Thought about it all weekend… still couldn’t figure it out

Last Friday, the Federal Housing Finance Agency (FHFA) announced a lawsuit against 17 major banks alleging misrepresentations involving of mortgage-backed securities sold to Fannie Mae and Freddie Mac.  Both Fannie and Freddie are presently under the conservatorship of FHFA after they went belly-up.  There’s nothing unusual about a conservator trying to recapture losses due to misrepresentation, but this particular case is awfully confusing.

So confusing, in fact, that I tried to flowchart it this weekend and couldn’t figure it out.  Since I’m not particularly the finest drafter of flowcharts nor an expert on the economics of banking, I thought I’d share my conclusions here and maybe a reader could help me understand.

The facts as I read them are as follows:

  • Freddie Mac and Fannie Mae were infused with $200 billion in taxpayer money to keep them from collapsing under the weight of bad mortgages prior to them being put under the control of FHFA.
  • The banks being sued were infused with $245 billion in taxpayer money via the TARP program to keep them collapsing under the weight of bad mortgages.
  • In exchange for bailing out Fannie and Freddie, the U.S. Treasury received $2 billion in preferred shares of the GSE’s, paying a 10% dividend.
  • The troubled Residential Mortgage Backed Securities involved in this lawsuit are worth about $55 billion, plus any punitive damages.

So…  if I understand the facts…

Taxpayers put a total of $445 billion into a combination of the prosecutor and the defendant.  If the prosecutor should prevail, $55 billion plus damages of taxpayer money would be transferred from the rescued banks to the rescued GSE’s.  The resulting shuffle of already-spent taxpayer capital would result in an estimated 30, 000 banking jobs lost, while the political capital of  “sticking it to the banks” would be invaluable.

The net economic effect of the lawsuit?  Zero.  The number of underwater mortgages resolved as a result of the lawsuit?  Zero.  The taxpayer benefit of the lawsuit?  Zero.

Am I missing something here?

It’s like living in a metaphorical version of a 1912 high-class cruise.  We’ve spent billions on this lovely ship.  It hits an obstacle and splits in half in the North Atlantic.  The deck chairs (or billions of dollars) are shuffled about and the band plays on (the lawsuit is jawboned) to keep the passengers happy.  Rearranging the chairs and hearing the pretty music seemed nice for a while…

For a while.

But ultimately, the passengers come to realize that shuffling chairs under the dulcet tones of the orchestra does nothing to keep the ship from sinking.

You can perform superficial acts to keep fear at bay for a while, but ultimately reality sets in.

When you’re finally dunked in the briny deep, the water is very, very cold.