I saw recently that Fannie Mae and Freddie Mac are exploring potential IPOs — again.
These government backed real estate giants failed spectacularly in the last financial crisis. There is serious skepticism on the Street for whether being outside government control means that a future government backstop goes away.
Fannie and Freddie’s mortgage portfolios imploded in 2008, requiring almost $200 billion in bailouts. While these entities deal only in residential real estate financing, they are so massive and so deeply integrated into the financial system that their problems can cause serious problems far and wide. Fannie and Freddie are too big to fail, and so they’ve been in government conservatorship ever since.
Now there’s talk of shifting their ownership back to investors. Is this a good idea? Their intended role is to offer government backing to mortgage lending, which makes home ownership more accessible to the public. Unfortunately, this model creates some bad incentives to take extra risk, safe in the knowledge that Uncle Sam is waiting in the wings with unlimited bailout money. Count me as unsurprised that they have shown themselves historically to be poor managers of risk.
Unlike regular companies, Fannie and Freddie face limited risk of bankruptcy and dissolution in the case of a total failure. In short, they are a classic example of moral hazard — managers taking excess risk with other people’s money.
And there is clearly a lot of money to be made in mortgage backed securities, as demonstrated by the mortgage-backed-securities feeding frenzy back in 2006-2008. Selling Fannie and Freddie back to investors would mean that profits that are currently going to the US treasury will instead be paid out in dividends, while the new equity holders would assume the risk of Fannie and Freddie’s possible failure.
None of this directly affects Alliance’s commercial real estate market, but it matters indirectly. I’m generally skeptical of government interference in markets, and the mortgage market is a great example of that. Bureaucrats simply cannot allocate capital as wisely as a market can. I’m not sure if the proposed IPOs would change anything, but it’s a developing story that I’ll be keeping a close eye on.