Congress and the Administration have now picked their targets for regulatory reform following the long-inflating credit bubble that finally burst in 2008, the aftermath of which still suppresses economic activity here in America as well as the rest of the world. Commercial banks, investment banks, financial products, derivatives, etc. . . .all were placed in the crosshairs of the big legislative and regulatory guns in Washington and, perhaps, well they should be. One trophy-size culprit, however, seems nowhere to be found on the target lists of the Congressional or Administration grenadiers. Fannie Mae, that publically traded, congressionally created, private enterprise (GSE or government-sponsored enterprise in beltway speak) seems to have totally escaped the purview of the government blame seekers. Small wonder. Of all of the bailouts handed over to private banks, investment firms, automobile companies and insurance companies, none have been more outrageous than the bailouts provided to Fannie Mae and it’s first cousin, Freddie Mac. Although the government very belatedly seized these GSEs, taxpayer money continues to be provided to these hybrid public‑private creations right under our collective noses each and every day. The Congressional pontificators have focused attention on every miscreant except the one they (or their predecessors) created and which they continue to feed.
Everyone agrees that the overheated housing market created a pricing bubble that was destined, like the San Andreas Fault or Eyjafjalljokull, the volcanic mountain in Iceland, to experience a major blow-up. Thus, the country was treated to the laborious hearings, the parade of witnesses, the written testimony and the mountains of documents presented at the recently staged congressional hearings. We now have, from the Senate, a gargantuan 1500-page bill that will, when reconciled with an earlier House version spawn new federal agencies, regulatory rulemaking, changes in market trading patterns, reorganization of many of our major financial institutions and the sure-to-follow litigation being cooked up by hordes of trial lawyers to make sure the evil doers are punished (and their own pockets are lined with large class-action contingency fees).
Absent from this amazing flurry of lawmaking oversight “reform” activity, however, are Fannie and Freddie whose policies were, perhaps, most responsible for the housing and related financial market wreckage, the individual bankruptcies, the supply overhang and all of the related effects of a burst housing bubble. These two companies have operated with a largess of support from the federal government (that would be we taxpayers). We, all of us who pay taxes, provide to these public-private basket cases lines of credit through the U.S. Treasury, exemption from state and local income taxes and a lower cost of borrowing. The bonds of Fannie Mae and Freddie Mac are perceived to have the backing of the government; and while that is not literally the case, that perception has enabled these hybrids to enjoy lower costs of borrowing resulting from the higher credit ratings which the implicit backing of the government makes possible. How could any company with such advantages, i.e., exclusion from state and local taxes, lower borrowing costs, virtually unlimited demand for its services and very high-powered, high-salaried, highly bonused, politically connected executives ever make such a mess of things.
Fannie and Freddie were created to buy fixed-rate mortgages from banks, which provide loans to lower and middle-income buyers who often invest little equity in their homes. As these two government-sponsored enterprises purchase mortgages from banks, the banks are able to lend more money to buyers. The ease with which people could acquire homes with the help of Fannie and Freddie, of course, increased the demand for homes, which is exactly what the government intended when it created Fannie and Freddie. In fact, the government required lending institutions to increase the ratio of loans in low-income areas. Because of the increased ratio requirements, institutions in the primary mortgage market pressed Fannie Mae to ease credit requirements on the mortgages it was willing to purchase, enabling them to make loans to subprime borrowers at interest rates higher than conventional loans. Fannie Mae and Freddie Mac, of course, also had an obligation to maintain shareholder value by maintaining profitability. Huge executive bonuses were tied to earnings, which would have been fine as long as those earnings were legitimate and consistent with the mission of the companies. But long before the current financial crisis unfolded the Securities and Exchange Commission had ruled that Fannie Mae had violated accounting rules, overstating profits by an estimated $9 billion between 2001 and 2005, which represented approximately 40% of its profits during those years.
This relatively new market, consisting of a large number of unqualified buyers, artificially stimulated demand, which, in turn, increased the prices for homes available for purchase. Homeowners, seeing the value of their homes appreciate year after year borrowed against the increased (inflated) equity to finance everything from college tuition for their children to improving the family standard of living, Hundreds of billions of dollars were loaned with borrowers putting little or no money down. As housing prices rose, homeowners cashed in their imaginary new wealth to pay bills, buy boats, cars and other creature comforts. Suddenly millions of Americans found themselves with a lot of debt and very little equity to prop up that debt. Add to this the millions of Americans who were convinced they could borrow beyond their means because, they rationalized, “their means” would increase as their home values increased. But, when the housing market began to run out of steam and home prices began to retreat, the decline in home values, represented a decline in the net worth people had, or thought they had accumulated.
The rest of the story is, of course, history. Taxpayers were left holding a bag containing hundreds of billions, if not trillions, of dollars of debt. Not only is this risk to the taxpayer not addressed by the new legislation, it continues unabated. Within the past couple of weeks Fannie Mae and Freddie Mac asked the Treasury for an aggregate $19 billion of additional taxpayer funds, and the hemorrhage is going to continue. These government-created behemoths, according to the Wall Street Journal, backed over 96 percent of all home loans in the first quarter of 2009.
Although ownership of Fannie and Freddie has been, since September of 2008, under federal conservatorship, by that time, Fannie and Freddie owned or guaranteed over half of the U.S.’s $12 trillion mortgage market.
In substance, government policy, at least since the Clinton Administration, has been to expand so‑called affordable housing in America. In furtherance of that policy, lending institutions vastly lowered the credit standards they historically applied to underwrite loans resulting in low or no equity loans for buyers who clearly could not otherwise afford the homes they were buying. Along the way it became the mantra of politicians that every American should be able to own a home . . . one step from saying every American should have the right to own a home. Sounds familiar doesn’t it? Read: right to a college education, right to government provided health care.
Given the incredibly relaxed lending standards, including low or no equity loans, one would assume that our lawmakers now would be screaming for overhaul and oversight of Fannie and Freddie. Their portfolios represent trillions of dollars in off balance sheet debt (which by 2007 consisted largely of sub‑prime or Alt‑A loans made without traditional underwriting standards) potentially as large and threatening to the nation as the unfunded liabilities of Medicare and Social Security. Such an assumption, however, would have been, and still is, wrong.
Repeated warnings by economists, members of the Bush Administration and Republicans in Congress that the debt of the GSEs was like a barrel of dynamite waiting to explode fell on deaf ears. In 2006, Sen. John McCain weighed in with a pointed plea for improved regulation of the GSEs. He warned of the enormous exposure of our financial system and the taxpayers to the unnecessary risks being taken by Fannie and Freddie. The Wall Street Journal has, on their editorial pages, for over a decade, alerted its readers to the risk to America of the grossly over‑stated balance sheets of Fannie Mae and Freddie Mac. By the end of 2007, the year before the housing bubble burst, Fannie Mae and Freddie Mac were sitting on combined debt and mortgage guarantees of $5.2 trillion that was supported by $83.2 billion (1.6%) of capital.
Democrats in Congress have been far less vigilant about the systemic risk posed by Fannie and Freddie than they have been about Wall Street investment bankers or large national banks that, essentially, packaged and sold bundles of mortgages ostensibly backed by these government sponsored enterprises. Whether this chronic failure by Congress to recognize the systemic danger to the financial markets the pathetic balance sheets of Fannie Mae and Freddie Mac represented was, and is, a result of the symbiotic relationship arising out of the campaign contributions congressmen and senators regularly receive from these GSE’s is really not for us to judge but the circumstantial evidence surely points that way.
Among the fifteen lawmakers who received the largest political contributions from those two companies in the ten years ending in 2008, the list includes: Sen. Chris Dodd (D‑Conn.), Sen. John Kerry (D-Mass.), then Sen. Barack Obama (D-Ill.), then Sen. Hillary Clinton (D-NY), Sen. Tim Johnson (D-SD), Sen. Kent Conrad (D-ND) and Rep. Barney Frank (D‑Mass.) . . . most of whom are the most vocal critics of Wall Street, or who serve on Committees which regulate the banking and lending industry (e.g., House Financial Services Committee, Senate Banking Committee, Senate Finance Committee) and who are among the most vocal advocates for campaign finance reform. Mr. Frank may be deserving of the “chutzpah” award since he has spent years blocking Republican efforts to impose tougher regulations on Fannie and Freddie even though he blames Republicans for their failure.
What we are witnessing in the debate now reaching its apex in Congress is the usual Washington game . . . an effort to shift blame rather than to legislate effective change. This is particularly so in an election year, especially a year when incumbents are being challenged by new political forces like those typified by the tea party activists. Democrats want to shift the focus to the evils and excesses of Wall Street and the big banks and they are not without some very good arguments. But can the voting public take Congressional Democrats and the Administration seriously about the need for more financial oversight if Fannie Mae and Freddie Mac, the two companies most directly involved in the funding of the housing bubble are allowed to continue, even under federal conservatorship, with business as usual? It looks to us like the Congressional majority is more interested in hiding their oversight malfeasance and restoring their candy store flow of reliable campaign contributions than protecting the taxpayers from the predatory practices against which they have been relentlessly inveighing.
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You know they would NEVER attack their cash cows and this is even more so now that these GSE’s hold a patent on residential cap and trade Software filed by Franklin Reins. They probably believe they have an enviromental gold mine with their pet GSE’s or so they think until the government bubble bursts.