View Full Version : Conversation with FDR...long

09-27-2004, 05:00 PM
From www.martinweiss.com/ (http://www.martinweiss.com/)
An interesting read, but I'm not making any political commentary here...just passing it along, jjd
During the Depression, Franklin Delano Roosevelt had
a dream -- to create a government agency that would
help buy homes for American families that could
otherwise not afford one.

And in 1938, the dream came true: Congress gave birth
to the Federal National Home Mortgage Association,
later nicknamed Fannie Mae. Still later, Congress
transformed it into a stock company with special
government privileges.

Today, however, that dream is turning into a

-- The company has grown into a government-subsidized
monster that so thoroughly dominates the mortgage
market, its contraction or failure could cause a
collapse of the entire housing industry ...

-- Its executives have just been caught with their
hands deep in the cookie jar -- an accounting scandal
that's potentially so serious, it could make the
Enron and WorldCom scandals look like a game of
marbles ...

-- Its shares have just taken a big beating, wiping
out more than $11 billion of shareholder value last
week alone, and ...

-- Its balance sheet is so shaky, any change in the
marketplace, or even any sudden legislative or
regulatory moves to fix its problems, could
precipitate serious financial difficulties.

This is not new. I warned about it over thirty years
ago when I published my first book, The Money Panic.
I warned about it again in the 1980s and the 1990s in
my Safe Money Report. And on September 18, 2000, I
warned my readers still another time, when I wrote:

"Fannie Mae is already drowning in a sea of debt. It
has $34 of debt for every $1 of shareholder equity.
That's big leverage and of the wrong kind. Plus, the
company has only one one-hundredths of a penny in
cash on hand for every $1 of current bills.

"How could a company get so laden down with debt and
operate with such scant cash reserves? Because of
Fannie Mae's unusually close relationship with Uncle
Sam ...

"Think Fannie Mae can't go under? Think again.
[Someday] Fannie Mae ... could lose one of its most
important assets of all: The implicit backing by the
U.S. government.

"Indeed, Representative Richard Baker is leading the
charge in Congress to repeal the line of credit from
the Treasury Department that Fannie Mae receives.
That means Fannie Mae's bonds would no longer have
government funds to back them up.

"Fed Chairman Alan Greenspan himself has raised a
related issue. He's apparently unhappy that
government-sponsored enterprises like Fannie Mae are
being subsidized by the government, in the form
reduced borrowing rates from the Fed."

That warning was published exactly four years and
nine days ago. But since that day, even while this
situation has continued to deteriorate, there have
been few voices of protest ... and even fewer
concrete steps taken to avert the disaster we face

Reason: Fannie Mae's executives, while allegedly
enriching themselves at the expense of investors and
taxpayers, mobilized one of the most powerful -- and
most fearless -- lobbies on Capitol Hill. Congress,
the SEC and the Justice Department were pushed back.
Even Baker and Greenspan were repeatedly forced into
reluctant retreat.

And throughout it all, the company just kept growing
in size and power, virtually nonstop, emerging as the
greatest single monopoly on the face of the earth.

So this morning, I wondered ...


I imagined how I'd present the facts to Franklin
Delano Roosevelt, and what his response would be ...

"Mr. President, I have some surprising news for you.
A lot has changed since the 1930s. Now, the agency
you originally created, Fannie Mae, plus and a
smaller, younger cousin, Freddie Mac, control 90% of
the home mortgage market in America."

The former president is shocked. "What?! 90%?! Fannie
Mae was supposed to be like a national savings and
loan. It was supposed to supplement and support home
mortgages -- not take them over. How in the hell did
this happen?"

"Initially, it worked according to your plan. Fannie
Mae bought some mortgages from banks, bundled them up
and sold them to a few investors. This way, they
helped pump some extra pump money into the housing
market. But no one else besides Fannie Mae could do
this. So the government agency had a virtual monopoly
on this business, and the business grew like
wildfire. A whole new market was created in
America -- the secondary market for mortgages."

"Was that a problem?" asks FDR.

"Not immediately. But it kept ballooning in size.
Then, in 1968, the U.S. was in a war in Southeast
Asia and ran into budgetary problems. So the
president at the time, Lyndon Johnson, along with
Congress, transformed Fannie Mae into a semi-private
company and moved its finances off the books of the
federal budget."

"Why did they do that?"

"Most people in government knew it was mostly a
gimmick to make the federal deficit appear smaller.
But they went ahead and did it anyhow."


FDR is perplexed. "If Fannie Mae is no longer a
government agency, what the heck is it then?"

"They have a new name for it. They call it a
'government sponsored enterprise' or a 'GSE.' It's
essentially a private company with special subsidies
and privileges."

"What subsidies and privileges?"

"They have a line of credit to the Treasury. They're
exempt from some SEC insider trading rules. They're
exempt from local taxes. They don't have to meet the
same disclosure requirements as ordinary private

"How much are these subsidies worth?"

"According to the Federal Reserve, somewhere between
$119 and $164 billion."

FDR seems surprised. "That's a lot of money. How much
of that money are the shareholders and executives

"About $50 billion to $97 billion, according to the
Fed. So a big chunk of the taxpayer subsidy
underwrites executive salaries and stockholder
profits and is NOT passed on to borrowers in form of
lower mortgage costs."

FDR shakes his head in disapproval. "In other words,
instead of pursuing the original mission we
established in 1938 -- to help homeowners -- they're
mostly helping themselves?"

"Probably some combination of both."


The former president shakes his head again. "So what
we did was to take a giant, formerly government-
controlled monopoly ... let it fall into private
hands under private-sector management ... and then
let them play it up to the hilt without proper checks
and balances? That's crazy. Didn't anyone in Congress
or the administration do anything to stop this

"Not right away. But some people in Congress
eventually got around to saying: 'Hey! It's far too
dangerous to have so much economic power in the hands
of just one company. It's way too risky for the
entire mortgage market -- and for millions of
homeowners.' "

"So what did they do?"

"In 1970, they created another entity just like
Fannie Mae, with essentially the same mission and a
similar business model -- Freddie Mac. So now they
had two of these semi-private mortgage giants
instead of one."

"Did that break up the monopoly?"

"Of course not. We have over 10,000 commercial and
savings banks in this country ... more than 7,000
life/health and property/casualty insurance companies
... and over a thousand security brokerage firms.
That's free market competition."

"Yes, it is. But what about the GSEs?"

"We still have only TWO companies dominating
virtually the entire market for secondary mortgages!
That's anything BUT free market competition. Besides,
Freddie Mac, although a giant compared to most
companies, is still a midget in comparison to Fannie
Mae. Bottom line: Fannie Mae is still a monopoly, the
largest monopoly in the world."


FDR smirks, but then asks: "Can you give me a better
idea of the full dimensions of this monopoly?"

"Sure. But take a deep breath. The facts are so
shocking they could knock the wind out of almost

The former president sits silently while I rattle off
the facts one by one ...

"Fact number one. As I said earlier, Fannie Mae and
Freddie Mac control 90% of the secondary market for
home mortgages.

"Fact number two. Their combined debt is almost half
as large as the current national debt of the entire
U.S. government.

"Fact number three. Among all private financial
sectors of the U.S. economy, they have emerged as the
single biggest borrowers of credit in the financial
markets. They owe over two and a half times more
credit market debt than all the commercial banks,
bank holding companies and savings institutions put
together. They owe nearly 44 times more credit
market debt than all the nation's brokerage firms and
THREE HUNDRED times more than all the insurance

"That's quite unbelievable," says FDR after a few
moments of deep thought. "Even in the pre-Depression
era, we had nothing even remotely similar to the
situation you describe. Are you sure about your

"Absolutely. The proof is in the Federal Reserve's
Flow of Funds for the second quarter of 2004, in the
section covering the LEVELS of debt, under their
table L.3, 'Credit Market Debt Owed by Financial
Sectors.' And it's available in an easily accessible
public forum known as the 'Internet.' Almost anyone
can view this data instantly ...


"Fact number four. These government-sponsored
enterprises themselves actually hold more of their
own securities than any other sector in the

"What do you mean?"

To clarify, I give FDR the following stats:

-- All banks, including thousands of commercial banks,
bank holding companies and foreign banks are
currently holding $1.1 trillion in agency - and
GSE-backed securities;

-- Thousands of insurance companies are holding
$733 billion of those securities; and meanwhile

-- Just these two GSEs -- Fannie Mae and Freddie Mac --
hold over $2.6 trillion! That's two and a half times
more than amount held by all banks and over three and
half times the amount held by all insurers.

(The source of this data is also the Fed's Flow of
Funds, table L.210, 'Agency- and GSE-backed
Securities.' ") Take a look ...



Roosevelt is shocked. "Just TWO companies holding
more of their own stuff than thousands of banks and
insurance companies put together? What happens if
these two companies fall on hard times?"

"It could create a mean vicious cycle. The more their
balance sheets deteriorate, the less the $2.6 trillion
they hold in their own securities will be worth; and
the less those securities are worth, the more their
balance sheets will deteriorate. They have a name for
this in the financial world."

"What's that?"

"Incest. It's supposed to be taboo. But it isn't."


FDR's next question is right on point: "From what
you're saying, it sounds like they're exposed to huge
risks for themselves, for investors, for taxpayers,
for homeowners, for everyone. My question to you is:
Don't they know this? Aren't they aware?"

"To some degree, yes, they are. That's why they
engage in huge special transactions in instruments
called 'derivatives.' That's their attempt to
somehow offset some of the risk. But these
instruments are very complex and potentially risky
themselves. Just last year, Freddie Mac booked
shocking losses in these derivates."

"What does the current Federal Reserve Chairman have
to say about this?"

"His name is Alan Greenspan, and he recently opined
on this very subject. He said 'the current system
depends upon the risk managers at Fannie and Freddie
do everything just right.' He says 'our financial
system would be more robust if we relied on the
market-based system that spreads risks, rather than
the current system, which concentrates such risk with
the GSEs.' "


FDR raises his hand signaling he wants to interrupt.
"Let me go back to what you said earlier. You said
Fannie Mae and Freddie Mac own the biggest chunk of
their own notes and bonds. That's the incest. But
they can't be the only ones. Who else owns them?"

"Banks. More than 3,000 banks have all their reserve
capital requirements met by investing in these
government-sponsored entities. Plus 74 central banks
around the world invest in them. So as you can see, the
Fannie Mae and Freddie Mac bonds are more common in
financial institution portfolios than almost any other
securities, perhaps even more than Treasury

"Banks?! Foreign central banks?! How in the heck did
THEY wind up with so many Fannie Mae bonds?"

"Remember: Fannie Mae bonds used to be like
government securities. So nearly everyone in the
market thinks they're still safe, that they still
have the tacit backing of the U.S. government."

"Do they really have that backing?"

"Good question. Fannie Mae and Freddie Mac securities
carry explicit disclaimers stating that they're NOT
insured by the U.S. Treasury Department. And our
current Treasury Secretary, John Snow, recently
warned investors not to count on a federal bail-out.
He said he doesn't believe in the 'too big to fail'
doctrine. In other words, no matter how big they are,
they can still go under."

FDR nods and then asks: "So are investors getting the

"Stockholders? Yes, they're starting to get the
message. That's one of the reasons they started
dumping Fannie Mae shares last week. But bondholders
like banks and insurers? No, not yet. They still
don't get it. They still think the government and
millions of American taxpayers will bail out Fannie

"That's strange," says FDR with a smile. "From what I
remember in the 1930s, bond investors were a pretty
smart bunch. Why are they still believers in Fannie


"The rating agencies share a large part of the
blame," I respond. "They're rating Fannie Mae and
Freddie Mac notes and bonds as if they still had some
government guarantee. But that's going to change soon."


"Don't know. But on Thursday of last week, Standard &
Poor's said it may downgrade some of Fannie Mae's debt,
noting that the company may be riskier than once
thought. S&P said it may cut Fannie Mae's 'AA-minus'
subordinated debt and 'risk-to-government' ratings. The
latter represents Fannie Mae's credit quality exclusive
of the implicit government

"Then what?"

"If the rating agencies are serious about the
downgrades, they'll drop the ratings several notches
further, one notch at a time. Then, Fannie Mae and
Freddie Mac notes and bonds will get dumped in bigger
and bigger amounts. Their prices will plunge, and
you'll see gaping holes appearing in the portfolios
of everyone who's loaded with these notes and bonds.
That includes the banks, the central banks and, of
course, Fannie Mae and Freddie Mac themselves."

FDR is again pensive. "If I were still president," he
says in a near whisper, "I wouldn't let them fail.
But what about today's president?"

"We don't even know who the president will be. But
there's one thing we do know: The federal budget
deficit is already huge. Some independent economists
estimate that, unless Medicare, Medicaid and Social
Security are cut, we could have a total, accumulated
deficit of up to $9 trillion over the next few years.
So, sure, there may be some GSE bail-outs by the
government. But it's going to be partial, not total.
It's going to be messy and complicated -- not a clean


"What about right now?"

"Right now, no lobbyist in the world is going to be
able to restore Fannie Mae's credibility to its former
level. Fannie Mae is going to get smacked so hard for
their bad behavior that their business will never be
the same again."

"What exactly are these people at Fannie Mae accused
of doing?"

"The authorities have been investigating them for
eight months and just issued their report last week.
They say that Fannie Mae's management deliberately
developed and adopted inappropriate accounting
policies. They say that management supported
widespread violations of generally accepted
accounting principles. They say management tolerated
lax internal controls. And they accuse management of
postponing $200 million in expenses so executives
could get bigger bonuses. This looks like it's far
worse than a similar accounting scam that came out in
June of last year at Fannie Mae's smaller competitor,
Freddie Mac. Freddie Mac manipulated profits to the
tune of about $4.5 or $5 billion. But the Fannie Mae
scandal may be both bigger and more egregious."

"So what's going to happen next?"

"Now, suddenly, the regulators are plowing in. Fannie
Mae is going to come under more intense scrutiny by
Congress to take away its taxpayer subsidies ... by the
Justice Department to take away its monopoly ... and by
the Securities and Exchange Commission to take away its
insider trading and privacy privileges."

"When is this starting?"

"Almost right away. U.S. Representative Richard Baker,
the same one who's been leading the charge against the
GSEs for many years, has called for an October 6
hearing to unearth the extent to which Fannie Mae
manipulated its financial statements."

"Can he really have an impact?

"Yes. Baker is pretty powerful now. He's chairman of
the Capital Markets Subcommittee under the House
Committee on Banking. In Fannie Mae's case, Baker says
executives apparently manipulated the numbers not only
to smooth earnings but to enrich themselves -- which,
if proven, is criminal."

"What's your point?"

"My point is that, after this damning report that just
came out, Baker may finally get enough political
support to prevail and pass a law that could kill the
golden goose of the GSEs. Fannie Mae is going to get
dragged through the mud -- in Congress and in the
press. And worst of all, its stocks and bonds are going
to get punished by investors. Sure, their lobbyists
will fight back. But this time, I think the GSEs will
lose the political battle."


Hurricane Jeanne is gone, and windless sunshine is
flowing onto my laptop screen. I'm at my sister-in-
law's condo in Tamarac, Florida, which, fortunately,
was just beyond the storm's outer reach.

As with Francis, everyone here is safe, and at the
office, all our back-up systems are working -- so I
can get this issue of "Martin on Monday" to you on

Unfortunately, however, the storm coming in the
mortgage market in America will not be over so

The first victims will be stock investors. You saw
that start already last week.

The next victims will be bond investors, especially
when the next rating downgrades are announced.

Even before Congress passes tougher legislation, less
money will be flowing into Fannie Mae and Freddie Mac.
And these two companies, in turn, will have less money
to pump into the home mortgage market. The housing
industry, already a house of cards, could suffer a
serious blow.

Mortgages will be scarcer -- and more expensive.
Result: Homeowners, especially those with adjustable-
rate mortgages (ARMs), will be victims as well.

My advice: If you own Fannie Mae or Freddie Max stocks
or bonds, get out now. If you have an ARM, convert to a
fixed-rate mortgage ASAP. Or better yet, if you have
the cash flow, pay down your mortgage more quickly than

Good luck and God bless!


Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.

P.S. If you're interested in concrete proposals for
change at the GSEs, visit the website of the Citizens
Against Government Waste and see their most recent
release ...


Martin Weiss and "Martin on Monday" are non-partisan.
Third-party ads do not necessarily represent their
opinion and should not be interpreted as an


09-27-2004, 05:39 PM
Interesting read, indeed. Worthwhile IMHO. It (Government control) seems to me, in this case, to mirror the Soviet model of central control of the economy - of course, theirs was total. Yet here we are not looking at a small piece of the pie. Now, this is not political? Cradle to grave swaddling of our citizens, lest they bump their shins, lest they become unemployed or dispirited. Let us institute a program to retrain them to accept our Federal or State handouts, let us forbid them to have to work, let us not repeat the Civilian Conservation Corps.. let us teach them to vote Democratic, so the teat of public welfare sustains them in virtual slavery, as long as they vote democratic. Let us demonize guns, and do all in our power to disarm the honest ones, keeping our guns for protection, and allowing the criminals who follow no laws to prey upon their own communities. Let us learn ourselves that it is evil to prosper, unless one donates token amounts to worthless causes for the sake of 'positive' publicity. Let common sense be denigrated, let drugs take over our inner cities, let those using soft drugs go to prison for endless years at an immense cost to our society. Let alcohol be distributed freely, have no school education programs agains the gin, the whiskey, the lite beer, let the good times roll. Stick blindly to programs that do not work, it is easier. Always take the easy way out, especially if you have 'got yours'. Follow the polls, and tailor your remarks to raise your standing.

Good clean fun!

Fair Play