Power Lunch

Power Lunch

Why mortgage giants Fannie Mae and Freddie Mac pose a huge threat to the market

Fannie Mae and Freddie Mac are huge, systemic risks to the global financial markets and American homeowners.
Shaky Ground: The Strange Saga of the U.S. Mortgage Giants book cover.
Source: Amazon.com

Some of the major concerns involving investors' money right now include China, the Federal Reserve and weak U.S. growth.

But perhaps one of the biggest threats to the markets could be lurking right in your backyard. Namely, Fannie Mae and Freddie Mac, two of the world's largest financial institutions that collectively control over five trillion dollars in mortgage debt

Because what happens to these two government sponsored enterprises, or GSEs, impacts nearly everything from the broader housing market to the global economy.

Which is why Wall Street and Washington are locked in a battle to decide their fate, and one of the reasons why noted author Bethany McLean decided to write a book, "Shaky Ground," about this critical situation.

Mortgage giants on 'Shaky Ground'?
Mortgage giants on 'Shaky Ground'?

Mclean told CNBC's "Power Lunch" on Wednesday about the lurking risks.

"Here we are seven years after the financial crisis and these two are still supported by a lifeline from the U.S. Treasury," said McLean. "Basically the U.S. government has decided to sweep all their profits and use them as a little slush fund for budget deficit reduction. They have no capital, none, and this despite the critical purpose they serve of guaranteeing most Americans' mortgages."

McClean describes the government's profit-taking a prime example of political dysfunction.

"The government has an addiction to GSE's profits," said McLean. But if they suffer a loss, they will need to draw from taxpayers. We are talking a massive systemic problem in the works."

With the Federal Reserve in the middle of its two day meeting this week, McLean said if a rate hike occurs, the repercussions will be enormous for American taxpayers.

"If there is a wrinkle in the market, if this interest rate increase causes havoc in the market, it will affect the lives of every homeowner…mainly because it could cause Fannie and Freddie to have a huge quarterly loss."

Big hedge fund managers are also deeply concerned about their fate of these two GSEs.

"You have many irate investors who bought shares back in 2008, 2009 in hopes of creating value," said McLean. "Then the government stepped in and took those profits. A shakedown, of sorts."

Among those taking issue with Uncle Sam over Fannie and Freddie is their largest shareholder, Pershing Square Capital founder, Bill Ackman.

Earlier this week, Ackman said the government is doing an "illegal" act by taking these profits. " If the US government can step in and take 100% of profits of a corporation forever, then we are in a Stalinist state and no private property is safe."

And Ackman is not alone in his concerns. John Paulson at Paulson & Company,along with Perry Capital, Blackstone and Claron Road all hold considerable stakes in Fannie and Freddie.

"These investors are all a thorn in the government's side, due to lawsuits and public outcry," said McLean." If not for these powerful and influential investors, the government would essentially have free rein."

Bank of America Merrill Lynch analyst Ralph Axel recently said: "The fate of government-sponsored enterprises (GSEs) is not only of critical interest to home buyers, home builders and mortgage bankers but also to almost every investor class across the globe. For a market that thrives on being considered a substitute for Treasury debt, turbulence and uncertainty is the worst case scenario. But unfortunately, the fate of the GSEs is still very much in flux, and more so today, in our view, than ever before."

McLean added "I cannot believe in an era where everyone is up in arms about capital requirements at the big banks that we are content to let the GSEs operate with next to no capital. The housing market and financial system remain on very shaky ground."