Shaky Ground: The Strange Saga of the U.S. Mortgage Giants by Bethany McLean, Columbia Global Reports

Home ownership has long been a pillar of the American Dream. Bethany McLean argues that, in this day and age, it probably shouldn't be, but that doesn’t change the story she’s about to tell.

If you don’t know who Bethany McLean is, you should remedy that. She is the co-author, with Peter Elkind, of The Smartest Guys in the Room, a book that documented the rise and fall of Enron. She also co-authored, with Joe Nocera, one of the best books on the financial crisis that led to the Great Recession in All the Devils Are Here. Both are not only monumental in the business book genre, but important histories that will help future historians understand what happened in America business and finance, and what that meant for the country itself, as the twentieth century turned to the twenty-first.

McLean has a new book of her own with yet another scandalous tale to tell. And the kicker here is that the saga is ongoing, largely ignored, and probably affects you personally. The story of Shaky Ground hinges on a lawsuit (or, rather, about 20 of them) filed by hedge-fund managers against the United States government. These hedge-funds all own stock in Fannie Mae and/or Freddie Mac, and they would like to see these two Government Supported Enterprises (GSEs) returned to a “safe and sound condition” so that they can capitalize on their investments.

This is where things get slightly complicated. Fannie and Freddie are still publicly traded companies, but they were put into conservatorship during the financial crisis. In fact, McLean argues that while most people put the start date of the global financial crisis at September 15, 2008 when Lehman Brothers declared bankruptcy, it more rightly belongs 9 days earlier when the U.S. Treasury put Fannie and Freddie into conservatorship (extending a $200 billion line of credit to guarantee loans), where it remains until this day with no end in sight. Though the government owns 79.9 percent of the company, 20.1 percent of their shares were left in private hands. Some savvy investors bought up those shares as their stock price hovered around zero, but they are not being paid dividends on their investments because the (now very substantial) profits Fannie and Freddie make today have been used to reduce the federal deficit—per new, “Third Amendment” terms of their bailout established in 2012. That may be good news for us at taxpayers, but it's very bad news for someone who was hoping to cash in on buying their stock when it was low.

But lets back up and explain how these Government Supported Enterprises (GSEs) got to conservatorship in the first place, and why they remains there. That is a sad and sometimes funny tale. "The GSE world," as one long-time lobbyist told her, “is a cross between Monty Python and Shakespeare.” It all started when Wall Street began aggressively entering the subprime mortgage market, and Fannie and Freddie felt compelled to join the fray to maintain their market share. This is a story that’s been told very well many times, including in All the Devils Are Here. But there’s a brief description in Shaky Ground of the conscious decision made by Fannie Mae in 2005 that sums it up perfectly:

In a presentation for a 2005 executive retreat, Tom Lund, who was then the head of Fannie’s single-family business, put it this way: “We face two stark choices: stay the course [or] meet the market where it is.” According to an interview with staff of the Financial Crisis Inquiry Commission, Lund went on to say that if Fannie May stayed the course, it would maintain its credit discipline, protect the quality of its book, preserve capital, and be able to speak publicly about its concerns over the declining quality of mortgages. However, he said, Fannie would also face lower volumes and revenues, continued decline in market share, lower earnings, and a weakening of key customer relationships.

So they made their choice, with disastrous consequences. And while other financial institutions have largely recovered, and now must abide by government regulations that force them to hold more capital, Fannie and Freddie keep no cash reserves, because the federal government is taking “practically every penny of profit that the two companies generate to shrink the federal deficit.” In essence, all the rules they are now enforcing on private institutions, they are forcing the GSEs to break so that the mortgage market won’t completely collapse and they can use the profits to pay down some of the debt.

McLean extends the narrative to give us a history of how the government’s involvement in the mortgage market even began, and that takes us back to the story to the Great Depression, and the “Federal National Mortgage Association, or FNMA—or Fannie Mae,” set up to buy loans the government had guaranteed in an attempt to get privately owned mortgage associations to do the same. None ever did, leaving the government to do the work on its own and leading to the unusual system the U.S. has today. As the former governor of the Bank of England, Mervyn King, told Mclean: “Most countries have socialized health care and have a free market for mortgages. You in the United States do exactly the opposite."

As McLean explains, Fannie Mae remained a government owned organization until 1968, when the Johnson administration privatized it to keep its debt from being added to the national deficit. We then head through the savings and loan days, and the S&L's push for a competitor to Fannie Mae they could sell their loans to, which prompted congress to create the Federal Home Loan Mortgage Corporation—Freddie Mac. The collapse of the savings and loans companies, and the rise of Wall Street securitization and “private label” securities are explained in some detail, as is how the GSEs, before the collapse, had become a part of a “housing industrial complex” that kept (and largely still keeps) construction booming, banks loaning, and people buying. Fannie became the centerpiece in that complex, with political muscle extending across the country and a revolving door to congress and other political institutions. Until the financial crisis and resulting conservatorship, that is, when a condition of their bailout forced them to fire all their lobbyists.

Returning to the modern day, McLean handily dispels the myth that government policy in the way of affordable housing goals, and Fannie and Freddie’s need to meet them, were primary causes of the financial crisis—as a popular narrative at the time contended.

The majority of risky mortgages were not made to put people in homes. Rather, they were cash-out refinancings and purchases of investment properties. … A study published by the National Bureau of Economic Research in early 2014 says that the wealthiest 40 percent of borrowers got 55 percent of the new loans in 2006—the peak year of the bubble—and over the next three years, the were responsible for nearly 60 percent of delinquencies.

But that didn’t stop the agencies from becoming public pariahs, hated by all sides. And because all sides were so long calling for their abolishment, they have largely been gutted. McLean calls them “zombie agencies”—not quite dead, but not really alive, either.

They have managed a worst-of-both-worlds status: too political to be financially secure, but too financially insecure to accomplish their political mission.

And though there was then a time when it seemed no one would say a nice thing about “the toxic twins,” and everyone was tripping over each other to be the most vociferous supporters of abolishing them, a bill to do so never reached the Senate floor and we now have a kind of limbo in which the GSEs still exist to grease the wheels of the mortgage industry and their profits pay off the national debt. Democrats see a mission still to be fulfilled, and Republicans want to starve the agencies of any cash, so their profits are still being sucked away to pay down the debt. And, oh yeah, that lawsuit—or, rather, 20 of them—that the story hinges on? It’s likely to go nowhere.

After all her copious reporting, McLean offers a glimpse of her own thoughts on the American Dream, suggesting it would ultimately be wise to untether it from the idea of home ownership, to make the American Dream more mobile and relevant to the lifestyles we lead today, in which we are more likely to change jobs every few years and live in multi-family urban housing. If nothing else, we should rethink the assumptions of a system that was established in the 1930s. She ultimately concludes that “If we cannot move away from the cult of homeownership right now, then let’s fix what we have.” She offers many ways we could potentially do that, including a suggestion by former Fannie CEO Franklin Raines to have "Fannie and Freddie become cooperatives that are owned by homeowners, much as big insurance cooperatives like State Farm are owned by policyholders." To me, that seems to align the American Dream of home ownership with our ongoing experiment in self-government, and puts it on more soled ground than the legal limbo Fannie and Freddie find themselves in now or the quasi-public state they were in before.

In Shaky Ground, Bethany McLean exposes a largely ignored issue that affects us all personally—where we live and work. And it's not just a domestic issue because our mortgage debt has been bought up by investors around the world (two notable examples, the Chinese and Russian governments, are geopolitical rivals), so it affects us geopolitically as well. So, regardless of what it looks like or who inherits the problem after the 2016 election, we all share a stake in the outcome.