Editor's Note: Shah spotted this crisis unfolding. It affects your money, so he wanted to let you know about it immediately. Here's Shah...
Do you remember the financial crisis of 2008?
The one caused by a meltdown in mortgages... trillions of dollars of which were owned and "guaranteed" by government-sponsored enterprises Fannie Mae and Freddie Mac?
Do you remember that Fannie and Freddie had to be bailed out by the government - I mean taxpayers - so their total implosion wouldn't trigger a global depression?
Well, the man behind their bailout, former Treasury Secretary Henry Paulson, remembers, and vividly.
He's now going public with his recollections because Congress is blocking theirs out... reaping the profits... and setting the table for a repeat performance...
The "Deadbeat Duo" Is Still on the Loose
The Washington Times recently conducted an exclusive interview with Mr. Paulson, the architect of the Fannie and Freddie rescue.
That rescue put them into a government "conservatorship" before they destroyed the financial world.
As Paulson said, "Every financial crisis has its roots in flawed government policies that lead to excesses in the markets that build up and build up, and then you get a bubble and it bursts."
Thing is, he wasn't talking about then. He was talking about now.
The interview precedes the release in theaters this week of Hank: Five Years from the Brink, a documentary collaboration by Bloomberg BusinessWeek Films and award-winning director Joe Berlinger. It's about the drama and debacle of the mortgage meltdown.
Paulson used the interview to express his fear of the increased dominance of both Fannie and Freddie since the crisis and how their still massive size and subsequent profitability (yes, they're very, very profitable now) has crowded out private mortgage insurance operations and once again puts the country and taxpayers at risk.
Paulson cites Congress' failure to break up the leviathans and instead their support of them to reap the billions of dollars in profits they now feed the Treasury. He believes that's the reason they're still around and the reason he's worried about another crisis.
Paulson believes, "Political leaders and the public have not focused as much on their critical role in the housing debacle, perhaps because he stepped in and took control over the Goliath's before a crisis occurred, in what he views as his single biggest move to stem the crisis."
"We took action before they started to unravel, before there was a failed auction. The public never saw that horror show," he said. "People never focused on what their failure or near-failure would have done," he said.
He suggested the ensuing crisis would have been much bigger than the financial collapse in the wake of the Lehman bankruptcy. They [FHLMC & FNMA] were collectively nine times bigger than Lehman Brothers "and the massive damage to the housing and mortgage markets could have been many times worse."
Paulson said, "It perplexes me that nothing has been done and both parties seem content to just allow the housing market to drift through yet another era of government dependence and dominance that potentially is creating even bigger market distortions."
The problem, which Paulson doesn't go into in depth, is that as of this week, Fannie and Freddie have collectively paid the U.S. Treasury more than $187 billion in "dividends" from operations. It's an amount larger than what the government said they used to bail out the deadbeat duo, because the payments include interest.
The Real Story
While that sounds good, it's really shady. The Housing and Recovery Act (HERA), passed in July 2008, authorized the newly minted Federal Housing Finance Agency (FHFA) to put both Fannie and Freddie into a statutory conservatorship and required FHFA to manage the assets of both corporations to facilitate their orderly return into private hands upon repayment of the government advances.
Under terms of the agreement that governed the conservatorship, each corporation had to issue a new class of senior preferred stock to the United States, which bore interest at 10% per annum. That sum increased to 12% if Fannie and Freddie chose to conserve cash instead of paying dividends.
But the deal changed in August 2012. An amendment called for a "net worth sweep" whereby the FHFA and Treasury converted all the net receipts of Fannie and Freddie into "dividends" to be paid to the government.
Now the two corporations will never pay off their debts to the United States, no matter how much money they pay, because they're paying dividends and not principal. The Wall Street Journal rightly charged the federal government with "astonishingly duplicitous behavior."
Paulson intimates that Congress is happy to let the Duo do their thing because their payments reduce the deficit and facilitates spending.
Without an alternative to Fannie and Freddie guaranteeing mortgages and warehousing them (before the crisis, they owned or guaranteed more than half all mortgages in the United States, and according to Paulson, have "increased dramatically their dominance"), there would be far fewer mortgages made, grossly impacting the nascent housing recovery.
But what Paulson points out, and in fact is worried about, is that the dominance of the two Government Sponsored Conservatorships are prone to listing and potentially keeling over again if another mortgage missile misfires and hits them broadside.
If Hank Paulson is worried, we ought to be worried too...
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.