WaPo Scoop Shows Government’s Bailout Conflicts

The Washington Post fronts a pretty big scoop on friction at Freddie Mac caused by its untenable straddling between responsibility to private investors and accountability to its government masters (I know, I know—this is not a new thing. But it’s certainly exacerbated by the de facto nationalization).

The Post reports that Freddie’s regulator/majority owner, the Federal Housing Finance Agency, has tried to suppress negative information about the government from appearing in Freddie’s financial disclosures, which it’s still required to release because it’s a publicly traded company.

But when Freddie Mac’s executives concluded a few weeks ago that they had to disclose that the government’s management of the McLean company was undermining its profitability and would cost it tens of billions of dollars, the firm’s regulator urged it not to do so, according to several sources familiar with the matter.

Freddie Mac executives refused to bend. The clash grew so severe that they threatened to go to the Securities and Exchange Commission, which oversees corporate disclosures, to secure a ruling that the regulator’s request was out of line. The company’s regulator backed down, the sources said.

That’s no good, folks. It’s clear that the government’s mandates (which it has a right to require, giving that it owns the vast majority of Freddie stock and that it saved it from bankruptcy) are going to hurt the private corporation’s “profitability”—or, more aptly, “remote chance of profitability a long way down the road.” If that’s the case, it needs to be disclosed to shareholders just like any other threat to a business is disclosed in SEC filings.

While this is boneheaded and outright wrong by the government, it shows how untenable the Obama administration’s financial-rescue plans are at their core: They rely on significant public bailouts of private-companies’ shareholders to (trying not to be cynical here) accomplish a public purpose: Preventing further economic collapse by enabling lending.

But politicians (and bureaucrats) have broad public goals, which are not what corporations are for. That’s why the premise for Fannie and Freddie was so flawed to begin with, and why it’s gotten worse now, as the Post skillfully explains:

They have been called on by the Obama administration to carry out its public policy objective of reviving the housing market by restructuring mortgages, cutting prices on home loans and taking steps to avoid foreclosure.

But the government doesn’t want to nationalize the companies, which would end their pursuit of profits and the requirement that they make regulatory disclosures for the benefit of private investors.

This ambiguity over Freddie’s status has at times also made it difficult for the company to reduce mortgage interest rates and to hire and hold on to top executives. The requirement that Freddie pay dividends to the government also increases its debt load, reducing the chances it can ever reemerge as a profitable company.

Right, and this is why so many say nationalization (real, full nationalization) makes sense. The government takes over an insolvent company, wipes out the shareholders, haircuts the bondholders, cleans up its balance sheet, fires the management, and breaks it up, spins it off, or sells it to another private company. That way the company can go back to doing what a financial corporation is intended to do: Lend money to make a profit in the best way it sees fit (within the regulations, of course!), not how a politician wants it to.

It doesn’t mean permanent nationalization—although that makes much more sense in the case of Fannie and Freddie.

But meanwhile, you get stuff like this (emphases are mine):

As Freddie Mac executives were preparing their annual 10-K financial disclosure this month, they reported that carrying out the Obama administration’s housing plan would cost $30 billion this year. That sum would have to be covered by the Treasury Department. The federal government has pledged to cover $200 billion each in losses for Freddie Mac and Fannie Mae, of which the pair have asked for about $60 billion.

The housing agency asked that the cost of the program be withheld and that the firm soften language describing how government management was undercutting profitability, according to sources.

People familiar with the dispute offered different views about why the regulator sought to prevent the disclosures. One source said the regulatory officials didn’t want to make it seem like government actions were causing big losses at the company and would require more taxpayer dollars. Another person said the officials thought that accounting rules would soon change, making the disclosure unnecessary.

Either way, that’s, well, corrupt.

The Obama plan will require Freddie Mac to modify mortgages, which entails reassessing the value of loans and marking them down to current market price. The company must then record a charge to reflect these decreased values. Based on Dec. 31 figures, Freddie Mac said it would incur “an initial pre-tax charge” of $30 billion. That number could grow as the economy declines and would have to be offset by infusions of government capital.

I’d like to see follow-up on this to name the regulators were responsible for this. Following that trail might lead straight back to the Obama White House.

Great work by the Post.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.