During the 2008 financial crisis, public officials in Washington took extraordinary steps to contain a systemic collapse of the global financial system. However, despite the gravity of the moment and the urgency for action, Congress deliberated carefully on its actions and never wavered from its duty to act in the best interest of taxpayers.
The Housing and Economic Recovery Act (HERA) of 2008 stabilized the mortgage finance giants known as Fannie Mae and Freddie Mac with an infusion of funds from the Treasury Department and put them into conservatorship under the authority of the Federal Housing Finance Agency. The statute made it clear that the conservatorship was a temporary arrangement to conserve and preserve the assets of Fannie Mae and Freddie Mac and to restore them to a “sound and solvent” condition for the benefit of stakeholders.
That’s why it is so confounding that the federal government has asserted that it is acting within its authority as it continues a practice begun abruptly by the Treasury Department in 2012 to lay claim to revenues of Fannie Mae and Freddie Mac and use them for a variety of budget needs. What is called the “Third Amendment sweep” effectively prevents Fannie Mae and Freddie Mac from building a financial buffer for the proverbial rainy day. It is all but certain that the rainy day will come and when it does taxpayers will once again be asked to put the two entities, as Government Sponsored Enterprises (GSEs), on sound footing.
At this point, no one knows how long the conservatorships will last. Fannie Mae and Freddie Mac are back in business providing liquidity and stability to a housing market that has lagged other sectors in recovery. But that does not mean they are adequately capitalized.
Just last month, Fannie Mae’s Chief Executive Officer Tim Mayopoulos sounded the alarm over the undercapitalization of Fannie, saying “The fact that we don't have a significant amount of capital increases the likelihood that Fannie will need additional capital from Treasury at some point.” Mayopoulos was also unsparing in his description of why the GSEs were undercapitalized, adding “The GSE capital depletion is a direct outcome of the repayment terms embedded in the Preferred Stock Purchase Agreements (PSPAs) between the GSEs and the U.S. Treasury. That agreement requires the GSEs to remit 100 percent of profits, which precludes building capital."
The lack of capital at these companies that should by any definition be classified as Systemically Important Financial Institutions, or SIFIs, is putting the taxpayers at risk for future bailouts. But despite this, the government continues to strip them of all of capital.
As for the justification for this policy, in legal challenges by investors, the government has stonewalled on revealing the thinking that went into the sweep in 2012. According to media reports based on documents related to these court cases, the Justice Department considers 669 documents to be subject to various kinds of executive privilege or confidentiality agreements and thus cannot be made public in cases pending in federal courts. Even allowing for the occasional case of attorney-client confidentiality, that is a lot of documents. The government is so determined to prevent disclosure of this information that it has invoked executive privilege without even reviewing some documents.
Unlike national security interests, it is hard to construct a scenario in which the deliberation and communication of government officials as far back as seven years ago would create any sort of clear and present danger to the economy or financial markets today. In short hand, the government is saying, “Don’t ask questions. Just trust us.”
But how can we not ask questions? The “sweep” was adopted at a time when Congress and the administration were tangling over budget issues but found common ground on an expensive payroll tax cut. Maybe all of those protected documents simply explain that the government needed to make up for those revenues in one way or another. Of course, this is speculation. What was supposed to be an open and transparent administration is making it very hard to answer that question.
While Congress and the administration debate the future of Fannie and Freddie and as the courts ponder the legal issues at stake, we should at the very least get back to the terms of the conservatorship stipulated in HERA. Those terms are very clear, and require that Fannie and Freddie be restored to a “sound and solvent” condition. Instead, the “sweep” continues to use the GSEs as slush funds for Treasury and leaves taxpayers completely exposed for future losses.
Pagliara is executive director of Investors Unite, a group made up of more than 1,400 individual Fannie Mae and Freddie Mac investors.