original outlay.
The conservatorship, still in place, has worked well. It has operated as a de facto nationalization of this critical piece of plumbing in the mortgage market. Fannie and Freddie returned to their business of buying and securitizing mortgages, mainly of the plain-vanilla variety. There have been no more losses or bailouts. And with that government imprimatur, they have been able to help standardize loan terms and even building standards for multifamily units, which they dabble in, serving a key regulatory function.
The two government-sponsored entities (GSEs) currently hold about $7 trillion in mortgages, or about half of all single-family home mortgages. Releasing them from conservatorship could allow all the past abuses to return.
A prime architect of the privatization idea is Bill Ackman, one of the sleaziest hedge fund operators and a close ally of Trump in the assault on Harvard University. Ackman’s Pershing Square Capital Management and other hedge funds have invested heavily in Fannie and Freddie stock since 2010 or so, betting that the GSEs would be spun out to the private markets. Trump’s team considered it in his first term but failed to do so. But the stocks soared after Trump’s more recent announcement, meaning the long-awaited payday may yet come in.
This piece for the American Economic Liberties Project by our friend Bharat Ramamurti raises several questions about how release from conservatorship would affect the availability and cost of mortgage credit. The initial windfall would be to Wall Street companies, like Pershing Square, that already hold Fannie or Freddie stock.
Moreover, as Georgetown University’s Adam Levitin explains, now that Trump has said out loud that the companies have a guarantee, under typical accounting standards they should be considered part of the government and on the government’s books, adding trillions of debt and immediately taking the U.S. over the debt limit. Legislation may be needed to sever that explicit guarantee, which could imperil the mortgage market by raising the potential for deep losses.
The most important risk is that a reversion of Fannie and Freddie to pre-2008 rules would set off another cycle of investment banking companies, hedge funds, and private equity firms creating and speculating in exotic and opaque mortgage-backed securities, with Fannie, Freddie, and the taxpayer once again holding the bag. It’s part of a larger pattern of Trump deregulation of financial markets, ignoring the historical lesson that these ploys invariably end in economic carnage for ordinary people, and government bailouts.
