CONGRESS GOT IT WRONG WITH FANNIE AND FREDDIE - August 22, 2008

The Problem

Fannie and Freddie continue to lose money on their loan portfolios and the loans they insure. They are levered at better than 60 to 1 and are technically insolvent. Just a one percent decline in the value of their assets will bankrupt the companies. Huge financial risks and unnecessary derivative bets undertaken by Fannie and Freddie have led to enormous financial losses. This practice continues unchecked today.

Fannie and Freddie are currently allowed to lobby Congress to influence legislators who oversee these organizations. Fannie and Freddie have doled out more than $170 million to Representatives from both sides of the aisle since 1998. Top management positions in Fannie and Freddie have become highly paid jobs for favored, politically connected individuals. Most visible was Franklin Raines, former CEO of Fannie Mae and President Clinton's budget boss, who presided over the most abusive financial misstatements.

The Bailout

The Act recently enacted by Congress burdens taxpayers with enormous costs and does nothing to address the inherent weaknesses in Fannie and Freddie. Ensuring that big Wall Street banks and foreign governments are repaid does nothing to address the root cause of the problem. Their highly leveraged business models are broken. The Act virtually ensures that losses will grow larger and sticks the taxpayers with a huge bill. The longer these two entities remain in business, in their current form, the more bad loans they will buy and insure, and the more taxpayers will lose. To make matters worse, this bail-out pumps massive liquidity into the system which will fuel inflation in food, energy, raw materials, commodities, services and transportation to name just a few.

The Krikorian Plan

Given where we are today, Fannie and Freddie are integral to the mortgage origination process by providing a secondary market. Therefore, these institutions must be reformed in order to be saved.

Instead of the short-sighted legislation rushed through Congress, this is what should be done:

1. The federal government should extend a short-term loan to Fannie and Freddie at a fixed interest rate to help with immediate liquidity concerns. This loan would be senior, and in preference to, current Fannie and Freddie debt and equity. No dividends should be paid on any stock, common or preferred, until the loans are paid back in full.
2. Fannie and Freddie should return to their roots of providing liquidity to the mortgage market. Risky and unnecessary investments in exotic derivative instruments that provide zero benefit to the original mandate of these two institutions should be eliminated.
3. Top management compensation should be adjusted to the federal government pay scale.
4. Those responsible for the mismanagement of Fannie and Freddie should bear the full responsibility of their actions. Management should be held accountable. Current equity and debt holders should not be protected.
5. Fannie and Freddie should not be allowed to lobby Congress.
6. Taxpayers should be told the truth about the full magnitude of the problem and how much capital is required to shore up these institutions.
7. Once these institutions are in sound financial condition, Fannie and Freddie should be publicly listed with the proceeds from the stock offering accruing to the government. Once listed, current and future Fannie and Freddie debt would no longer be backed by the federal government.

Once again, Congress needs to do its job and take a closer look at all the issues relating to this problem. Our country cannot afford the missteps that Congress has so often made in the past. I urge our government leaders to implement the actions I have outlined above to save and reform Fannie and Freddie. It is an important issue and America deserves solutions, not politics.