Too Big to Fail [103]
Paulson could see that unease about Fannie and Freddie was growing. On CNBC’s Squawk Box that Tuesday morning, James B. Lockhart III, chairman of the Office of Federal Housing Enterprise Oversight, which regulated Fannie and Freddie, tried to calm the markets: “Both of these companies are adequately capitalized,” he said. “Both of these companies are managing through these issues and have tested management teams.”
Paulson had a one-word judgment of that assessment that he later shared with his staff: “Bullshit.” For months Paulson and his team had been discussing ways to unwind Fannie and Freddie should a real crisis hit—he considered their situation far more important to the long-term health of the economy than Lehman’s or the other investment banks’. But he knew it was all too easy to get bogged down in the political fighting over the controversial companies that had made home ownership a near right during the boom. With its critics insisting that Fannie and Freddie were neck-deep in the subprime mess, Paulson had a year earlier called the debate over Fannie and Freddie “the closest thing I’ve seen to a holy war.”
While shares of the companies recovered on Tuesday from the Monday sell-off, both were still trading below $20, and there were other indications of nervousness. Credit default swaps on the debt sold by Fannie and Freddie—essentially, insurance—were trading at levels reserved for companies with credit ratings five levels below their own triple-A ratings, the highest a company could have. Those ratings were, in fact, more a reflection of the government’s implicit backing than the companies’ own fundamentals.
As Paulson and his staff prepared for a congressional hearing two days hence to discuss the fates of Fannie and Freddie, Steel stuck his head into the conference room next to his office.
“Okay, Hank. I’m taking off.”
Paulson glanced up for a moment. “Okay, Bob. I’ll see you later.”
“No, no,” said Steel. “I mean, this is it. I’m leaving.”
Finally realizing that Steel was bidding his farewells to the staff, Paulson got up to see his deputy off.
As they walked down the hall, Paulson joked, “You’re getting out just in time.”
Virtually from the moment that Congress created Fannie Mae (originally the Federal National Mortgage Association) in 1938, it was politically divisive. A product of the housing slump of the Great Depression and Franklin Delano Roosevelt’s New Deal, the company was formed to buy loans from banks, savings banks, and other lenders in order to promote home lending by reducing lenders’ risk and to increase the amount of capital available for housing. Republicans saw Fannie as a mere sinecure for their political opponents. In 1968, with a federal budget burdened by the costs of both the Vietnam War and the Great Society, Lyndon Johnson began the process of privatizing Fannie. As a sop to its critics, a rival company, the Federal Home Loan Mortgage Corporation, or Freddie Mac, was created in 1970.
Fannie and Freddie played the political game even more fiercely than their opponents, spending millions of dollars on armies of lobbyists on Capitol Hill. Each company was a revolving door for the powerful in Washington—both Republican and Democrat. Newt Gingrich and Ralph Reed, among others, worked as consultants for Fannie or Freddie; Rahm Emanuel was a board member of Freddie.
By the 1990s, Fannie’s chief executive could boast, without much exaggeration, that “we are the equivalent of a Federal Reserve system for housing.” At their pinnacle the two mortgage giants—neither of them an originator of loans—owned or guaranteed some 55 percent of the $11 trillion