Private Investors and Taxpayers:
The Case of Fannie Mae and Freddie Mac

Sankarshan Acharya
Founder, Pro-Prosperity.Com and Citizens for Development

To:       Honorable President Barack Obama

Cc:       Mr. Eric Holder, Attorney General
Mr. Preetinder Singh Bharara, Attorney for the Southern District of New York
Mr. Mel Watt, Director, FHFA

Sub:     Private investors and taxpayers.

Date:   May 20, 2014

Dear President Obama,

Should the government be involved in (worry about) raising or lowering the value of private stakes in business enterprises? 

A unanimously agreeable answer is no due to the following reasons:

  1. The free market system is supposed to appropriately value private stakes (like debt and equity) in business enterprises including, e.g., Fannie Mae and Freddie Mac.  Any government intervention distorts this system.
  2. Government intervention is fundamentally unfair (unconstitutional) for the stakeholders adversely affected by it.
  3. Government intervention negatively impacts investment in business enterprises prone to it.
  4. Private stakes are buffers that absorb the risk of losses of business enterprises before such risk is ever passed on to taxpayers.
  5. Frequent government intervention leads to dependence of business enterprises on taxpayer bailout.
  6. Jeopardizing private investment and dependence on taxpayers of business enterprises can decimate employment, collapse the pool of taxpayers and then destroy the economy dependent on printed or borrowed money.  

The reason for perpetual undercapitalization of banks is the fear of private equity holders about government intervention.  Potential government intervention induces equity holders and executives of banks to take away as much dividends and paychecks as they can. The government has to intervene because of moral hazard (blackmailing) due to federal guarantee of bank deposits.  

The biggest banks were so badly undercapitalized by 2007 that they acted through the government to take away private equities of smaller banks and even of large government enterprises like Fannie and Freddie.  The 2008 catastrophe made obvious that government intervention in business enterprises is deadly for an economy.  The government had to get more deeply involved in private enterprises to arrest a cascading crisis.  

The above analysis tells the FHFA to protect Fannie and Freddie equity holders in order to keep taxpayers off the hook.  Recently the FHFA Director has said that he does not worry about Fannie and Freddie investors.  He certainly meant to not take sides.  This is a breath of fresh air in governance. By continuing to let Fannie and Freddie equities trade in highly restricted and manipulated OTC markets, however, the current FHFA Director (despite benign intents) is willy-nilly subverting his own goals of protecting taxpayers and remaining fair for the following reasons:

  • Fannie and Freddie were delisted from NYSE by the government (FHFA and Treasury) to benefit Big Shorts, who are directly and indirectly affiliated with market making of mega bank holding companies, and who short-sell securities of companies into oblivion after inducing the government to shut down the companies.  [Soon after my previous memo to you on this issue, the Federal Reserve has asked the mega BHCs to raise $68 billion in new capital.  The Fed has even asked some banks to stop dividend payments.  If this is intended to force the mega BHCs to cover their short positions, this is highly welcome.] 
  • To have free market valuation of Fannie and Freddie equities, these companies should be relisted in NYSE.  Fannie and Freddie are bluest of the blue chip companies in the world because their revenues and profits come from the strong enterprising and creditworthy American middle-class that has made America the greatest economy in the world.  It is mindboggling how the Big Shorts and associated government decision makers ever conceived of a strategy to destroy Fannie and Freddie, by short selling their stocks, that have made what America is.  
  • If at all, the FHFA Director (as conservator) should take the side of Fannie and Freddie equity holders who, as opposed to Big Shorts, have protected the taxpayers by absorbing the risk of loss in mortgage lending by private banks as demonstrated in 2008.  By design, equity absorbs the risk to debt of a private enterprise.  Equity and debt together absorb risk to taxpayers.      

To protect the taxpayers, the FHFA should and can (under HERA) do the following:

  • Relist Fannie and Freddie stocks in NYSE.  If the previous FHFA Director used his power under HERA to delist Fannie and Freddie from NYSE–with the only ulterior purpose of benefiting the Big Shorts by hurting the home mortgage borrowers and taxpayers–the current FHFA Director can and should use the authority under HERA to really serve the American home mortgage borrowers and taxpayers by relisting Fannie and Freddie stocks.  How?
  • Fannie and Freddie stocks will be appropriately valued by a free market exchange like NYSE.
  • The revaluation of Fannie and Freddie stocks will facilitate raising new capital by offering rights to current shareholders and mortgage borrowers and shares to the public.
  • Present a plan for recapitalization of Fannie and Freddie (as required by HERA) by (i) raising more equity capital through rights and public offers, (ii) retention of all their profits, (iii) refunding the Treasury sweeps already made above the amount lent by Treasury, and (iv) returning all mortgage fraud settlement penalties to Fannie and Freddie.   
  • Release Fannie and Freddie from conservatorship after presentation of a recapitalization plan as per HERA.As desired by HERA, wind down the previous version of Fannie and Freddie that the Big Shorts could manipulate through government intervention to privatize profits and socialize losses by decimating the persevering and creditworthy American households.

With profound regards,

SankarshanAcharya     
Founder, Citizens for Development and Pro-Prosperity.Com