Newal Company: Corporate Strategy |
Freddie Mac Current Strategy:
Freddie Mac and it’s recently hired CEO, Ed Haldeman, are in the difficult position of managing one of the mortgage markets most critical enterprises through the greatest housing crisis since the Great Depression. The political and public backlash associated with the unprecedented $200B in government backstops for the failed GSEs have handicapped the management of these entities and forced a compromise between policy and shareholder responsibility. Policy makers and government regulators have publically blamed the GSEs (Fannie Mae, Freddie Mac and others) for the mortgage crisis and subsequently imposed significant ...view middle of the document...
In addition, Freddie Mac’s strategy hinged on convincing the public of their importance to the housing market historically and in the future. Haldeman believed that decreasing the public’s distaste to the GSEs was paramount to successfully exiting conservatorship. It was widely understood that the GSEs could not be competitive or even considered a going concern until they were able to successfully rid themselves of government limitations and develop a profitable business model going forward. This new business model must be flexible enough to sustain drastic changes to the government’s role in guaranteeing Freddie Mac’s liabilities and obligations.
Freddie Mac’s Performance Review:
Through the series of policy relaxations and efforts to revive the economy from past recessions, politicians slowly eroded the quality of mortgages that were eligible for GSE guarantees. The increasingly higher default risk to Freddie Mac mortgages created the securitization wave that pooled GSE mortgages and sold them to third parties as a diversified mortgage bond product (MBS). This process drastically increased the liquidity in the mortgage market and the ability of GSEs to offer low interest rates. It is worth noting however, that the GSEs became dependent on liquidity within these markets to maintain profitability and loan growth. As this process continued and evolved GSEs found themselves compiling mortgage pools of riskier and riskier assets. This practice drastically weakened Freddie Mac’s financial position. This weakening was not met with increased borrowing costs for the GSEs as the market deemed the implicit government guarantee as sufficient to warrant an ultra-high credit rating.
The housing downturn and subsequent decline in average home value increased the default rates in these pools as borrowers found their home equity destroyed by decreasing value and high principal balances. A mortgage borrower with little-to-no equity has little motivation to service a loan that they cannot afford. Distressed borrowers were often incentivized to abandon mortgages since the collateral for the mortgage was worth far less than the remaining principal. The result was increasing calls for the GSEs to honor their guarantees. The lack of clarity and oversight in the securitization process and secondary markets for these products made it difficult to accurately measure the extent of defaults in a given MBS. This confidence issue caused the once liquid MBS markets to all but dry up completely. The ballooning liabilities forced regulators to issue an unprecedented guarantee on their assets.
The terms of conservatorship left public shareholders holding a mere 20% of Freddie Mac’s equity. However, the law reserved 100% of voting rights for the government. In almost all instances of public ownership a CEO is charged with maximizing shareholder value. When the government took control of Freddie Mac they essentially removed this motivation, sacrificing shareholder...