Former FDIC Chairman Criticizes Lack of GSE Reform

Former FDIC Chairman William Isaac has released a sharp critique of the federal government’s 2012 decision to sweep all of the Fannie Mae and Freddie Mac profits into the Treasury. On an Investors Unite Conference call Wednesday, Isaac said while in the midst of the 2008 financial crisis the government used Fannie and Freddie to stabilize housing finance, the government’s current actions could cause another, potentially worse, crisis.

Isaac said the lack of urgency by regulators and policymakers in resolving the status of Fannie and Freddie and driving their capital to a variety of government budgetary needs is a major issue. “They are not toys for the government to play with,” he said on the call.

Beyond there being "no excuse" for the length of time the GSEs have been in limbo, Mr. Isaac said the government changing the terms of the deal it put into place in 2008 threatens the nation's financial system.

"It's not good policy. It doesn't settle the market," he said. "I'm always looking at the next crisis, and I don't want to make the next crisis worse because of the actions taken during the current crisis."

In 2002, Fannie Mae had about $30 billion in equity. By 2007, that number increased significantly, but today their equity has dropped to single digit numbers. Once the conservatorship ends, those reserves will need to be replaced for the companies to be able to operate effectively. For now, that money is going into the U.S. Treasury general fund, where it is hard to tell where that money is being spent.

Host of the conference call, Tim Pagliara, said this was “blatantly irresponsible.” He noted that at the time of the financial crisis the GSEs were nearly 100 times leveraged and now they are 700 times leveraged with almost $5 trillion in liabilities.

Isaac commended Rep. Marsha Blackburn (R-Tennessee) for legislation she introduced recently that would place Fannie and Freddie into escrow until reforms were made. In a piece he wrote for the Wall Street Journal, Isaac criticized the lack of reform for the GSEs he said the public should be concerned about the state of Fannie and Freddie.

“By denying Fannie and Freddie the ability to accumulate capital, the government is putting taxpayers on the hook for any future losses they may incur. The Obama Treasury is ignoring the threat. A senior Treasury official, Michael Stegman, told a Goldman Sachs conference earlier this month that recapitalizing Fannie and Freddie would come at taxpayer 'expense,’” he said. “The only logical reading of this analysis is that a dollar going to rebuilding capital is one less dollar going into the Treasury's general fund. Mr. Stegman has it backward: The risk of another massive taxpayer bailout, arising from undercapitalization, is precisely why Treasury must end the net-worth sweep and allow Fannie and Freddie to emerge from the limbo of conservatorship."

Isaac noted on the call that he supported the government's "tough terms" when it effectively acquired ownership of 79 percent of the GSEs' common stock. As structured, these terms avoided a complete government takeover of the GSEs and protected taxpayers from future bailouts but now, the Third Amendment sweep and inaction on the GSEs, it is the government that is not living up to the terms of the deal. And this sets a dangerous precedent, he warned.

"We're losing sight of the rule of law, and the financial system won't work without that," he said.