Former Regulator: Move On Freddie, Fannie Now

By David S. Hilzenrath

The federal government has the power to put Fannie Mae and Freddie Mac into receivership now and should do so without delay to prevent the mortgage funding giants from digging taxpayers into a deeper hole.

That's the assessment of Armando Falcon Jr., who from 1999 to 2005 headed the agency that oversaw the companies' financial stability.

"I would force the more accurate accounting of their assets and liabilities, and that would show them to be insolvent," Falcon said in an interview.

Armando Falcon Jr. File photo by David Scull -- Bloomberg News

"The reason you have to do it now is to reduce the cost of resolving the two companies," Falcon said "We know from the savings and loan crisis that forbearance in dealing with insolvent institutions only increases the cost of resolving the failed institutions," he added.

Regulators allowed many deeply troubled savings and loans to continue taking risks in the 1980s, delaying their collapse and making the eventual bailout more expensive, Falcon said.

Today, as home prices decline and foreclosures mount, one of the big questions facing policymakers is what to do with Fannie Mae and Freddie Mac, which provide crucial funding for mortgage lenders.Together, they own or guarantee $5.3 trillion of mortgages and securities backed by mortgages.

The companies have been losing money and their share prices have plummetted this year. Congress recently authorized the Treasury Department to prop them up with unlimited amounts of government loans or investments -- if the companies consent. Such a bailout could cost taxpayers billions and wipe out current shareholders.

A veteran of Washington battles over Fannie Mae and Freddie Mac, Falcon made his comments before the Web site of The Wall Street Journal reported this afternoon that the Treasury was finalizing a plan to shore up Fannie Mae and Freddie Mac. Details of that plan were not known Friday afternoon.

Falcon, now a Washington-based consultant to banks, investment funds and foreign governments, said he has been telling clients that the government will have to take over Fannie Mae and Freddie Mac and that their stock will become worthless.

While much attention has focused on Treasury Secretary Henry M. Paulson Jr.'s options, Falcon focused on the power Congress recently conferred on a new regulator that replaces his old agency, the Office of Federal Housing Enterprise Oversight. The new regulator, named the Federal Housing Finance Agency and headed by OFHEO director James B. Lockhart III, has the authority to put the companies in receivership if any of several conditions are met. Those include the companies becoming "critically undercapitalized" or becoming "undercapitalized" with no reasonable prospect of rebounding.

Falcon said he would put the companies in receivership on a Friday; wipe out all the shareholders, both common and preferred; remove their boards and management; place their bad assets in a separate entity, and reopen the companies on a Monday under government ownership. Backed by the full faith and credit of the government, they could borrow money at lower interest rates and pass that savings to consumers, Falcon said.

Though the Treasury would need the agreement of the companies to intervene, the agency can act unilaterally, Falcon noted.

Fannie Mae, based in the District, and Freddie Mac, based in McLean, have said they don't need government intervention. In a recent appearance on the Diane Rehm Show, Fannie Mae chief executive Daniel H. Mudd was asked "how in the world" he can make up the lost stock value. "Well, we're going to make that up by continuing to operate the business," he said.

Fannie Mae and Freddie Mac "will never agree to get taken over and will string [Paulson] along until a new administration takes office," Falcon said by e-mail.

Spokesmen for Fannie Mae, Freddie Mac and Lockhart declined to comment for this story.

Falcon, a Democrat, worked on savings and loan issues as a member of the House Banking Committee staff. He faced criticism in 2003 when, shortly after OFHEO gave Freddie Mac a favorable review, the company disclosed major accounting problems. Falcon later initiated a probe of Fannie Mae's accounting, which found that the company flouted rules to inflate profits and bonuses.

Though some Fannie Mae supporters in Congress denounced him for making such accusations, the company ultimately admitted it had overstated profits by $6.3 billion and reached a $400 million settlement with the Securities and Exchange Commission.

In interviews this week, Falcon took issue with the companies' current accounting, saying they have taken only small writeoffs in relation to their billions of dollars of paper losses on mortgage-related investments. The companies have refrained from taking a larger hit on the grounds that they expect the investments to recover their lost value.

"At some point the notion that their assets are only temporarily impaired becomes a fiction and a fraud," Falcon said. "If we're not there, we're approaching it very, very soon."

Peter Wallison of the American Enterprise Institute, a longtime critic of Fannie Mae and Freddie Mac, said he doesn't think it is clear that either of the companies is critically undercapitalized, but he said a regulator's first instinct is to keep an institution alive and functioning. In the world of perceptions, "if a regulator has to declare that one of his charges has failed, that means the regulator has failed," Wallison said.

Freddie Mac recently reported that, if it liquidated its assets and liabilities at their values as of June 30, it would have been left with a negative $5.6 billion. That disclosure could give the regulator additional grounds to put the company in receivership, Falcon said. Under the new law, the regulator can do so if the company's assets are less than its obligations.

Accounting specialists interviewed for this story said there are other ways of comparing assets to obligations that would lead to a different conclusion.

By Dan Beyers  |  September 5, 2008; 5:20 PM ET  | Category:  Fannie Mae , Freddie Mac
Previous: The Weekend Movie: "7 Days In September" | Next: Dan Mudd Says Goodbye


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Not long ago, China made a thinly-veiled threat that if our government allowed Fannie Mae and Freddie Mac to become involvent, that they would retaliate against us economically. It would appear that we have become "economic hostages" who must cater to the whims of foreign nations and sovereign wealth funds. Fannie Mae and Freddie Mac are in their present state as a direct result of our government allowing Wall Street to package up real estate loans and sell them throughout the world with an implicit assurance that they would be backed by the federal government. It would appear that no one seriously thought through the fact that field laborers in So. Cal. were qualifying for mortgages exceeding $500K and the simple economic reality that real estate prices could not continue to go up forever. When there is money to be made, no one really cares about the long-term consequences. Furthermore, we have recently learned that the large financial houses outsmarted even themselves since many of the exotic deriviative products they were pushing did not even have a market value - they had to rely on computer models. The feds did not rush to the aid of investors when Enron and Worldcom violently imploded. Why should they now when a couple of badly run GSEs find themselves under water? Especially, when the majority of those holding onto worthless paper are not even U.S. citizens? To whom do our government really owe their loyalty? I believe that it is a safe conclusion that our economy was overly dependent on real estate in the past. Perhaps the feds should just get out of real estate alltogether and let private business assume the risks (and rewards). Shareholders wield more power than the general voting population, since politicians know that we can be controlled by 30 second soundbites. Besides, of all the things our government has been accused of - efficiency has never been one of them. We can only blame ourselves. Our government is AFU'd because we do not hold our representatives accountable and we allow our opinions to be swayed by cutesy t.v. ads. When all is said and done, I guess we get what we deserve. And that, my friends, is a crying shame.

Posted by: Boomer55 | September 5, 2008 8:13 PM

Looks like we (taxpayers) are about to reap more "benefits" from deregulation.

Isn't Reganomics just wonderful?!

Posted by: Clint | September 5, 2008 8:37 PM

Those who do not believe it is possible for the United States government to go bankrupt need but to consult any history text, because the truth is stranger than fiction. No doubt it seemed impossible for the Roman empire to dissolve, and yet it did. "Once a century" hurricanes now occur regularly, the water is no longer fit to drink, and the air is poisoned, yet so many disbelieve that America is headed toward bankruptcy. Don't forget that bankruptcy proceedings involve seizing collateral- what will the Chinese want? Mineral rights? Natural oil and gas reserves? Timber? Land? What makes you think they won't just come and take them, like Russia took parts of Georgia? America's present day "leaders" are leading us to Armageddon. No one cares- the candidates have charisma, and a nice smile like John Edwards- probably smiling whiles he bumps your wife. Americans need to wake up, and take back this country before it is to late. The day elections became modeling contests, instead of contests of balance and wisdom, was the day America started down the tubes.

Posted by: David E. Connolly, Jr. | September 5, 2008 8:42 PM

Why move to preserve the shareholder's value? If the entity is insolvent then it's stock value should be $0. If it is still viable let it run. Removing the risk from investment by artificially proping up value has long term consequences that far outwiegh this short term benefit.

Posted by: Ken | September 5, 2008 9:51 PM


If China ever actually uses military means to seize anything, that could wind up in a nuclear standoff. (Both China and US have nukes and presumably know how to use them). So they're going to have to use diplomacy to resolve the issue (and that could have weird effects on both countries. We might attempt to withdraw capital from China, or China might try to kick us out, both of which run the risk of a Chinese recession - which would make the Chinese government look bad. So we and China are both in a pretty tight spot here.

Posted by: Someone | September 5, 2008 10:30 PM

sometimes having a low paying job and holding federally tax free state bonds has its rewards. glad i won't be footing the bill of yet another example of mismanagement.

Posted by: low income | September 5, 2008 11:25 PM

Several days ago a friend and I were wondering if James H. Kunstler got
it right about Fannie Mae and Freddie Mac, or whether they would succeed in muddling through, like the politicians and talking heads were saying. They all proclaimed that the government would not have to do a take-over, that Fannie+Freddie could sell stock and raise the needed cash to cover their losses.

Well, it's official right now -- just came out in the NY Times, the Washington Post, and Bloombergs. The gov't is taking over both of them. The stockholders will get wiped out, and the US govt will guarantee all of the loans and mortgages that Fannie/Freddie are holding.

But just 2 weeks ago, Fannie Mae sold 3 billion dollars worth of new stock. I guess that stock is now worthless. Somebody is mad as hell, I guess. You really can't trust any of those guys, or believe anything that they say. Three billion dollars down the drain in two weeks?

The criminals who are running high finance aren't just hurting the little guys now -- they are hurting everybody. When you deregulate banking, the big criminals steal all of the money. Why is that so hard for some people to understand?

Posted by: Terrance H. | September 6, 2008 12:31 AM

totally agree! if you have a low paying job that is safe from downsizing, you are good to go in this type of asset deflationary economy. the tax hike will go to those that earn more.

Posted by: low income 2 | September 6, 2008 1:21 AM

Fannie and Freddie will have their friends in Washington protect them of what is left. Just wait and see. The value of common and preferred stocks may be more than assumed. Do not underestimate the propensity of power brokers to protect themselves before the average guy on main street. This has less to do with China than indulgence by a public that spends beyond its means , albeit encouraged by free enterprise government. China has virtually no national debt and net creditor with high savings rate although per capita GDP is low. This is not by accident but by design and habits. Maybe US wants to teach China about the "joys" of reckless spending. The other really big players are Japan and Mid-East oil rich states waiting in the wings to buy US on the cheap.

Posted by: Basil | September 6, 2008 5:23 AM

@Boomer55, while what you say is true, you fail to grasp the ramifications of antagonizing the Chinese, Russians, Indians, Japanese and the petrodollars. They have collectively invested trillions in the US. If they start to pull out their money, the US economy will tumble like a rock slide. It is more important to appease them than the investing American public. If the US is seen as an iffy investment destination, the flight of capital will be enormous.

Posted by: Nathan | September 6, 2008 10:09 AM

The writing is on the wall and has been for some time now. The US, as the financial powerhouse is surely dying. Call it decadence, call it greed and call it funny-money economics. We are no longer in the cutting edge of anything. In fact, most corporations now prefer having asian CEOs and CFOs. They seem to know a thing or two about running large corporations that we don't. Our education system is a shambles. Our kids are busy celebrity watching and date-hunting that they cannot hold a candle to the bright, educated kids from India and China. Like every other civilization before us, our excessive prosperity will be our undoing. Well, it was fun while it lasted. Adios.

Posted by: David S | September 6, 2008 10:14 AM

Another example of what eventually happens when the nanny state decides to intrude into what should be commercial interests. Where does the constitution authorize the government to be in the mortgage business? Any fool that thinks the bureaucrats and their empire building "team leaders" are better managers than private enterprise is very uneducated. What the government is authorizsd to do is be an impartial referee and keep the game fair...they are refs..not players. All the government should provide is an environment for business to operate within that is free from cheating, bullying, manipulating and stealing. The function of government is to protect the people, not run their lives,or business.Small efficient honest government shopuld not be a dream..enforce our constitution and treat all special interests, rich or poor, with indifference and disdain.

Posted by: roneida | September 6, 2008 1:33 PM

I guess that all the talk and action about privatization in the early 80's and the anti-regulatory movement that swept the land is a great idea if uncle sugar is there to give all you rich cats socialist aid. Why don't you get all that profit that you have made since you have went private and put it back into these companies to make them solvent. Is this the new socialism, where one can take big risks without government intervention and as soon as things go south the government minimizes your risks and saves you.
Our country learned this lesson already with the great depression and the people that supported neo-classical economics are totally wrong. We have already learned that lesson. I do notice though that some people made billions on this debacle at the expense of the rest of us. Maybe they should shovel some of those profits back into these companies so that they don't go broke. Maybe the government should insist on it!

Posted by: MarkG | September 6, 2008 2:36 PM

God will save the ignorant from disaster, just ask any bible thumping evangelical moron. The founding fathers removed religion from governance for a very good reason. Those who believe in fairy tales are prone to believe almost anything you tell them as long as you make it biblical in context. Reality dictates that we are now well into the fall of the American Empire due in total to the management of the republican religious radical machine and it's constant repetition of distorted statistics. When punishment for abuses of power are left to the "higher power of God" then there is no way to prevent the current abortion we are now suffering through under the trash from Texas and the great white lawyer hunter soon to be replaced by another incarnation of Jim Jones and the peoples temple gang.

Posted by: anOPINIONATEDsob | September 6, 2008 4:04 PM

I'm really tired of the feds bailing out the rich, letting the small guys take the hit. Execs get richer, folks get laid off, and businesses feed off the government.

Posted by: John | September 6, 2008 10:43 PM

No doubt Congress will pull a King Solomon and make a public purpose mortgage guarantor company( perhaps an expanded Ginnie Mae) and privatize the remaining Fannie and Freddie Mac to handle non-public purpose mortgage pools.

My question is: what guarantee do we have that the government will not have to bail out the private Fannie/Freddie entitiies? I doubt there will be any.

Posted by: DickD | September 8, 2008 1:38 AM

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