McLean, Shaky Ground

At the request of the publisher, I removed my earlier review and am reposting it to coincide with the launch date of the book.

Columbia University Press has launched a new publishing imprint, Columbia Global Reports, to produce “six short, ambitious works of journalism and analysis a year, each on a different under-reported story in the world.” Bethany McLean, co-author of The Smartest Guys in the Room and All the Devils are Here, has written the first title, Shaky Ground: The Strange Saga of the U.S. Mortgage Giants. It's an auspicious beginning for the series.

Mervyn King, the former governor of the Bank of England, told the author: “Most countries have socialized health care and a free market for mortgages. You in the United States do exactly the opposite.” (p. 9) And, he didn’t add but I will, we do both badly.

In this well-crafted if depressing 160-page book McLean recounts the origins of the housing crisis, its temporary fix, and the aftermath, which she describes as “limbo.”

Fannie Mae and Freddie Mac have been in government conservatorship since the fall of 2008, at which point they had a combined $5.3 trillion in outstanding debt. If this figure had been put on the government’s balance sheet, the public national debt would have increased by about 50%. Partly for this reason, some of their common and preferred stock remained in private hands.

Hedge funds made big bets in the darkest days of Fannie and Freddie that these two companies would become profitable again and that they would make a fortune on stock they had bought for next to nothing. They were right on the first count. The companies have paid $231 billion back to the U.S. Treasury, over $40 billion more than they got from taxpayers. But they were wrong on the second count since, in 2012, the government “changed the terms of the bailout and is now directing almost all their profits toward reduction of the federal deficit.” (p. 19) The hedge funds cried foul, filing some 20 lawsuits, alleging that the bailout’s third amendment, the one in 2012, “violates the Constitution’s Fifth Amendment: The government cannot confiscate private property without paying for it. … [T]his isn’t about the government’s actions in a time of crisis, but rather about the government’s actions after the crisis had passed. … A joke goes: ‘What’s the difference between the GSEs in the United States and Repsol in Argentina?’ The punchline: ‘Argentina settled.’” (p. 125)

The investors have been losing their battle in the courts, with one judge dismissing a suit because of a provision in the Housing Economic Recovery Act that reads: “No court may take any action to restrain or affect the exercise of powers or functions of the Director as a conservator or a receiver.” (p. 128) But they haven’t given up on the GSEs. Bill Ackman bought about 13% of the remaining 20% of the GSEs’ common stock in the spring of 2014, and in February of this year Bruce Berkowitz’s Fairholme Fund picked up nearly five million shares. They are betting that Fannie and Freddie will be revitalized.

The federal government has been trying, though not very hard, to kill off Fannie and Freddie ever since the housing crisis. At a conference in early 2015, a Treasury official said that the administration “’believes that private capital should be at the center of the housing finance system.’ And he reiterated that Fannie and Freddie had to die. ‘The critical flaws in the legacy system that allowed private shareholders and senior employees of the GSEs to reap substantial profits while leaving taxpayers to shoulder enormous losses cannot be fixed by a regulator or conservator because they are intrinsic to the GSEs’ congressional charters,’ he said.” (pp. 146-47)

But Fannie and Freddie soldier on, severely undercapitalized and on shaky ground. They seem destined to have long, if not necessarily happy, lives. And the cult of homeownership remains intact—at least in Washington, if not among millennials.