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Rule of Law for me but not for Thee

Article by Ike Brannon April 28, 2014 //   5 minute read

Should the government give different protections to different classes of property owners based on a politician’s ability to demonize them? The Senate Banking Committee may soon weigh in on this matter when it considers a proposal to reform the mortgage-finance market on Tuesday.

The question arose in the context of the government bailout of Fannie Mae and Freddie Mac. The terms of the 2008 conservatorship imposed upon them gave the federal government just less than 80% of the stock in the two entities, with the private shareholders keeping the other 20.1%

For the first couple of years of the conservatorship, Fannie and Freddie posted substantial losses as many of their failing investments were wound down, but by 2012 real estate prices had begun to rebound, along with their profits.  Profits from Fannie and Freddie totaled nearly $100 billion in 2013, amped by a few one-time accounting changes, and this revenue surge played no small part in allowing the Obama Administration to declare victory over the deficit, which fell to a post-crisis low of “just” $657 billion.

As it became clear that Fannie and Freddy had returned to their former status as cash-generating machines, Treasury peremptorily changed the terms of the conservatorship: rather than content itself with a 10% dividend and the market value of its 80% share of the two entities, which it set forth when it created the conservatorship, it laid claim to the entire net worth of the two, in essence rendering the private stock worthless.

The Treasury could squeeze out the private investors, they averred, because a good share of the stock the government doesn’t possess is owned by hedge funds--and they’re to blame for the financial crisis. Since there’s no more need to milk them for campaign dollars why not stoke up populist outrage at their expense?

Hedge funds do possess an outsized share of the stock of the two: Before 2008 Fannie and Freddie were considered safe investments, and regulators often pushed community banks to stock up on their preferred stock in order to shore up their balance sheet, most of whom abandoned the stock after the conservatorship. But other investors looking for safe investments and steady dividends bought Fannie and Freddie stock through the years and some of them have held onto their stock, among whose numbers happened to be Ralph Nader--who’s pissed. He remains a shareholder, as do some small banks that failed to heed the appropriate warnings to ditch their stock and take what they can get.

And that puts the administration--and certain Democrats--in the awkward position of supporting the confiscation of wealth from hedge funds but not objecting to the fleecing of community banks and the paragon of consumer protection.

Their answer, apparently, is to try to squeeze out the hedge funds while buying out the rest of the shareholders. At an event put on by Ralph Nader’s group, AEI scholar Jim Glassman reported that the office of senator Mark Warner--author of one of the GSE reform plans currently working its way through Congress--tells constituents who call on the matter that this is precisely what he hopes to do.  

When the answer to “what is it worth” is “it depends on who owns it”, a crisis in the rule of law is afoot.

On Tuesday the Senate Banking Committee will mark up and vote on the Johnson Crapo bill and, most likely, send it on for a vote by the full Senate. The bill as it currently stands contains language that would essentially codify the status quo for the non-governmental stockholders.  If the bill that gets voted out of the committee keeps that codification, it would not only going to have trouble passing the House of Representatives but would also send a very ambiguous message to anyone investing in the U.S. Caveat Emptor.

Ike Brannon is a Senior Fellow at the George W. Bush Institute and President of Capital Policy Analytics, a consulting firm based in Washington D.C.

Image by Katie Harbath