GOVERNMENT SPONSORED ENTERPRISES
Government sponsored enterprises (GSEs) are stealth recipients of corporate welfare. Instead of cash or federal tax subsidies, GSEs like Fannie Mae and Freddie Mac receive their government largesse in the less obvious form of credit enhancements.
Thanks to their extensive links to the federal government, Fannie and Freddie borrow money in the markets at almost the same rate as the U.S. Treasury, something that no competitor can come close to matching.
Like other GSEs, much of the risk of these housing finance enterprises remains with the federal government while the profits flow to private shareholders.
It is true that the secondary market operations of these GSEs provide an important service by improving access to mortgage credit by home buyers and stabilizing the mortgage market. The GSEs obtain funds from the bond markets and acquire mortgages from local lenders. The process ensures that home buyers can tap into the nation's savings pool for mortgage financing.
Could these functions be carried out without government subsidy? Could private corporations -- without links to the government and without corporate welfare -- perform the same functions? These are questions meriting close Congressional scrutiny.
The key to Fannie and Freddie's phenomenal profits and soaring stock values is the financial market's perception that there is an implicit government guarantee behind the obligations of these corporations.
There are good reasons for the financial market's belief that the U.S. Treasury and the taxpayers would be the fall guys in the event of a default. Here are some of the GSEs' links to the federal government:
• Fannie and Freddie each have a contingency fund of $2.25 billion that can be drawn from the U.S. Treasury.
• Their securities are government securities for the purposes of the Securities Exchange Act of 1934.
• Their securities serve as eligible collateral for Federal Reserve banks' discount loans.
• The securities are exempt from registration under the Securities Act of 1933.
• The Secretary of the Treasury approves the issues.
• The Federal Reserve is the fiscal agent for the issues.
• Their obligations are eligible for unlimited investments by national banks and state bank members of the Federal Reserve as well as by federally insured thrifts.
Both Fannie and Freddie are exempt from local and state taxes -- another benefit that clearly falls under the rubric of corporate welfare. (Even when the District of Columbia was struggling on the edge of bankruptcy, Fannie Mae refused to cough up a dollar in lieu of local income taxes.)
There are varying opinions about how much these links, and resulting savings on borrowings, mean to Fannie and Freddie. Fannie Mae Chairman and CEO Franklin Raines concedes there are "benefits" (he prefers the word "benefits" to "subsidies"), but does not assign a dollar figure to the government ties.
However, the Congressional Budget Office (CBO) conducted an extensive study of Fannie and Freddie entitled "Assessing the Public Costs and Benefits of Fannie Mae and Freddie Mac." CBO estimated that the credit enhancement stemming from the government links was at least $6.5 billion in 1995. [69]
According to CBO, Fannie and Freddie pass only part of that subsidy on to home buyers -- about $4.4 billion -- with the remainder of the credit enhancement subsidy pocketed by private shareholders, the corporations' executives, and lobbyists. [70] In other words, for every two dollars delivered to home buyers, Fannie and Freddie take one dollar of the subsidy for themselves.
CBO estimates that in 1995, about 40 percent of the of the earnings of Fannie and Freddie could be traced to the benefits of their government-sponsored status. [71]
These corporations have prospered under their GSE status and credit enhancement subsidies. Fannie Mae's stock appreciated 1,053 percent between 1989 and 1998. Freddie's stock appreciation was even greater, 1,260 percent. Sixteen years ago, Fannie Mae had a market value of $500 million. Today, the corporation is worth $70 billion.
In the process, Fannie and Freddie have become the dominant force in the housing finance market.
It is obvious that some of the subsidy derived from their GSE status is being used, not for home buyers, but to increase corporate power and control over all facets of the mortgage business.
Will this growing duopoly enjoyed by Fannie and Freddie stifle competition by private companies -- competition that might reduce costs and encourage innovation in a variety of mortgage products?
Not only stockholders, but officials of Fannie Mae and Freddie Mac are enriched by the subsidy.
In 1997, for example, Jim Johnson, Fannie Mae's chairman, received $5,441,232 in salary, bonuses, stock options, and other compensation. His predecessor walked away with a whopping severance package worth more than $20 million. Lawrence Small, president and CEO, received salary, bonuses and stock options of $2,948,751 in 1997. Jamie Gorelick, after leaving the Justice Department as deputy attorney general in May 1997, was the recipient of $1,850,993 in salary, bonuses, and stock options as vice chair of Fannie Mae during the last eight months of the year. She had no previous experience in housing finance.
The directors and officers of Fannie and Freddie have long enjoyed lucrative stock options. At the end of 1995, according to the CBO, executive officers and directors of Fannie Mae owned 1.6 million shares of the corporation. In Freddie Mac's case, CBO said executive officers and directors owned 695,000 shares of their corporation. In addition, the compensation agreements with officers of both corporations include generous options on hundreds of thousands of additional shares worth millions of dollars. [72]
All of the government sponsored enterprises are huge issuers of debt. Fannie and Freddie along with two other GSEs -- the Federal Home Loan-Bank System and the Farm Credit System -- issued $1.62 trillion of debt during the first quarter of this year.
The Federal Home Loan Bank System has been under fire from the Treasury Department for its borrowing practices. The FHLB System has used its ability as a GSE to borrow cheaply and engage in arbitrage by making investments in non-housing related investments.
But the champion of the arbitrage games among the GSEs has to be Farmer Mac, the newest addition to the rank of government sponsored enterprises. The General Accounting Office reports that Farmer Mac holds $1.18 billion of investments unrelated to its agricultural finance mission -- or 61 percent of its assets. [73]
House Banking Committee Chair Jim Leach calls it "unconscionable" for a government sponsored enterprise to have more than three-fifths of its assets in non-mission related activities.
"When a governmentally-privileged institution, that is established to serve farmers, abuses its status by investing disproportionately in arbitraged financial investments rather than agricultural loans, the Treasury and the Congress have an obligation to review its management practices," Leach says.
Leach is right about Farmer Mac. But Farmer Mac is but one small corner of the GSE story, particularly compared to the mammoth operations like Fannie and Freddie. All of these GSEs enjoy a special status because of their links to the federal government -- they all enjoy benefits because of the market's perception that the U. S. Treasury and the taxpayers stand behind their obligations -- a fail-safe status that leaves the federal government with the risk and the shareholders and the GSE executives with the profits.
A top-to-bottom review is needed of all the government sponsored enterprises. Are these hybrid half government, half private entities needed to meet credit needs? How well do they meet their statutory missions in specific sectors? And how much of their operations are devoted, not to their missions, but to playing the market in outlandish and unneeded arbitrage games? How much of their subsidy is used to benefit consumers, and how much is siphoned into shareholder profits and bloated executive compensation arrangements? Are existing capital standards adequate?
Addressing these problems will require confronting the familiar issue of corporate welfare beneficiaries' political influence. Some of the GSE subsidies intended to lower costs for home buyers are being diverted to build political and lobbying power designed to make it difficult, if not impossible, for the Congress to provide (or for the public to demand) proper oversight or regulatory improvements which would protect the public, increase support for affordable housing, or ensure open competition in the mortgage market.
A report by the Campaign Reform Project reveals that Fannie and Freddie are some of the largest political soft money donors -- contributing more than $900,000 in the 1997-1998 election cycle. This is in addition to contributions by key employees.
Many of Washington's premier law firms along with former Members of Congress show up on the GSEs' list of lobbyists. The lobbying lists have included Ken Duberstein, former chief of staff to President Reagan, Nicholas Calio, President Bush's Congressional liaison and Michael Boland, former aide to Senate Majority Leader Trent Lott. Former Members of Congress on the GSE lobbying payroll include Senator Steve Symms, Representative Vin Weber and Representative Tom Downey.