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PAUL MCMORROW

No more Fannie, Freddie sequels, please

FANNIE MAE and Freddie Mac collapsed into the costliest bailout of the financial crisis because they nurtured impossible internal conflicts. The two government-chartered mortgage companies grew reckless and greedy during the run-up to the housing bust. They swallowed billions in toxic mortgage instruments as they chased profits for their private investors. The chase destroyed them.

Several years and $187 billion in taxpayer-funded bailouts later, America’s housing market is reemerging, and so are Fannie and Freddie. The two government-owned firms are profitable again, and Wall Street is trying to sink its hooks back into the mortgage companies. The opening is there, because Congress has punted away any plans for putting Fannie and Freddie out of business. And if the current Wall Street gambit succeeds, it could reestablish the same dynamic that helped ruin the companies in the first place.

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The current conflict centers on investor lawsuits seeking to crack open the September 2008 bailouts of Fannie and Freddie. The two companies owned or backed half of the country’s mortgages at the time of the housing market collapse, and the Treasury Department nationalized them to head off the total implosion of the housing and banking industries.

Treasury’s takeover wiped out Fannie and Freddie’s stock, which wasn’t worth anything as long as the companies themselves were worthless. The lawsuits Fannie and Freddie are fighting off now come from investors who bought the companies’ stock on the cheap at the depths of the housing bust, and are now asking the federal courts to make that stock worth something again.

Perry Capital, a New York-based hedge fund, is leading a pack of investors in seeking to overturn a key 2012 change to Fannie and Freddie’s bailout. Before the change, the companies paid interest on their bailout funds to the Treasury. But because they were broke, Fannie and Freddie would borrow from the Treasury to make interest payments to the Treasury.

The 2012 change eliminated the interest payments, and instead swept most of the firms’ profits to the government. And lately, the windfall has been significant. Fannie and Freddie, which combined to lose more than $250 billion from 2008 to 2011, have posted $130 billion in profits over the past year. The investors who bought Fannie and Freddie stock when it was worthless now want a piece of that action; they’re claiming the deal to hand all Fannie and Freddie profits to the Treasury was illegal self-dealing.

The government has argued that any profits that Fannie and Freddie produce belong to the taxpayers who effectively own the companies. Still, the lawsuits put the government in an uncomfortable situation.

More than five years after rescuing Fannie and Freddie, Washington still doesn’t know what to do with the two companies. By claiming all of their profits, the Treasury bought policymakers some time. Fannie and Freddie still underwrite a huge portion of the housing market, but if they don’t keep their profits, they can’t become a vehicle for private speculation. Perry is trying to roll back the clock, to a time when Fannie and Freddie’s government backing made money for wealthy investors.

The issue is much bigger than whether some hedge funds are able to make a bet on Fannie and Freddie’s junk stock pay off. If Fannie and Freddie stop depositing their profits in the Treasury, they’re viable private businesses again — private businesses backstopped by the federal government.

This is exactly the conflict of interest that ruined the two mortgage companies in the fall of 2008. Fannie and Freddie took huge risks in the name of making profits for private investors, and when those risks soured, taxpayers ate all the losses. Fannie and Freddie lost enormous amounts of money, not just because they covered half the country’s mortgages, but because they’d gorged themselves on subprime Wall Street bonds — bonds full of toxic mortgages that Fannie and Freddie couldn’t legally write themselves. Their subprime bond binge had nothing to do with helping Americans buy homes, and everything to do with chasing profits for private shareholders.

The conflict between taxpayer risk and private profit is on ice, so long as Fannie and Freddie have no profits to speak of. But it can only be solved by putting the companies down for good. Congress dithered and ducked the issue for years. And now, as a reward for Washington’s inaction, they’ve tempted a federal court to take the decision away from them.

Paul McMorrow is an associate editor at Commonwealth Magazine. His column appears regularly in the Globe.
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