Financial Market Reform Legislation - Another Failed Political Class Action

As a result of the recent economic crisis and financial market meltdown, Congress and the Obama administration have been trying to craft a law that reforms the financial markets so that we do not have another meltdown in the future. Without even reading the proposed legislation, I can promise you that it will be a failure. However, before I prove it, lets review some numbers:

• Taxpayer cost to bailout Fannie Mae and Freddie Mac SO FAR: about $145 billion and counting. The Obama administration has publicly stated that it will continue to back both organizations until at least 2012 regardless of their losses. (source: Business Week, May 17, 2010 issue and other sources)
• This bailout of Fannie and Freddie has cost the taxpayers about $7 billion a month, about $318 million a day, and about $40 million an hour since the bailout began.
• Fannie Mae stock price in 2007 = about $70, Freddie Mac stock price in 2007 = about $65.
• Fannie Mae stock price today = $.96, Freddie Mac stock price today = $1.21. Thus, both entities have destroyed over 98% of their shareholders' value in just two years. This is the market talking and putting a value on their operations, a valuation of near zero.
• According to Business Week, both organizations now hold $340 billion in "non-performing" (i.e., worthless) assets.
• Despite their incompetency, both organizations now basically control the entire $5 TRILLION mortgage market in this country, making it almost impossible to get a mortgage without their help.
• The Congressional Budget Office estimates that keeping both organizations alive will cost taxpayers $389 billion between 2009 and 2019, far exceeding any other bailout, including AIG, from the bailout era. This comes out to a per household average cost of $3,400 per household, $3,400 each household does not have to spend on expanding the economy and generating jobs.
• A lot of their problems were started in the early 2000s, according to the Business Week issue, when they started to purchase billions and billions of dollars of subprime mortgages and packaged them as securities. As we all know, the primary reasons for the economic collapse was the dangerously risky subprime securities that were sold in the market, of which these two government agencies were the biggest offenders.
• Their numerous accounting scandals through the years are too numerous to list here but most were monumental and potentially criminal.

Let's review: two government agencies are leaking great amounts of money hourly that the Obama administration says the U.S. taxpayer will gladly pay or "back stop" for at least another two years. These agencies have never had decent accounting procedures but now control the entire American mortgage market. These agencies destroying untold billions of dollars in shareholder value in a very short amount of time. These agencies were at the center and are primary causes of the economic collapse we are still living through.

Given this atrocious performance, you would think that the financial reform legislation before Congress is heavily involved in getting this runaway disaster under control. It is obvious that Fannie Mae and Freddie Mac were root causes of the financial meltdown. But, no surprise here, there apparently is not part of the legislation that will address this root cause problem. All of the focus on financial reform is elsewhere, namely the banking industry, most of whose players have already paid back their bailout money or who never received bailout money to begin with. The largest recipient, Fannie and Freddie, who have no chance of repaying the taxpayers, are not included in the reform bill.

Anyone who reads this blog knows that if you do not identify and quantify the root causes of a problem you have no chance to solve that problem. Just like with health care reform, the political class has not taken on the root causes and thus, I can confidently say that this legislation will be a failure.

Don't believe me, consider some quotes from the Business Week article:

• John McCain, U.S. Senator: "..like declaring war on terror and ignoring Al-Qaeda."
• Craig Pirrong, professor of risk management at the University of Houston: "Fannie and Freddie are the poster children of the moral hazards of government guarantees - even implicit ones."
• Phillip Swagel, Treasury economist under the first President Bush: "They are now being used as a conduit for the executive branch to spend money for policy purposes without having to get a vote and without transparency."

What a mess. The obvious question that comes to mind is why isn't the political class addressing this root cause? I have a number of theories:

1) Fannie and Freddie have been big contributors to politicians' campaign re-election efforts. Downsizing them or eliminating them would dry up a set of funds that they use to stay in office. This is especially true of the Democrats who are the biggest recipients of the donations from these two government agencies (ponder on the absurdity of that statement - government funded organizations who take taxpayer money and donate it politicians!) Of course, if Step 6 in "Love My Country, Loathe My Government" (allow only individual citizens to contribute to election campaigns), Step 39 (term limits), and Step 36 (require all politicians to take and pass a course in economics before serving) were in place, a lot of this issue would go away.

2) The political class does not not know how to fix the problem of Fannie Mae and Freddie Mac. Given that they rarely fix any other problem in this country, this theory has a high probability of being true. That is why term limits and dumping all incumbents in November is important, we need new blood and new leaders that are smart enough to fix these types of problems.

3) The scariest theory is that since these two entities control the mortgage market, without them the recovery may take longer than expected if they are not backing up housing loans. the problem with this theory is that it just prolongs the root cause and we continue to waste billions of taxpayer dollars every month keeping these two terminal patients alive.

4) The last theory is based on comments by two Democratic Senators who are pushing this bill, John Warner and Chris Dodd. Both have said that Fannie and Freddie's problems will be addressed next year. More absurdity. They are the biggest problem, why not address them first? They are costing the American taxpayer the most money, billions of dollars, why not fix them first? Could it be that the political class does not want to shut off the campaign donation spigot until after the November election even though at $7 billion or so a month, it will potentially cost the American taxpayer over $80 billion to wait another year?

Again, I repeat, what a mess. I do not know what theory or combination of theories above are the cause of the inaction but I do know this: without addressing the root cause of the problem, Fannie and Freddie, we will not solve the problems inherent in the country's financial markets.

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