By Porter Stansberry in the S&A Digest:
Oh, no. There's a new scheme for what to do with Fannie and Freddie. Grab your wallet... For years, Fannie Mae and Freddie Mac existed to guarantee mortgages. They were, in effect, government-backed insurance schemes. Unlike insuring banks that are inherently insolvent (like the FDIC does), insuring mortgages was actually a pretty good business, provided you charged reasonable fees, you insisted on good underwriting, and kept plenty of capital on hand in the event of a crisis.
Freddie and Fannie operated this way... for a while. But later, after they became publicly owned, Fannie Mae and Freddie Mac primarily existed to enrich their government overseers and their government-appointed executives. Well-connected politicians would "stop by" the company for a year or two and walk away with several hundred thousand dollars in compensation. And as you already know, Fannie and Freddie operated the largest and most lucrative lobbying machine on Earth. Everyone got paid.
This "paying" couldn't be financed solely by insuring safe mortgages. So Fannie and Freddie borrowed huge sums of money and bought up mortgages of all types - including roughly $500 billion of subprime mortgages. They made enormous amounts of money, but only because they were taking enormous risks. (They used all sorts of fraudulent accounting to hide these risks, too.) By keeping less than 2% of their balance sheet in equity, even the slightest losses on their mortgage books would wipe them out.
And as you know, that's what happened in 2008. There's probably never been a financial debacle more widely expected than the collapse of Fannie and Freddie. In fact, that was the only possible outcome since at least 2000 - as many Washington observers warned, year after year.
And now the saga takes a most interesting twist. Fannie and Freddie are now (again) owned by the government. That puts the two firms at the mercy of politics. Nonbank mortgage finance companies are being squeezed out of the business because the big banks that operated the so-called warehouse lines of credit have stopped supplying these competitors with credit. The big banks have finally wised up: Why fund your competition? Since 2006, credit available on warehouse lines has decreased by 90%. Bank of America and Wells Fargo are now making a lot more money than they used to make on mortgages because they face much less competition. That's probably good - especially considering our government is now a large shareholder in both banks.
But politics doesn't care much about profits (or the taxpayer). So now, Fannie and Freddie are being asked to create a new market for warehouse lending, all in an effort to save the nonbank mortgage companies - the very firms that were largely responsible for the decline in mortgage underwriting. There's never been a bad idea a politician couldn't find a way to use to his advantage. But the worst of these bad ideas is to combine politics with banking. It inevitably will destroy both the economy and the currency. And once it gets started, it's almost impossible to kill.
Crux note: The S&A Digest comes free with a subscription to Porter Stansberry's Investment Advisory.
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