SPOILER ALERT! THE Plans for Privatizing Fannie Mae and Freddie Mac

The following text was taken from a white paper, Privatizing Fannie Mae and Freddie Mac, authored in 2004 by a group of Koch family funded lobbyists, masquerading as academics and analysts. We've posted extensively about Peter Wallison's misinformation campaign, and his connection to the unsuccessful effort to place blame for the subprime crisis on Fannie and Freddie's low-income housing initiatives (represented by Ed Pinto's untruths). The paper reads like an instruction manual for efforts to justify the conservatorship and then privatize Fannie and Freddie. Ironically, many of the concerns in the "risks" section were called out by Fannie Mae executives throughout 2000 with calls to increase guarantee fees and increase the risk-capital requirements, but were denied by the Bush appointed, government overseers of Fannie and Freddie (see details). This created a self fulfilling prophecy, in an attempt to generate one big free lunch for the government's subprime crisis bailout plans. I encourage you to get a cup of coffee before you begin reading the excerpt from the paper below. After reading the paper, it does not take long to realize that many of the items in this paper are playing out like greek poetry, which began on the first day that Fannie and Freddie were placed into conservatorship by the Bush administration.

The events leading up to the crisis, including the overstated losses of roughly $100B, were calculated maneuvers, which instantiated a planned effort to shift the entire secondary mortgage market to private banks. However, the turmoil, or disruptions to the mortgage market that erupted as a side-effect, as Wallison puts it, and the rampant fraud by big banks leading up to the conservatorship, were some of the "risk" factors that Wallison posited that his plan would avoid in leading up to the subprime crisis; these can be found in the sections preceding page 25 in Privatizing Fannie Mae and Freddie Mac. In other words, as you read the excerpts below from the document, including the insights into the outcome for Fannie and Freddie shareholders, realize that this paper was written in 2004, and then contrast Wallison's detailed plans with the current Corker-Warner GSE reform bill; they're almost entirely the same plan. As events often happen and history tells us, the impacts on the global economy and the magnitude of losses were never considered in AEI's plans for GSE reform. As the old poem states, and Ben Bernanke quoted in his speech to Princeton's graduating students, " . . . the best laid schemes of mice and men go often awry." Still doubt that the keys to the kingdom were handed over to big banks? Then why is the recently appointed CEO of Fannie Mae (appointed by the good friend of Mercatus, Ed DeMarco) a former top executive at Bank of America during the financial crisis?

Be sure you don't skip the juicy details below about the future of Fannie and Freddie shareholders.

Beginning from page 25 of Privatizing Fannie Mae and Freddie Mac

Mortgages and MBSs Held in Portfolio. Immediately upon enactment of privatization legislation (the act), the plan requires Fannie Mae and Freddie Mac to stop acquiring mortgages and MBSs for their portfolios but permits them to continue their activities as GSEs solely through the securitization of mortgages and the issuance of MBSs. The immediate effect of this step will be to stop the accumulation of interest rate risk by both enterprises and simultaneously begin the process of shrinking both their portfolios and their risks. However, because the process of mortgage securitization will continue, there will be no disruption of the residential mortgage market. Originators of mortgages, if they choose, will continue to sell their mortgages to Fannie and Freddie for subsequent securitization, or establish pools of mortgages against which MBSs guaranteed by Fannie or Freddie will be issued.

Since Fannie and Freddie will be forbidden to acquire any additional mortgages or MBSs for their portfolios as of the date of enactment of the act, their portfolios and their overall size will immediately begin to decline as mortgages are paid off or refinanced. To supplement this normal runoff, the plan requires that Fannie and Freddie sell off mortgages and MBSs according to a previously established five-year schedule. The purpose here is to assure that, at the end of five years from the date of enactment of the act, Fannie and Freddie will have sold off all the mortgages and MBSs they hold and will not delay disposition in the hope that Congress will eventually relieve them of this obligation. The plan contains penalties for failure to meet the required disposition schedule.

The proceeds of the sale of mortgages and MBSs will of course be used to pay down debt as it comes due during the five-year period after enactment. Nevertheless, at the end of that period, Fannie and Freddie are likely still to have outstanding debt contracted while they were GSEs. The plan provides for this debt to be defeased in a transaction in which Treasury securities in an amount sufficient to pay all interest and principal on the outstanding GSE debt will be placed in separate trusts by Fannie and Freddie. As the debt comes due, the proceeds of the sale of the Treasury securities will be used to liquidate it.

After providing for the defeasance of remaining debt, Fannie’s and Freddie’s charters will sunset and their remaining assets and liabilities be transferred to the holding companies they were permitted to establish, as described later. If Fannie and Freddie have taken certain necessary steps, also described later, their holding companies will be permitted to carry on any business, including the businesses of acquiring and securitizing mortgages.

Mortgage Securitization and the Issuance of MBSs. For six months after enactment, Fannie and Freddie will be permitted to continue to securitize mortgages and issue and guarantee MBSs without limit. Thereafter, for the next two and a half years, they will be required gradually to phase down their GSE securitization activities according to a schedule that will result in the complete termination of these activities three years from the date of enactment. At the end of this period, the remaining MBSs in trusts operated by Fannie and Freddie will be transferred to one or more well-capitalized trusts with independent trustees. The following summarizes the sequential privatization steps required under the plan:


Date of enactment

All purchases of mortgages and MBSs for portfolio cease. Mortgage portfolio begins to run off.
Securitization continues as before.

Six months after date of enactment

Phase-out of GSE securitization activity begins.
10 percent of mortgage and MBSs portfolio on date of 
enactment (DOE) should have been liquidated.

One year after enactment

GSE securitization activity should be reduced by 20 percent. 20 percent of DOE mortgage and MBS portfolio should have been liquidated.

Two years after enactment

GSE securitization activity reduced by 60 percent.
40 percent of DOE mortgage and MBS portfolio should 
have been liquidated.

Three years after enactment

GSE securitization terminates.
60 percent of DOE mortgage and MBS portfolio should 
have been liquidated.

Four years after enactment

80 percent of DOE mortgage and MBS portfolio should have been liquidated.

Five years after enactment

100 percent of DOE mortgage and MBS portfolio should have been liquidated.

Remaining mortgages backing outstanding MBSs are transferred to trusts.

Debt not yet extinguished is defeased. Charters sunset.

The phase-down of Fannie and Freddie’s securitization will not necessarily result in any diminution in the total amount of securitization activity in the market. First, if Fannie and Freddie comply with two requirements outlined later, they will be permitted to set up non-GSE affiliates, under ordinary state-chartered corporations functioning as holding companies, to continue securitizing mortgages. These companies, as will be described, can engage in any other activity permitted by the laws of the state of their chartering. Second, once Fannie and Freddie (as GSEs) no longer occupy the entire field for securitization of conventional and conforming loans, many other companies that currently securitize mortgages in the so-called jumbo market will be able to compete for product in the conventional and conforming market.

The Establishment of Holding Companies and Affiliates. Immediately after the enactment of the act, Fannie and Freddie will be permitted to establish holding companies—ordinary corporations chartered under the law of a state. These companies will be authorized to engage in any activity permissible for corporations chartered in that state and will be the parent companies of both Fannie and Freddie and their non-GSE affiliates that, among other things, will be permitted to engage in acquiring and securitizing mortgages.

However, although the various corporate steps can be taken to create these holding companies and their non-GSE subsidiaries, neither the holding companies nor any non-GSE subsidiaries will be able to engage in any business activity (other than acting as the parent companies of Fannie and Freddie) until their respective GSE subsidiaries have taken two steps: (1) achieved a level of capitalization that the then regulator of Fannie and Freddie considers equivalent to the level of capitalization a company would have to maintain for its debt to be rated AA by a recognized debt rating agency; and (2) spun off, to separate companies owned, respectively, by the shareholders of Fannie and Freddie, copies of their automated underwriting systems and copies of all information in their databases that pertain to the business of underwriting, acquiring, or securitizing mortgages. The regulator of Fannie and Freddie is required by the plan to certify that all relevant information has been spun off and Fannie and Freddie continue to maintain what would be the equivalent of an AA rating on their debt.


The purpose of requiring an AA-equivalent rating is to prevent Fannie and Freddie from using their continuing GSE status to attract capital and support their operations, while transferring most of their assets to the holding company. The purpose of requiring that they spin off copies of their automated underwriting systems is to assure that, even as privatized companies, Fannie and Freddie are unable to dominate the mortgage market through their superior data on conventional/conforming mortgages or the fact that many originators have become accustomed to working within the parameters of their automated underwriting systems. By requiring that these assets be spun off to independent companies owned by their shareholders, the plan intends to give the shareholders of Fannie and Freddie an opportunity to realize the value of these assets. The spun-off companies, which will be required to maintain their independence from the GSEs, the GSEs’ holding companies, or any other participants in the mortgage market, can engage in any activity, but they will be required to license the automated underwriting systems and the databases to all comers, on essentially comparable terms.

Thus, at the conclusion of this process, Fannie and Freddie will have been liquidated and their charters revoked. However, they will be succeeded by fully private companies that can engage in any activity, including the same businesses in which Fannie and Freddie engaged as GSEs. The residential finance market, in addition, will have become considerably more competitive. Instead of two companies dominating the market and earning oligopolistic profits, many companies will compete, seeking to make what are now classified as conventional/conforming loans, to hold them as investments or securitize them. It is likely that this competition and the innovations it will spawn relatively quickly will drive mortgage costs down to a level equivalent to the level that prevailed when Fannie and Freddie dominated the market. However, in this case, the shareholders of the competing companies, and not U.S. taxpayers, will bear the risks associated with this business.

This privatization program bears a strong resemblance to that of Sallie Mae, which was implemented in the mid-1990s. Sallie Mae was also privatized through the creation of a non-GSE holding company and the gradual runoff of its GSE portfolio. As the GSE portfolio declined, the business of the holding company grew, so that, after a period of years, the holding company was operating without the restrictions applicable to a GSE.

However, there are important differences between the two structures. Sallie Mae was permitted to continue buying and selling student loans through the GSE for ten years from the date of enactment, and few controls were placed on the transfer of assets from the GSE to the holding company, so that the holding company received significant benefits, courtesy of the taxpayers. In this plan, the portfolios of mortgages and MBSs held by Fannie and Freddie are not permitted to grow and are required to meet a phase-out schedule that will result in the liquidation of the entire portfolio within five years. In addition, by requiring that the GSEs maintain an AA-equivalent rating if they want to be affiliated with operating holding companies, the plan will prevent them from transferring assets to their holding company parents until they are fully liquidated.

As it happens, we believe the mortgage market can be further improved through the establishment of mortgage holding subsidiaries for banks and other entities. That concept, developed by Bert Ely for the American Enterprise Institute, is discussed later in this monograph. At this point, however, we proceed to a discussion of the privatization of the FHLBs.

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