The Guru Is In

Once More unto the Breach?

By David A. Smith
June 30, 2025 6 min read

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On May 21, with his flair for the bombshell, President Trump, in a post on Truth Social, stated his strong interest in privatizing Fannie Mae and Freddie Mac –

I am giving very serious consideration to bringing Fannie Mae and Freddie Mac public. I…will be making a decision in the near future. Fannie Mae and Freddie Mac are doing very well, throwing off a lot of CASH, and the time would seem to be right. Stay tuned!

– and I flashed back to October 2008.

Three weeks earlier, after a hot summer of market-rocking implosions of financial institutions going bust like a string of firecrackers, the U.S. Treasury seized Fannie Mae and Freddie Mac, placing them into Federal conservatorship. This action, unprecedented in American history, essentially wiped out the shareholders’ equity and made explicit the Federal guarantee that had lived in sacred ambiguity since 1970. 

At the time, I was at Sol Krezner’s stately pleasure dome in Sun City, outside Johannesburg, South Africa, on an International Union of Housing Finance panel. Even as I spoke about expanding housing finance in Africa, a roomful of international bankers half-listened to me while doomscrolling their BlackBerrys (the apotheosis of tech back then) for green-pixelated fears that nationalizing America’s two most important Government Sponsored Enterprises (GSEs) wouldn’t stop the most significant financial collapse since 1929. As soon as my talk ended, I was asked by the audience, “Will it work?”

I paused, pretending that I had either inside information or unusual wisdom.  “I think so,” I said, hoping I believed it.

To everyone’s massive relief, it did work. 

Though conservatorship was an awkward and impermanent solution with no clear exit strategy, a breathtaking recovery occurred: the losses Fannie Mae and Freddie Mac reported on portfolio writedowns were subsequently reversed by asset writeups; under new management, the companies stabilized at profitability; their conservator the Federal Housing Finance Agency (FHFA) took the opportunity to recapture their earnings (‘Net Worth Sweep’), for which the government was sued, and eventually lost; and successive Administrations and Congresses kept putting reprivatization of Fannie Mae and Freddie Mac back in the ‘too hard for now’ bucket, with no end in sight, even while making quiet preparations for reprivatization (such as capital accumulation).

Now, 17 years after that near-financial-death experience, are we going back to that before time? 

Perhaps in response to financial folks feeling risk-evaluation whiplash, the President followed six days later with another Truth Social post, in his inimitable syntax, seeking to calm the turbulent political waters:

Our great Mortgage Agencies, Fannie Mae and Freddie Mac, provide a vital service to our Nation by helping hardworking Americans reach the American Dream — Home Ownership. I am working on TAKING THESE AMAZING COMPANIES PUBLIC, but I want to be clear, the U.S. Government will keep its implicit GUARANTEES, and I will stay strong in my position on overseeing them as President. These Agencies are now doing very well, and will help us to MAKE AMERICA GREAT AGAIN!

Exactly how one can put the genie of explicit guarantee back into the implicit-guarantee bottle may be clear to the President, but is unclear to us mere mortals. Even if that is solved, returning the companies to being publicly traded securities will reanimate thorny conflict-of-interest and policy-profit tensions inherent in their previous publicly traded incarnations:

1. Moral hazard with the Federal balance sheet. Before conservatorship, the capital markets’ approach to Fannie/Freddie securities was a masterful crowd hypnosis of doublethink. Elected officials continued to deny the guarantee’s presence: “there is no guarantee,” Barney Frank once said in his trademark rapid-fire slurry, “there is no explicit guarantee, there is no implicit guarantee, there is no wink-and-nod guarantee,” and the capital markets cheerfully believed he and everyone else were fibbing, for they priced Fannie Mae and Freddie Mac securities at levels indistinguishable from like-term Treasuries.

• Expanding affordability versus riskier loans. Starting with the 1992 amendment to their charter that the GSEs “have an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families in a manner consistent with their overall public purposes, while maintaining a strong financial condition and a reasonable economic return,” Fannie Mae and Freddie Mac went down the income pyramid and up the risk pyramid. They moved steadily and in progressively larger volumes into providing liquidity for subprime lending, continuing up through August 2008, with massive balance sheet growth that ceased only at conservatorship. 

As the Washington Post wrote pre-conservatorship, when Fannie’s losses were shooting up, “With the dual incentives of fostering affordable housing and making money, [Fannie Mae was] caught between the imperatives of increasing its market share while avoiding excessive risk. In a bid to juggle these demands, the company’s executives took on risks they either misunderstood or unduly minimized.” 

• Principal-agent risk, governance, and executive compensation. When corporate managers can bet with the company’s balance, they have the financial levers to ‘privatize the gains, socialize the losses,’ as a 100-year-old Wall Street motto has it. Fannie Mae’s pre-collapse CEO, CFO, and Controller were sued by shareholders and settled their lawsuits with fortuitous timing, five months before the companies were seized.

In short, between 1990 and 2008, the last time these tensions were in place, the GSEs’ growth made them politically bulletproof. Though FHFA’s predecessor as GSE regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), periodically issued scathing and prophetic reports stating that the balance sheet was turbocharged, earnings were smoothed out, and criticism was squelched or sidelined, the GSEs (they imperiously declined even to comment), and Congress ignored the warnings.

This failing of regulatory backbone, alas, was not unique to those Congresses or this country.  Around the world, countries repeatedly endorse and regularly elect politicians who facilitate riskier lending choices to low-income households. No matter the moral hazard (or turpitude) of the lenders’ management, some institutions can become too big, and too dominant, to be allowed to fail. In the 1933 Emergency Banking Act, the Federal government became the ultimate reinsurer of market existential risk, and other post-Depression democratic central bankers followed. This played out around the world in 2008, as country after country found itself having to seize, recapitalize, and absorb a large portion of the losses of its overly exuberant major financial institutions. 

Political-risk guarantee feels baked into modern democracies, and in 20-plus years of impotently worrying about these issues, I’ve found no solution – nor have far more insightful economists than I, Ken Rogoff and Carmine Reinhart, who titled their 2009 book on a century’s worth of financial crises, “This Time is Different.”

Perhaps there is a way to resolve all the tensions inherent in what the President has proposed – take them public, maintain the guarantees of safety and soundness, and help hardworking Americans achieve homeownership. 

Today, if I were asked on a panel about GSE reprivatization, “Will it work?” I would say, “I don’t know,” hoping I could believe otherwise.