Midafternoon on Friday, September 5, 2008, while the rest of official Washington sought to beat weekend rush hour traffic, Richard Syron, Freddie Mac CEO and Board Chairman, and his Fannie Mae counterpart, Daniel Mudd, met their fates in a conference room in an obscure office building not far from the White House. Across the table were the nation’s top financial regulators.
It would not be a good day for either man.
Reminiscent of the scene in the movie Mary Poppins, where rueful board members relieved George Banks of his banking duties and plucked the poppy off his lapel, their regulator, James Lockhart, joined by Treasury Secretary Henry Paulson and Chairman of the Federal Reserve Ben Bernanke, summarily fired the two executives sitting at the twin helms of disaster. The leaders of two of America’s most successful companies, then hopelessly insolvent by the government’s reckoning, signed over control of their firms to their federal regulator, the Federal Housing Finance Agency (FHFA), which would take on the added role of conservator going forward.
Rather than liquidate the two firms, FHFA’s job was to keep them running, rebuild financial strength, and shrink their outsized mortgage portfolios. Directed to “preserve and conserve” the public’s newly acquired assets, FHFA acts as a steward for US taxpayers until Congress decided what to do with the failed GSEs. For the past 10 years, the firms have not been able to amass capital, lobby Congress, or undertake new ventures as they did in the past. Practically speaking, Freddie and Fannie are tied, gagged and stuck. Yet they remain absolutely critical to the stability of US housing markets.
At the time of the takeover, the outstanding amount of GSE debt and mortgage-backed securities amounted to about $5.5 trillion. To put that number in perspective, on the day of the takeover, the amount of outstanding GSE securities exceeded the $5.3 trillion in public debt held by the U.S. Treasury.[i] Like U.S Treasuries, GSE obligations were spread all over the world, held by central banks and investors who had bought them in good faith and counted on stable returns.[ii] That, therein, was the problem. As George Banks was reminded, “When fall the banks of England, England falls.”[iii]
On Sunday, September 7, the government take-over was announced, and markets rallied around the globe. Monday morning, September 8, Treasury Secretary Paulson summoned all 5,000 Freddie Mac employees—of which I was one—to an all-hands meeting. No rally there. The grim event was held at the company’s McLean, Virginia headquarters in a cavernous room generally used for divisional meetings and the executive holiday party.
On that fateful morning we stood woodenly at attention and learned that Freddie Mac was now under government control and that Paulson had hand-picked a new CEO to replace the outgoing Syron. Paulson was no-nonsense and firm. Despite the ousters at the top of Freddie Mac, he implored employees to remain at their jobs. Freddie Mac needed to keep buying mortgages as fast as it possibly could to keep the housing market afloat, even as house prices were sinking to an unthinkable nadir. The 30-percent decline in home values was setting off a tsunami of mortgage defaults in communities across the nation.
Employees also were told of the stiff, strong-armed agreement Paulson had wrested out of the departing executives. To assure investors that the U.S. government would honor the massive quantity of outstanding GSE securities, thereby assuaging the very real concern about contagion and systemic risk, the U.S. Treasury took drastic measures. In bailing out each GSE, Treasury required the GSEs to issue $1 billion in preferred stock, which gave the U.S. government a near 80 percent stake in each company.[iv] This massive issuance of new shares diluted the value of everyone else’s shares and essentially wiped out common shareholders. In return, the government gave each GSE access to $100 billion in capital, which was later raised to $200 billion when losses skyrocketed. Both entities were levied a hefty 10 percent quarterly dividend on the government’s considerable stake in the firms.
Employees would later learn that Paulson designed the stringent terms to ensure that the two companies would not be able to grow out of their problems without significant reform. In this way, Paulson sought to force Congress to deal, at long last, with some of its worst skeletons–the powerful and politically connected GSEs, which had been created by congressional decree decades earlier. At the time of the government take-over, our firms were known in some quarters as the bastards of politics and finance…
The Treasury chief’s announcement was brief, and we left in silence. Back in our offices across the street, I called a staff meeting. There wasn’t much to say or do. Nine months later, I resigned. I had worked for Freddie Mac for nearly two decades.
Several years later, a man knocked on the front door of my home and handed me an envelope. I opened it as he sprinted away.
It was a subpoena, and my hands went cold.
Excerpted from chapter 1, Reckoning Day, Days of Slaughter, Inside the Fall of Freddie Mac and Why it Could Happen Again (Johns Hopkins University Press, 2017)
[i] W. Scott Frame, “The 2008 Federal Intervention to Stabilize Fannie Mae and Freddie Mac.” Federal Reserve Bank of Atlanta Working Paper 2009-13, April 2009, 1.
[ii] Department of Treasury Department Office of Public Affairs, “Fact Sheet: Treasury Senior Preferred Stock Purchase Agreement,” September 7, 2008.
[iii] Mary Poppins, Directed by Robert Stevenson. Burbank, CA: Disney Studios, 1964.
[iv] Ibid. The Senior Preferred Stock Purchase Agreement (PSPA) sought to provide “significant protections for the taxpayer, in the form of senior preferred stock with a liquidation preference, an upfront $1 billion issuance of senior preferred stock with a 10% coupon from each GSE, quarterly dividend payments, warrants representing an ownership stake of 79.9% in each GSE going forward, and a quarterly fee starting in 2010.”
[v] The GSE’s required 10 percent quarterly dividend has been viewed by some investors as particularly severe. In contrast, although the bailout of the massive insurance company, American International Group, originally required a 10 percent coupon on a combined (Federal Reserve and Treasury) $182 billion infusion, Treasury later relented. In December 2012, the U.S. government sold its remaining shares in AIG and pocketed $23 billion in positive return, according to the government. See Treasury Press release dated December 11, 2012 at http://www.treasury.gov/press-center/press-releases/Pages/tg1796.aspx