Tuesday, December 20, 2011

Fannie, Freddie, and Inconvenient Facts

A battle of words, as well as political agenda's, is underway over the causes of the current financial crisis - in particular the financial services industry challenges in the fall of 2008 which came as part of the collapse of the housing market.

To many, the facts are clear that the collapse of the housing bubble was the seminal event which precipitated the financial crisis.
The left's preferred narrative of the financial meltdown goes something like this: Greedy banks, encouraged by reckless Bush-era deregulation and lusting after ever-higher profits regardless of the risk, caused the financial crisis.

Fannie Mae and Freddie Mac, the two government-sponsored mortgage companies, were mere victims.

Well, the left has it exactly backward: It is a well-documented fact that government regulators twisted the arms of private banks to make subprime and other risky loans to people who couldn't pay them back.

And it imposed "goals" on Fannie and Freddie - with an implicit guarantee of taxpayer backing - to buy huge blocks of those loans and, ultimately, to resell them to gullible investors as mortgage-backed securities.

When the market fell apart, the banks were left with rotten loan portfolios, and Fannie and Freddie stuck the taxpayers with billions of dollars in losses.

To date, taxpayers have spent $169 billion on Fannie and Freddie's mistakes. But some analysts believe the losses could ultimately reach as much as $1 trillion.
Among the owners of the financial meltdown are not only the Clinton era appointees, including Jamie Gorelick, formerly of the DoJ, who was the creator of the 'wall' between intelligence services which impeded the sharing of information and contributed to the conditions for the 9/11 terror attack on the US, as well as former Senator Chris Dodd and Representative Barney Frank - who not only resisted all efforts to reform / regulate Fannie and Freddie, but also where the leaders pushing Fannie and Freddie to pressure banks to make subprime and high risk mortgage loans on the basis of 'social justice'.

These progressive lawmakers and officials used these GSE's to enact, via their powers to define and control mortgages, and therefore the housing market, to ensure that all, in particular minorities and those who did not have the financial history, security, or means to afford their debt obligations, were not impeded by their lack of history, security, or means.  In effect, the intent was to 'eliminate' poverty by eliminating barriers to home ownership - and to permit those home owners to borrow 100% or even more, since the assumption was made that prices will always increase, of the home's value for whatever material wants and needs the home owner's had.

The progressives in the US, obviously, dislike these facts.  Not only does it link their agenda and ideology to the root cause of the financial meltdown, but it also highlights the intellectual and fiscal bankruptcy of their approach towards 'social justice'.

Unsurprisingly, Joe Nocera writing in the New York Times today, takes these facts to task and attempts to place the blame back on greedy bankers and the lack of effective regulations which created an environment for unscrupulous lenders to prey upon minorities trying to live the American dream.  He spins the yarn that Fannie and Freddie only reluctantly got into the subprime mortgage market in 2005 - 2006 - under the previous Administration - and not only did not have any significant exposure in guaranteeing subprime mortgages, but didn't really guarantee these - the banks were the one's that did this.

Needless to say, Nocera's piece is deeply flawed - so flawed in fact, that the Times already has had to make one major correction to the piece.

The New York Times reporter Gretchen Morgenson, along with co-author Joshua Rasner, has already detailed the much of the problems related to the causes of the financial meltdown in their excellent, and fair, book "Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon".   They detail the corruption, greed, and desire to enact a political agenda on a 'free market' created the circumstances for the meltdown.  Many of the major players in this are progressive democrats and those who strongly supported progressive democrats.

Beyond this review of the problems, facts specifically counter the mantra of the left, like that articulated by Joe Nocera in the Times. Facts like the information from the Securities and Exchange Commission... 
Fannie and Freddie entered into agreements accepting responsibility for misleading conduct discovered by the SEC, including:

1. As of June 30, 2008, Freddie had $244 billion in subprime loans, while investors were told it had only $6 billion in subprime exposure.

a. Freddie knew it was inadequately compensated for the risks it was taking. For example, it was taking on “subprime-like loans to help achieve [its] HUD goals” that were similar to private fixed-rate subprime, but the latter typically received “returns five to six times as great,” says the complaint.

b. Freddie had concerns about risk layering on loans with an LTV >90% and a FICO <680. (Yet, in Freddie’s disclosures it only noted risk layering concerns on loans with an LTV >90% and a FICO <620. This is a major difference since only 10 percent of its loans fell into the LTV >90% and a FICO <620 category, while nearly half fell into the LTV >90% and a FICO <680 one.)  
2. As of June 30, 2008, Fannie had $641 billion in Alt-A loans (23 percent of its single-family loan guaranty portfolio), while investors were told it had less than half that amount ($306 billion, or 11 percent of its single-family loan guaranty portfolio).  
3. The SEC complaint disclosed that Freddie had a coding system to track “subprime,” “other-wise subprime,” and “subprime-like” loans in its loan guaranty portfolio even as it denied having any significant subprime exposure.  
These suits are important because they demonstrate that Fannie and Freddie “told the world their subprime exposure was substantially smaller than it really was … and mislead the market about the amount of risk on the companies’ books,” said Robert Khuzami, director of the SEC’s Enforcement Division.

Under pressure from influential progressive politicians, and eager to continue to receive multi-million dollar bonuses, the leaders of Fannie and Freddie undertook actions which were beyond risky.  They then lied about these actions to regulators and the financial services organizations which purchased the misrepresented mortgage securities.  They knew of their exposure to this growing subprime business - done to achieve the political goals of the Democrats, as those Democrats and their fellow progressives on Wall Street grew richer on the house of cards they created.  It was their political agenda and greed that created the circumstance where trillions in paper were effectively only paper - with no real value behind it as people could not pay their debt obligations.

These people were encouraged to act as the Federal Government acted - as if their debt obligations had no real meaning or effect on them.  Owe tens or hundreds of thousands?  Borrow more to buy more because you have a house and houses never drop in value.  Owe more than you make in income?  No problem, borrow more to cover the delta.

When jobs started to be lost - when the housing market started to cool off - when people could no longer borrow to finance their lifestyle - the real bill became due.  They could no longer borrow to live beyond their means. Unable to fulfill their debt obligations, they defaulted on those obligations which accelerated the problems for others. 

We are seeing this on a larger scale in Europe.  Greece, Italy, Spain, Portugal, Ireland, and soon France - unable and unwilling to live within their means, had to borrow from tomorrow to pay today's debt obligations.  As these countries find that they can no longer borrow - can no longer afford their increasing debt obligations, they approach default.  The cost of their default will be the extension of the crisis to other countries that were a little more fiscally responsible - or have a little more borrowing cushion left to draw on.  As one or more of these countries default, the problem will cascade to another, and another.

Here is the US, we are spending over $1.4 trillion per year than we bring in. We are borrowing over 40 cents on every dollar we spend.   Our annual deficit is nearing 10% of the Gross Domestic Product, and after having increased our national debt by about $5 Trillion since January 2009, we are faced with a national credit card balance of over $15 Trillion - or 100% of our GDP.  Rather than adjust our habits and reduce spending to live within our means, the political agenda of statism and bigger government is the primary focus on the Administration - and too many political leaders today.

Just as the mismanagement of these same forces contributed to the financial meltdown of 2008, these same forces are working towards a new financial meltdown - this time impacting the entire country and not just one segment of the marketplace.

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