Fannie's Lesson: The Real Scandals Are Legal

Commentary

I know the prospect of reading a column about Fannie Mae, the mortgage crisis and government bailouts is as appealing as a bowl of cough syrup. So let's consider the latest news about the giant company something young parents today call a "teaching moment."

The lesson is about this old and ignored government truism: The worst scandals are the ones that are perfectly legal.

The electorate and its press corps can get into an outraged lather about whether John McCain improperly took a ride on a crony's Gulfstream or whether Barack Obama is too close to a shady real estate operator. Congressional staffers are trained to know whether a gift basket of walnuts is kosher, and the difference between legal finger food and an illegal sandwich.

Fannie Mae is different. It is what is called a government-sponsored enterprise. It was established by Congress in the New Deal to buy mortgage loans from banks so they could unload some of the risk and make loans to homebuyers more safely. Wonderful.

So Fannie Mae was allowed to borrow money more cheaply than private mortgage security businesses and allowed to keep less emergency capital in the safe than competitors. As if that weren't enough, Fannie was made exempt from state and local taxes. Imagine if Goldman Sachs didn't have to pay New York City taxes.

There are strong arguments that Fannie Mae should have government backing to make home buying easier. There are strong arguments that the government should help stabilize Fannie Mae right now. I am agnostic on both points.

The ethical, as opposed to economic, fight is about whether the government-sanctioned benefits Fannie Mae has enjoyed should have been used to create the executive largess it did.

Fannie Mae was a quiet company that raised few financial eyebrows until the early 1990s.

Since then, however, Fannie Mae has been a government-sponsored wealth generator for its executives. That is wonderful, too, except for the small fact that this private wealth was gained by public support.

The man responsible for the change was James Johnson, a close aide to Vice President Walter Mondale who came to Fannie Mae in 1990. From 1990 to 2000, the company's stock grew 500 percent. Johnson earned scores of millions, and other executives earned money that was extraordinary for Washington at the time. It was extraordinary for a government-sponsored enterprise. That's when Fannie met controversy.

For example, the District of Columbia started wondering why, if Fannie was making so many people rich, it didn't pay the cash-strapped city any taxes. The nation's capital is still wondering, and local pols are trying to change the law and get at least a slice of the tax revenue, which was estimated to be around $300 million in 2007. That's a lot of cops on the street.

Johnson and Fannie responded by filling its executive row with former government bigwigs who were not there to manage money, but to twist congressional arms and protect Fannie's privileges. (A good list of those players can be found here.) They prevailed.

They still prevail. In just the first quarter of 2008, Fannie spent $1.39 million on lobbying. Those are huge numbers for Washington lobbying.

In 2004, Fannie was found to have misstated its finances. Thanks to its lobbying prowess, Congress trimmed no sails and added no regulation despite the obvious risks.

Lo and behold, the risks were real. Bad things happened. And now the government is pitching in and putting taxpayer funds at risk to stabilize Fannie Mae.

That is but another episode in a long-running legal scandal.

There are no hookers, embezzlers and slush funds. Just laws, lobbyists and pay packages.

In 1981, Congress passed the huge Reagan tax bill. The administration that declared its eternal fealty to the free-market made an exception for the tax code. The Reaganomics decided they, rather than the free market, should decide what specific industries should get special tax breaks to attract capital. Free marketers think otherwise, but never mind.

So capital flowed into oil exploration, real estate investment, llama ranching, jojoba bean cultivation and equipment leasing not because of profits, but because of paper tax losses that could offset real income. Those were the glory days of tax shelters, and for a spell, many of the wealthiest citizens paid no taxes at all. The tax breaks were protected by a cadre of the most swashbuckling.

That was a classic legal scandal.

Like the Fannie Mae saga, the scandal was intentionally sanctioned by government, perpetuated by professional lobbyists and of little interest to investigative reporters. The biggest scandals are the legal ones.

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