Fannie Mae Meltdown Explained

If you are a normal person, you may have seen all the headlines about "Fannie Mae" and "Freddie Mac" over the weekend and wondered why the economy cares about two old people with weird names. But these are both quasi-government lending companies which are on the verge of being officially taken over by the Federal government. This article attempts to explain the crisis in Fannie Mae in a way that a layman can understand.

By the time I showed up in the mid-1990’s, Fannie Mae had become one of the largest buyers of its own securities. Its stock was up over 40X from it’s 1980s nadir and it seemed as though the single biggest problem it had was deciding on how much money it wanted to make. This was a bigger problem than you might imagine because as a quasi-government agency, and a constant political football, Fannie Mae realized it couldn’t be seen to be abusing its market position. So rather than go crazy and buy every mortgage security in sight, Fannie Mae just settled on charting a nice predictable upward growth in earnings fueled largely by buying an ever increasing share of its own securities.

Now a normal private company could not pursue this strategy because as it issued more and more debt to fund the golden goose, the yields on the incremental debt would start to increase to the point where the strategy no longer made sense. But Fannie Mae was different. Because of the implicit government guarantee of its debt, Fannie could issue incremental debt with little or no regard to its existing debt load because everyone assumed the federal government would backstop the debt.

The more I hear, the more I think the operative term in the financial meltdown is "hubris". So many people doing so many stupid things with the assumption they'd be able to cash out before it collapsed.