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Minyan Op-Ed: Fannie, Freddie and Socialism for the Rich


Taxpayers on the hook for continued bailout.

The following editorial was written by Minyan James Quinn and is posted here with his permission.

September 7, 2008, the 10th anniversary of the Federal Reserve-arranged bailout of the infamous hedge fund Long-Term Capital, is now a more infamous date. This is the day that the US government chose socialism over free market capitalism.

Our elected leaders have increased the national debt from $9.6 trillion to $15 trillion, a 56% increase in one weekend.

Hank Paulson, the U.S. Treasury Secretary, seems to have a penchant for committing US taxpayer dollars on weekends. He previously arranged for the bailout of Bear Stearns on a weekend and convinced Congress and the President on a weekend to give him a blank check regarding the future of Fannie Mae (FNM) and Freddie Mac (FRE). He spearheaded the takeover of two of the worst-run financial institutions on the planet. They hold or guarantee $5.4 trillion of mortgages. James Grant, a keen financial mind, described what we are experiencing today, back in early 2007. "Capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich."

Skullduggery, Corruption, and Fraud

Fannie Mae was created during the Great Depression in 1938 as part of Roosevelt's New Deal. Its purpose was to provide liquidity to the mortgage market. For the next 30 years it operated as a government agency, with a monopoly on the secondary mortgage market. In 1968, in the midst of another fiscal budget crisis, Fannie Mae's activity and debt were removed from the annual balance sheet of the Federal Government and the agency was privatized. To provide some competition in the secondary mortgage market, Congress chartered Freddie Mac as a private corporation in 1970. This relationship with the federal government gave rise to the concept of an implicit guarantee from the government regarding their debt. This allowed these two companies to borrow at much lower rates than the average financial institution.

It wasn't enough for these two institutions to reap the benefits of their implicit guarantee. They spent $175 million between 1998 and 2008 on lobbyists to influence congressmen and senators so that their housing agenda was pushed forward and expanded. These two institutions have awful internal and accounting controls. Both companies were unable to file legitimate financial statements with the SEC for two years.

In 2003, Freddie Mac revealed that it had understated earnings by almost $5 billion, one of the largest corporate restatements in US history. As a result, in November, it was fined $125 million. A 200-page report issued by the Office of Federal Housing Enterprise Oversight indicated that the company's records were manipulated to meet Wall Street earnings expectations. The firm signed a consent order promising to improve internal controls and corporate governance.

On April 18, 2006 Freddie Mac was fined $3.8 million, by far the largest amount ever assessed by the Federal Election Commission, as a result of illegal campaign contributions.

Homeowner Bailout Boondoggle

Nicholas Taleb, while writing his book The Black Swan in 2006, foreshadowed what was to come for Fannie Mae and Freddie Mac.

"Banks are now more vulnerable to the Black Swan than ever before with 'scientists' among their staff taking care of exposures. The government sponsored institution Fanny Mae, when I look at their risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deemed these events 'unlikely'."

Democratic Representative Barney Frank, Chairman of the House Financial Services Committee, chose to blame short-sellers for Fannie and Freddie's problems when he made the following statement on April 25, 2008. Between 1989 and 2008, Fannie & Freddie contributed $42,350 to Mr. Frank's re-election campaigns.

"I believe Fannie and Freddie are better off than the market thinks. Over the long term the market is a very rational distributor of resources, but in the short term it can fall prey to hysteria. Sometimes you need to deal with that. Part of the problem is rumor mongering by short-sellers. Our hope is that just by making U.S. financial support available, we'll quiet the fears and eliminate any need for that support."
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No positions in stocks mentioned.

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