Notably, a discussion of the future of Fannie Mae and Freddie Mac was completely absent from financial-reform proposals, because, bluntly put, no one knew how to fix the mammoth mess. It was astounding, considering that the agencies held $5.3 trillion in mortgages. A frustrated insider complained to me, “How the government let Fannie and Freddie operate for the twenty-five years before 2008 was scandalous, and how the government now can fail to deal with them is even more scandalous.” I couldn’t find one person, on or off the record, who felt that a solution could be found while the economy was still fragile. “If the government were to stop supporting Fannie and Freddie as they are right now, that would cause a run on the government debt, as Fannie and Freddie debt is owned all over the world,” said an analyst. In an interview with Senator Dodd he admitted that he would have liked to have seen Fannie and Freddie be a part of financial reform, but it just wasn’t possible. “Nobody knows what to do with it,” he told me candidly. “It’s so big. Clearly you’ve got to replace Fannie and Freddie with some alternate idea. Frankly, no one knew exactly what they’d like to replace it with.”
The issue is that Fannie Mae and Freddie Mac, being GSEs—government-sponsored entities—have the support of the U.S. Treasury but are also partly investor-owned and publicly traded like any other public company’s stock. Companies, investors, and governments around the world buy their debt because of the belief that the U.S. Treasury will support them. As Frank told me in 2009, “We should not have entities that investors buy with a wink and a handshake that if anything goes awry, the U.S. Treasury will be there to bail them out.” But so far there has been no change to that structure, although in mid-2010, the companies were forced to de-list from the New York Stock Exchange, and they moved to another exchange. They did this after failing to meet the minimum trading requirement of $1 a share for more than thirty days. Fannie Mae and Freddie Mac stock prices hit lows of 35 and 40 cents, down from 2007 highs in the mid-50s and mid-40s respectively. Their all-time highs were well above $100 a share. Meanwhile, the cost to taxpayers of government conservatorship continues to mount—$145.9 billion as of this writing, and expected to rise much higher.
While financial reform was moving forward in Washington, the situation on Wall Street remained volatile. One disturbing note was a consistently nervous market. Upswings did not involve broad investor participation. There were a variety of reasons. One, of course, was that the wounds of 2008 and the first part of 2009 had not yet healed. The money lost was so severe in many cases that people couldn’t stomach the thought of losing even more. They opted for bonds and cash over the perceived risk of stocks. Banks were frozen, uncertain of the new expenses to come. A “flash crash” on May 6 didn’t help matters. It was a scary day at the NYSE as we watched unprecedented activity.
The day started with a lot of nervousness over the situation in Greece. By the afternoon, huge sell orders were coming in without balancing buy orders. The NYSE operates under an auction system. If there is an overload of sellers, the specialist must be a buyer in order to make a market. Amid volatile activity, the NYSE decided to employ a temporary time-out, stopping trading on a handful of stocks that showed unusual trading levels so the specialists could analyze their next steps. These included widely held stocks like Procter & Gamble and Accenture. But during the ninety-second trading pause, the business didn’t stop; it was diverted to other electronic traders. With no buyers, stocks plummeted, and the Dow dropped 1,000 points. It all happened in a flash.
The shocking event illuminated an uncomfortable reality: The NYSE may have stopped trading, but others didn’t. There was no standard across all exchanges. It was like putting up a fence but leaving a giant hole in the middle. The SEC knew it but did nothing about it. In effect, the system was flawed, and we were lucky it didn’t get much worse. Watching the Dow drop caused jitters, even though it recovered quickly.
SEC chairman Mary Schapiro told me it was a wake-up call, and the SEC acted very quickly. She summoned all the exchanges and said to them, “You’re not leaving this room until we figure out not so much what went wrong, that’ll take a little bit of time, but how do we deal with the symptoms and what happened?” She got a good response from the exchanges, and they set about establishing new controls that would prevent a recurrence. But the panic people felt on May 6 would take a while to subside.
This event brought me back to considering the question of confidence, the foundation of market strength. Did individual investors lack faith in the market? At the heart of investing is the idea that the stocks we buy will rise or fall based on the performance of an individual company, the state of a sector, or the health of the economy as a whole. If investors did not believe this to be the case—or, more pointedly, if they believed the game was rigged against them—they would stay away. Who
