Bailing out Zombies, Again

Fannie Mae and Freddie Mac, which guarantee about 90% of all new mortgages, have asked the Treasury Department—and thus you and me—to fork over another $13.8 billion to cover their losses incurred during the last quarter. The regular drumbeat of these billions barely makes it into the nation’s consciousness anymore. But it has added up: $184.8 billion since they were taken over by the government during Bailout Mania in September 2008. And there is no end in sight. Supercommittee, where art thou!

When the Treasury took over these two government-sponsored enterprises (GSE) in September 2008, it received senior preferred stock and a warrant to purchase 79.9% of common stock. In return, it has made a commitment to provide unlimited bailout funding to maintain their positive net worth. It’s a bailout on autopilot that will go on and on and on…. In an ironic twist, a fraction of the billions that the Treasury hands over to the GSEs are returned to the Treasury in form of senior preferred stock dividends. To claim that taxpayers are making money on their “investment?”

Fannie Mae’s net loss jumped to $7.8 billion in the third quarter. The shocker: a $4.5 billion loss on derivatives. In other words, counterparties made $4.5 billion at the expense of the tax payer. But who are they? Goldman Sachs? Hedge funds? Citi? Can someone explain to me why the taxpayer would want to bail out holders of derivatives? The aggregate bailout amount Fannie Mae has swallowed up so far is $112.6 billion.

Freddie Mac, smaller than Fannie Mae, lost $6 billion in the third quarter. Its total bailout has now reached $72.2 billion. Interestingly, in its 10-Q (PDF)  the company blames the losses on the convoluted situation it is in, as various government entities, including the White House and Congress, have been using it as an open wallet for their own purposes. The financial results…

…reflect, in part, direction we have received from the Conservator. We also have a variety of different, and potentially competing, objectives based on our charter, public statements from Treasury and FHFA officials, and other guidance and directives from our Conservator.

Fannie Mae, chartered by Congress in 1938 to subsidize the depression-era housing market, and Freddie Mac, chartered by Congress in 1970, have become zombie-monsters. “Zombies” because they’re still moving and eating up taxpayer money though they’re dead; and “monsters” because they’re huge: taxpayers are on the hook for over $5 trillion.

But those monstrous liabilities are hidden (in plain sight). Because the GSEs are considered independent enterprises, the $5 trillion is not counted as part of the U.S. gross national debt of $15 trillion, though the U.S. government is the de-facto guarantor. Off-balance sheet accounting at its best.

But whom is the taxpayer bailing out?

– Holders of GSE bonds, particularly China, which owns a big chunk of them. During the financial crisis, China got nervous and summoned Hank Paulson; understandably, they didn’t want their investment to go up in smoke. Paulson, an old China hand, knew what to do: make the American taxpayer pay for it. And not even a hint of a haircut. Of course, many banks, financial institutions, and investors who owned the rest of the GSE bonds, mortgage-backed securities, and other paper benefited as well.

– Counterparties of derivatives, to the tune of $4.5 billion in the last quarter alone.

– Banks and other owners of mortgages of underwater homes. With numerous programs, the GSEs induce homeowners to keep making payments on their inflated bubble-time mortgages, though they’d be better off walking away debt-free and letting the mortgage owner take the loss.

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