Giving 'chutzpa' a bad name

Kara, then about 6 years old, drew a bucket of oats being poured on the ground and a bird picking at the oat-flakes.

Dirk, about a year and a half older, drew a bucket of oats being fed to a horse and a bird picking away at what he delicately labeled “wuobaba.” Loosely translated from the Chinese, it means “horse manure.”

Dirk’s model was the more realistic of the two, because that one is widely used in our democracy: The horse model now is the chief business model of our financial sector.

The children’s sketches popped into my head as I read with wonderment the following report from the world of seasoned adults: “Buffett Joins Goldman in Bid for Fannie Mae Tax Credits” (The Wall Street Journal Online, November 5, 2009). It is an idea so brazen that it gives the word “chutzpah” a bad name.

Since 1986, the U.S. government has extended generous tax credits to investors who finance the construction of low-rent housing for low-income families. During the housing bubble earlier in this decade, Fannie Mae had loaded up on such tax credits by buying up mortgages on such projects, indirectly financing them. These tax credits were carried as assets on Fannie Mae’s balance sheet, because they could be used to offset future federal taxes owed on Fannie Mae’s future profits, which were expected to be solid.

“Who’s Fannie Mae?” you may wonder.

Fannie Mae is the nickname for the Federal National Mortgage Association (FNMA), a former federal agency established in 1938 to purchase government-backed mortgages from the original mortgage lenders.

In 1968, Congress, in its wisdom, chartered this agency as a private company whose stock has been traded on the New York Stock Exchange and whose executives — usually folks with political connections — had paid themselves as if they were private bankers, even though Fannie Mae is subject to oversight by the federal Department of Housing and Urban Development.

To its critics, myself included, Fannie Mae represents a truly grotesque economic mongrel that allowed by Congress to seek private profits (an lush executive compensation) at taxpayers’ risk. It has thrived over the years mainly on the support of federal legislators whose affection it purchased with hundreds of millions of dollars of campaign financing.

The huge debt Fannie Mae had issued over the years to finance its purchases of mortgage loans was never officially guaranteed by the federal government, but it was widely expected that the government would step in as savior, should the ostensibly private Fannie Mae ever be so mismanaged as to fall into bankruptcy.

That moment came in September of 2008, when Fannie Mae faced bankruptcy. As widely expected all along, the federal government swiftly came to the rescue with billions of taxpayer dollars.

Since then, Fannie Mae has been an even more grotesque creature: a government-owned entity on whose balance sheet sits billions of unused tax credits it cannot use in the foreseeable future — because it will not earn any profits in the foreseeable future. Still thinking of itself as a regular company, it now seeks to sell these tax credits at a discount to investors who have profits to shield from taxation.

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Enter the Goldman-Buffet duo, mouths salivating. They might offer Fannie Mae, say, 80 cents for every $1 of unused tax credit and with that credit pay the federal government $1 fewer profit taxes, for a handsome profit of 25% on a virtually riskless investment. (The actual discount offered by the duo is not publicly known)

Think about it. For some $3 billion in tax credits, the Goldman–Buffet duo might pay Fannie Mae substantially less — say, $2.4 billion. Their touching argument is that this money would support the low-income housing market, because government-owned Fannie Mae could then buy $2.4 billion of mortgage loans on such housing from local mortgage lenders. Once again, we have hungry horses movingly pretending to be bird lovers!

But to get that $2.4 billion injected into the low-income housing market, the U.S. government would lose $3 billion in tax revenue that other taxpayers would then have to make up with higher taxes.

Apparently, after brooding about it for about a week, the U.S. Treasury now is poised to turn down this deal. That is uplifting news. The wonder, though, is that the Secretary of the Treasury would ever have given this idea a courteous hearing, instead of throwing the brazen duo out on their ears.

The only virtue of the deal, as I see it, is that it gives us a marvelous insight into the wondrous cerebral processes that drive the world of finance. As I remark above, these processes give the word “chutzpah” a bad name.

Uwe E. Reinhardt is the James Madison Professor of Political Economy and a professor in the Wilson School. He can be reached at reinhard@princeton.edu.