Carney is now stepping beyond his perch as number one blasphemy artist on the topic, replaced by Chris Whalen apparently and is now ghost hunting on other people’s blogs.
What You Are Missing
Reader comment on: Fannie Mae and Property Rights
Submitted by John Carney (United States), Feb 23, 2015 10:42
I do think you are missing something. We’re in agreement that property rights are property rights, and that the profitability of a certain piece of property doesn’t diminish the rights of the holders.
The question with respect to Fannie Mae, however, is about whether the net profit sweep was a one-sided deal in which Treasury got a right to future profits in exchange for nothing at all. The government’s argument all along has been that the company did, in fact, get something in exchange: namely, the right to pay a lower dividend on the government’s stake when profits are slim.
In the past, when profits were inadequate to pay a quarterly installment of the 10% of Fannie’s dividend, the company was obliged to draw additional funds from the Treasury’s commitment. This happened a number of times prior to the summer of 2012, when the deal was changed. Each draw made further dividends more difficult to pay, since they added to the aggregate draw and therefore the amount due under the 10%.
What’s more, each draw brought the company closer to hitting the limit on the Treasury’s commitment. That is, closer to the point where no new money was available to bail out the company. Sometime before they hit that limit, there certainly would have been a market crisis, as no one would purchase the securities issued by the companies if they believed they might lack the capital to support them. Since the company’s capital is almost exclusively the government backstop, keeping that at a healthy level is the key to its survival.
The 2012 deal preserved the backstop from being eaten away by the need to draw down to pay the 10% dividend. It means that rather than taxpayers always receiving 10% from the company, taxpayers can receive less when profits fall short. In exchange for accepting the risk of lower payments in tough times, the Treasury gets potentially higher payments in good times.
The enormous accounting driven profits of 2013 obscured this reality. Many believed the companies were now so profitable that there was no chance they would ever fall short of being able to pay the 10% dividend. If that were true, the deal would indeed seem one-sided.
The fourth-quarter results show that this was an illusion. We had a relatively healthy housing market, where prices remained steady and defaults remained low, yet both Fannie and Freddie’s profits fell short of 10% of their draws from the Treasury. So this quarter they are paying the government less than they would have owed under the original deal.
That proves both that there is a benefit to the company to the net worth sweep and that the short-fall of profits is more than a theoretical possibility. It is has happned and it is something that is very likely to happen again in the future.
There are huge differences between Fannie Mae and any other publicly held company. First, Fannie was chartered by the federal government. Second, the government was authorized by a Congressional statute to bailout the company and to put it into conservatorship or receivership. Third, Fannie still enjoys a multi-billion dollar line of credit from the U.S. Treasury. Fourth, no one would buy a dime’s worth of Fannie’s paper without that line of credit.
If any other company found itself in a similar situation, dependent on an explicit government backstop for its ongoing operations, then I would expect that shareholders would also receive nothing. All of the equity of Fannie was wiped out in the crisis. All that remains are the shares, which trade despite being fundamentally worhtless. None of the current holders of the pre-crisis shares contributed new captital to the company. That all came from Treasury. So the government’s equtiy and backstop is responsible for all of the profits of Fannie. No one else has a claim on those profits.
I hope that clarifies why the fourth quarter results severely undercuts the argument that this is expropriation.
Bailout
Reader comment on: Fannie Mae and Property Rights
in response to reader comment: What You Are Missing
Submitted by Adam (United States), Feb 23, 2015 11:20
One of the items that i think is missing is what really happened during the bailout. As I am sure you are aware the credit market seized. Very simply you have what you feel to be liquid securities that you have earmarked to pay operating expenses that become no longer liquid for a reasonable fair market value. We can all agree this is what triggered the crisis yes? Now take this to the Nth degree with all of the banks and investment banks that are undercapitalized and no longer can generate cash without selling current assets at well below reasonable fair market value all over the country and world. MBS and CDO’s are now selling at pennies on the dollar and financial institutions are boardering on solvency from the perspective of not being able to generate cash to make payroll for this simple reason. How does the Federal reserve fix the problem? They create demand at 100c on the dollar by taking over AIG and the GSE’s under the guise of them being insolvent. Now banks and other financial institutions can sell these securities back (remember the government now owned the board and senior management) at 100c and help the institutions to pay their bills until the credit market unfroze. Would this not be the biggest bang for the buck? I personally think it was genius. If you want proof follow the cash. In a normal bailout scenario the company would churn cash. If that was the case, how did Fannie manage to pay back such massive amounts of cash in 2013 and 2014? The answer is simple. The securities they purchased were written down significantly as they paid well over market price creating GAAP write down of AFS securities. Once the housing market recovered these assets appreciated in price returning the balance sheet to significant GAAP solvency. The question is where did the GSE’s generate the cash to pay back 230b in really two years? The answer is simple and obvious. They never spent the bailout funds from the Treasury. If they would have churned the cash they never could have generated this level of cash flow from operations as you so succinctly stated above.
While I would agree with you if the bailout was one of operational failure. This was a bailout of Political creation to inject liquidity into financials by purchasing their previously valuable liquid current assets for pre crisis pricing. Take a look at Q1 2009 bank earnings sometime and look at the massive trading gains. The facts are in the numbers, not in the symantics and political posturing.
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Fannie Mae and Property Rights
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John Carney reports in the Wall Street Journal’s “Heard on the Street” column:
Fannie Mae isn’t the immensely profitable company some of its biggest investors hoped it would be.
Despite a sizable increase in the fees Fannie charges for its mortgage guarantees, the company on Friday reported fourth-quarter net income of $1.3 billion, down 80% from a year earlier. Revenue fell 21% to $5.5 billion…the results severely undercut the argument that a 2012 change to the company’s bailout, which allows the government to sweep substantially all of Fannie’s profits, amounts to an illegal expropriation. In fact, Fannie’s quarterly payout to the Treasury would have been about $1 billion higher under the bailout’s original terms. And to date, the internal rate of return to the Treasury on the bailout of Fannie is an unimpressive 5.6%.
Mr. Carney’s always been a mensch to me and in general I am an admirer of his work. But I don’t find convincing his claim that that Fannie’s lower profits “severely undercut the argument” that Fannie’s profits were illegally expropriated by the government from shareholders.
The way I see it, property rights are property rights, totally independent of the future condition of the property. For example, suppose that instead of the government seizing a company and its profits in 2012, it was a carjacker seizing a car. Does it make the carjacking any less of a crime, from the perspective of the car’s original owner or from an independent observer’s perspective, if in 2014 or 2015 the car breaks down?
If the government takes a business away from its owners, it doesn’t make it any less bad if the government earned an “unimpressive 5.6%” on the investment. This is the same government, after all, that is paying buyers of U.S. Treasury bonds an even less impressive zero percent coupon.
To me, the fact that a business is earning $1.3 billion a quarter doesn’t undercut the argument that the government was wrong to take it away from its owners, let alone “severely” undercut it. If the Wall Street Journal doesn’t grasp that, let’s see how it would react if the government decided to take the newspaper’s profits away from Rupert Murdoch and other shareholders and seize them for the taxpayers. It would be an affront against property rights even if the Wall Street Journal’s revenues were to decline in coming years, and even though the Journal yields profits of far less than $1.3 billion a quarter.
Am I missing something?
Update: Mr. Carney responds in the comments section here. I love how the Internet allows this quick kind of back-and-forth.