Defective Enterprises

Fannie, Freddie, and Failure

How sky-high rewards for CEOs turn respectable enterprises into muggers of the American dream.

By Sam Pizzigati

Last week’s reports that the just-fired top executives at Fannie Mae and Freddie Mac may walk off into the CEO sunset with getaway packages worth a combined $24 million — after leading the two mortgage loan giants to billions in losses — had commentators clucking up a quick consensus.

We Americans, huffed pundits and politicos alike, simply must not tolerate windfalls for CEOs who perform poorly!

Ignore these guys. They have the problem all wrong. They’re going crazy about outrageously high rewards for poorly performing CEOs. They’re missing the real driver behind our current economic meltdown: the notion that outrageously high rewards, in a modern economy, play a perfectly legitimate role.

Global incomesSuch rewards, we’ve been assured over recent decades, give top corporate executives an incentive to “perform” well.

In fact, outrageously high rewards do nothing of the sort. Outrageous rewards, in everyday corporate life, serve only to give top executives an incentive to behave outrageously. The jackpots that CEOs can win have become so huge that executives will do most anything to win them. They will even, as the Fannie and Freddie stories so shamefully demonstrate, recklessly endanger the American dream.

Back in the mid 20th century, ironically, no outfits nurtured that dream any more admirably than Fannie Mae and Freddie Mac. These two “government-sponsored enterprises,” by buying up the mortgage loans banks made to lower-income Americans, brought capital and quality-control to the mortgage market. Thanks to Fannie and Freddie, millions of American families gained first homes of their own.

So what went wrong? How did two sober enterprises that actually helped working families evolve into reckless wheeler-dealers that have left millions of average households deep in debt and foreclosure?

The answer is floating in the compensation sea-change that has, over recent years, flooded and swamped America’s corporate executive suites.

A generation ago, in the prosperous decades right after World War II, top executives had no trouble staying sober, mainly because they had no reason to go off the wagon, no incentive to behave recklessly. If they operated responsibly, they could make decent money, maybe 30 to 40 times what their workers were making.

These top executives, to be sure, could have tried to cut corners. But what would have been the point? In the middle years of the 20th century, high tax rates on high incomes discouraged any reckless CEO moves to get rich quick. In the 1950s and into the 1960s, income over $400,000 faced a 91 percent federal tax rate. In the 1970s, the top-bracket tax rate never dipped below 70 percent.

This would change, under Ronald Reagan. One by one, the checks and balances of the U.S. economy that had kept an informal lid on how much top execs could expect to make all eroded way. The top tax rate slid down to 28 percent. And two other key brakes on executive misbehavior — a strong union presence at the bargaining table and consumer-friendly federal and state rules and regulations — withered as well.

In this new environment, CEOs suddenly had plenty of incentive to start playing fast and loose. By taking risks to fatten quarterly bottom lines and wow Wall Street, top executives could now make spectacular money.

And they did. In the 1980s, CEO compensation more than tripled, rising 212 percent. Some CEOs, by the decade’s end, were routinely taking in hundreds of times more pay than their average workers.

Top executives at Fannie Mae and Freddie Mac, at least at first, found themselves on the outside of this CEO pay feast looking in. Their enterprises were doing the same work that Fannie had been doing since its New Deal creation in 1938. But the executive rewards for that work, in America’s new corporate pay environment, now seemed painfully modest.

Fannie and Freddie execs, not surprisingly, sought in on the new CEO good times. They started looking for alternatives to their traditional business as usual that might start exciting Wall Street. If they could do that exciting — by upping their corporate earnings — their share prices would rise. And if their share prices rose, then they, too, could finally share in the windfalls showering down on America’s CEOs.

The wheeling and dealing era at Fannie and Freddie had begun. The two mortgage giants would move quickly to get the green lights they needed to start stretching their traditional role. They unleashed a ferocious lobbying blitz on Capitol Hill, spending millions to ingratiate themselves with legislative power-brokers.  

The lobbying would pay off. In 1989, for instance, lawmakers made “some modest-seeming” rule changes that, a Washington Monthly analysis has noted, left the securities Fannie and Freddie marketed “much more attractive to investors.” Other changes enabled Fannie and Freddie to start buying up mortgages for upper middle class housing.

The two enterprises, once champions of lower-income households, were now championing any maneuver that promised higher short-term quarterly earnings — and using those higher earnings, critics would charge, to pump up profits, not help ease mortgage rates.

In 1992, one Republican moderate in Congress, Rep. Jim Leach from Iowa, would warn that Fannie and Freddie were evolving “from being agencies of the public at large to money machines for the stockholding few.” No one paid attention.

By the mid 1990s, notes Washington Post analyst Stephen Pearlstein, Fannie and Freddie were pushing the envelope big-time.

“Instead of just buying mortgages, insuring them and selling them in packages to investors,” Pearlstein points out , “they bought more of them for their own portfolios, using ever-increasing amounts of borrowed money.”

The rewards for this financial derring-do? Fannie Mae CEO James Johnson was soon pulling in $5 million a year. His successor, Franklin Raines, took just four years to accumulate stock worth $17.4 million and stock options worth an additional $113 million.

To keep these lucrative gravy trains running, Fannie and Freddie execs were willing to do anything, even cook their corporate books to a burnt cinder. At Freddie Mac, CEO Leland Brendsel’s creative accounting manufactured $4.5 billion in phony earnings. At Fannie Mae, $9 billion of accounting “errors” would eventually have to be corrected.

The Fannie and Freddie book cooking would eventually flame into the headlines in 2003 in 2004. Both Freddie’s Brendsel and Fannie’s Raines would end up getting axed. Gently, of course. Brendsel took up retirement residence in a $4.1-million country estate on Maryland’s Eastern Shore. Raines retired with $25 million in pension benefits.

The boards of directors at both Fannie and Freddie, suitably embarrassed, piously pledged a new era of reform. They installed fresh faces in their chief executive suites.

But the boards left in place the same outrageously lucrative executive pay incentives that had so tempted Brendsel and Raines, in the process brushing off analysts from the Federal Reserve Bank of St. Louis who advised that “executive-compensation arrangements in particular” ought to be “an important component of the reform agenda.”

The new Fannie and Freddie execs, if they played their cards cleverly enough, would now be able to win the same windfalls their predecessors so zealously went after.

The new executives, predictably enough, promptly started their card playing. Instead of blowing the whistle on the speculative national housing bubble then inflating so obviously, Fannie and Freddie jumped head-first into the speculation, rushing recklessly into the subprime market.

These new speculative games would help the top execs at Fannie and Freddie to sizeable personal fortunes. Freddie CEO Richard Syron would pocket $19.8 million in 2007, Fannie Mae CEO Daniel Mudd $12.2 million.

Then came the subprime crash — and an end to the speculative games. Fannie and Freddie currently stand awash in staggering buckets of red ink, and Treasury Secretary Henry Paulson has executed a federal takeover that leverages tax dollars to save the two enterprises from total collapse.

As part of the takeover deal, Freddie Mac CEO Syron and Fannie Mae CEO Mudd have been shown the door.

Their chief executive successors, the Federal Housing Finance Agency has announced, will be taking home “significantly lower” paychecks, a stunningly candid — if long overdue — admission that outrageously high rewards really serve no socially redeeming economic purpose.

Unfortunately, throughout the rest of our contemporary corporate casino economy, outrageously high rewards remain standard operating procedure. Average Americans, until that changes, will remain our economy’s most consistent losers.

Sam Pizzigati edits Too Much, the online weekly on excess and inequality published by the Washington, D.C.-based Institute for Policy Studies.

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