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bush
administration attempts to strengthen fannie and freddie regulation
from 2001 onwards
some facts about fannie mae and freddie
mac
some history of fannie mae and
freddie mac
on the
vast size of fannie mae and freddie mac
11september 2003 - fighting
against fannie and freddy regulation
accounting and influence peddling at
the fms
“Just the Facts: The Administration's Unheeded Warnings
About the Systemic Risk Posed by the GSEs
“For many years the President and his Administration have
not only warned of the systemic consequences of financial turmoil
at a housing government-sponsored enterprise (GSE) but also put
forward thoughtful plans to reduce the risk that either Fannie Mae
or Freddie Mac would encounter such difficulties. President Bush
publicly called for GSE reform 17 times in 2008 alone before Congress
acted. Unfortunately, these warnings went unheeded, as the President's
repeated attempts to reform the supervision of these entities were
thwarted by the legislative maneuvering of those who emphatically
denied there were problems.
“2001
April: The Administration's FY02 budget declares that the size of
Fannie Mae and Freddie Mac is "a potential problem," because
"financial trouble of a large GSE could cause strong repercussions
in financial markets, affecting Federally insured entities and economic
activity.”
Etc....
some facts about fannie
mae and freddie mac
Fannie Mae and Freddie Mac are GSEs [goverment-sponsored
enterprises]. They do not provide mortgages to house buyers but, instead,
buy mortgages from various institutions that do provide mortgages
to home owners. This allows the mortgage providers to carry on with
their business of lending.
These GSEs were designed to bundle up the mortgages
and sell them into the market (see Mortgage-backed Security - MBS
and Collateralized Mortgage Obligation - CMO). [1]
Since they were converted into a public-private hybrids by Lyndon
Johnson, they have become ever more powerful, and irresponsible, to
the extent of playing the market from their immensely privileged position.
- Fannie Mae is tax-exempt.
- Fannie Mae are allowed to hold only 2.5% capital
reserves (banks normally have to hold about 10%). This allows Fannie
Mae much greater leverage.
- Fannie Mae receives preferential low interest
rates because of implicit Fed. (government) guarantees. This allows
the GSEs [government sponsored enterprises] Fannie Mae and Freddie
Mac, to go head to head with other institutions, while having ginormous
competitive advantages.
- Fannie Mae is exempt from SEC [Securities and
Exchange Commission] regulation. This is allowing Fannie Mae to
bundle up mortgages, which are then rated AAA with no requirement
to make clear what is in the bundle.
This is what has allowed toxic instruments, that have been sold
across the world. It has also created a situation where money institutions
do not know whether potential inter-bank business partners are holding
these boiled babies on their books, complete with a golden stamp
on the wrapping, rather than safe instruments. This is inclining
banks to a natural caution, to be chary of lending good money to
other banks against these ‘assets’.
some history
of fannie mae and freddie mac
- 1930s: Franklin Roosevelt’s New Deal
Fannie Mae started as the Federal National Mortgage Association.
Fannie Mae provided local banks and thrifts with money needed to
finance home mortgages.
- 1968: Lyndon Johnson converted Fannie Mae into
a public-private hybrid called a “government-sponsored enterprise”
[GSE].
- 1970: Freddie Mac, was created so Fannie Mae
would not monopolise mortgage buying (but they have, in fact, marched
in concert).
- 1977: Under Jimmy Carter, the Community Reinvestment
Act [CRA] compelled banks to make loans to poor borrowers.
- 1999: Under Bill Clinton, banks were given strict
numerical quotas for forcing sub-prime loans.
on
the vast size of fannie mae and freddie mac
“the taxpayers are living under an
enormous rock suspended by a single rope.” on fannie mae, august
2002 [In 5 ‘pages’.]
August 2002
“ That means if housing prices crash or either company stumbles,
the taxpayers could be on the hook for hundreds of billions. It's
as if the public had cosigned Fannie and Freddie's debt, says Lawrence
White, a New York University business-school professor and former
Freddie Mac director. To pay for a very small cut in mortgage rates,
White says, the taxpayers bear the risk of a massive bailout.”
—
“Shays broke a political rule in Washington: Don't mess with
Fannie Mae. Wealthier than most nations, Fannie Mae is known to
try to devour anyone who crosses it. That's fine with Fannie Mae's
supporters, who say it has helped millions fulfill the dream of
homeownership by combining public spirit and private innovation.
Critics contend that Fannie Mae's public face of heartwarming largess
masks plenty of private greed. Fannie, they claim, is a company
with the lowliest of missions: to juggle politicking and public
relations so that its blend of subsidies and privileges remains
intact.
—
“A creature of Franklin Roosevelt's New Deal, Fannie Mae was
born as the Federal National Mortgage Association. In an era of
unemployment and foreclosures, FDR's brainchild provided local banks
and thrifts with money needed to finance home mortgages. Almost
70 years later, Fannie Mae is one of the world's biggest financial-service
companies. Eight trillion dollars pass through
its coffers yearly.”
—
“The government has come to Fannie's rescue before: Fannie
lost $1 million a day during the early 1980s, requiring tax relief
and other interventions. A few years later, taxpayers bailed out
the Farm Credit System, a government-sponsored enterprise for agricultural
loans. Together, Fannie Mae and Freddie Mac
have a trillion and a half dollars in assets--more than the gross
domestic product of every country but Japan, Germany, and the United
States. Their combined debt--also measured in the trillions--is
poised to outpace that of the US government. Says Republican Representative
Richard Baker of Louisiana, who chairs the House subcommittee overseeing
Fannie and Freddie: "The taxpayers are living under an enormous
rock suspended by a single rope. Once it breaks, there's no recovery."
“Some observers think the rope is fraying. Earlier this year,
the Wall Street Journal editorial board likened Fannie and Freddie
to failed energy trader Enron, attacking the two companies' exploding
debt and "terrible" financial disclosure. The Economist
called Fannie and Freddie "arguably the most worrying concentrations
of risk in the global financial system." ”
—
“ [...] It also stokes their[the nation's mortgage lenders]
greatest fear: that Fannie and Freddie want to exploit their cheaper
borrowing costs to monopolize the housing-finance industry [...].”
—
“On March 2, 2000, a story in the Washington Post suggested
that Fannie and Freddie's policies were harming the ability of African-Americans
and Hispanics to obtain mortgages. The bombshell came from William
Apgar, then a top official at the Department of Housing and Urban
Development, now a professor at Harvard's Kennedy School of Government.
[...] the gist of the Post story was correct. Fannie's good intentions
aside, for years HUD has found that Fannie and Freddie lag behind
private lenders in serving African-American borrowers and other
underserved communities.”
—
“ "It's all a matter of know-who, not know-how,"
complains Ralph Nader about Fannie's higher ranks. "They've
perfected all the techniques of lobbying and pay massive salaries
for Rolodex hiring to ensure against any change." Nader's favorite
example: Fannie Mae vice chair Jamie Gorelick, a well-connected
Washington lawyer who earned almost $1 million in her first eight
months on the job after serving as counsel to the Defense Department
and deputy to former attorney general Janet Reno.”
—
“In June, the [Wall Street] Journal's board argued that taking
on Fannie and Freddie would be President Bush's biggest challenge
after toppling Saddam Hussein.”
—
“ "It's grant payola," says Nader. "Fannie
sprinkles millions around the District and then calls on those groups
when the company needs to neutralize dissent.”
—
“Peter Wallison of the American Enterprise Institute thinks
the government should be fighting Fannie and Freddie's monopoly
power just as it went after Microsoft's. Wallison claims "it's
hard to know whether the government controls Fannie and Freddie
or they control the government." Some say the two companies
treat OFHEO, the agency that monitors them,
like a lap dog.
“Fannie's increasing size and debt also worry regulators.
Says one top official: "Every financial institution this leveraged
has gotten into trouble [...].”
“Despite all the noise, Raines says,
"the ratio of action to criticism is very low. If something
were really wrong, wouldn't someone in the government do something?"
”
[Quoted from washingtonian.com]
“New Agency Proposed to Oversee Freddie Mac and Fannie Mae
“The Bush administration today recommended the most significant
regulatory overhaul in the housing finance industry since the savings
and loan crisis a decade ago.
“Under the plan, disclosed at a Congressional hearing today,
a new agency would be created within the Treasury Department to
assume supervision of Fannie Mae and Freddie Mac, the government-sponsored
companies that are the two largest players in the mortgage lending
industry.
“The new agency would have the authority, which now rests
with Congress, to set one of the two capital-reserve requirements
for the companies. It would exercise authority over any new lines
of business. And it would determine whether the two are adequately
managing the risks of their ballooning portfolios.”
—
“Significant details must still be worked out before Congress
can approve a bill. Among the groups denouncing the proposal today
were the National Association of Home Builders and Congressional
Democrats who fear that tighter regulation of the companies could
sharply reduce their commitment to financing low-income and affordable
housing.
“ ''These two entities -- Fannie Mae and Freddie Mac -- are
not facing any kind of financial crisis,'' said Representative Barney
Frank of Massachusetts, the ranking Democrat on the Financial Services
Committee. ''The more people exaggerate these problems, the more
pressure there is on these companies, the less we will see in terms
of affordable housing.'' ”
The effort to put in regulation failed.
accounting and influence
peddling at the fms
11 September 2003
“The plan is an acknowledgment by the administration that
oversight of Fannie Mae and Freddie Mac -- which together have issued
more than $1.5 trillion in outstanding debt -- is broken. A report
by outside investigators in July concluded that Freddie Mac manipulated
its accounting to mislead investors, and critics have said Fannie
Mae does not adequately hedge against rising interest rates.”
[Quoted from nytimes.com]
20 June 2005
“In late 2004, the leadership of the Federal National Mortgage
Association (FNMA or Fannie Mae) was accused of having engaged in
a series of questionable accounting practices that led to an overstatement
of its earnings and an understatement of its risk. Although Fannie
Mae’s top officers denied the accusations, a careful review
by the U.S. Securities and Exchange Commission confirmed the allegations.
Within a few weeks, Fannie Mae conceded the charges and its top
officers were forced to resign. Any doubts about the seriousness
of the company’s shaky finances were laid to rest on January
19, 2005, when Fannie Mae cut its dividend in half to bolster its
cash reserves.”
—
“Both Fannie Mae and Freddie Mac have proven exceptionally
adept at lobbying Congress to preserve and enhance their privileges.
Any effort that relies on new regulations will likely perpetuate
the risk to the financial market and preserve their dominant influence.
Indeed, if Armando Falcon, director of the Office of Federal Housing
Enterprise Oversight (OFHEO), had not courageously persisted in
exposing Fannie Mae’s suspect operations, often in the face
of congressional hostility, former Fannie Mae President Franklin
Raines would still have his job and Fannie Mae’s shaky finances
and fabricated earnings would still be hidden.”
—
“Fannie Mae was created in 1936 during the Great Depression
to provide a secondary market to encourage greater use of the innovative
long-term, fixed-rate, level-payment, fully amortized mortgages
that the newly created Federal Housing Administration (FHA) was
insuring against loss of principal and interest. The exercise was
a success, and this type of innovative mortgage became the standard
means of financing the postwar housing boom that raised the homeownership
rate from 44 percent in 1940 to 69 percent by 2004.”
—
“ The evidence reveals that Fannie Mae’s management
team appears to be the chief beneficiary of the federal privileges
and the accounting irregularities that were recently uncovered.
For example, in 2003, 749 members of Fannie Mae’s management
team received a staggering $65.1 million in bonuses, a portion of
which was attributable to the overstated earnings that followed
from the accounting irregularities.[16] Over the past five years,
the top 20 Fannie Mae executives reportedly received combined bonuses
of $245 million...” [Quoted from heritage.org]
Good reading for background - longish.
11 July 2008
“Former U.S. Treasury Secretary John Snow said that Fannie
Mae and Freddie Mac have relied on leverage to fund their businesses
in the same fashion as a hedge fund, and that the government should
avoid taking them over.”
—
“Congress created Freddie Mac and expanded Fannie Mae in 1970
to promote home buying in the U.S. The companies' charters give
the Treasury the authority to buy as much as $2.25 billion in each
of their securities in the event of possible default, implying the
government will stand behind the companies' debt.”
—
“Fannie Mae and Freddie Mac ``have an enormous political organization,
lots of reach into many congressional districts, and they had a
storyline that at the time worked -- they were really promoting
housing,'' he said.” [Quoted from bloomberg.com]
end notes
- This area gets technical and even complicated
if you want to dig deeper. In this note, I’ll only give you
enough to dig deeper should you wish. There are several others of
these ugly government-private hybrid GSEs, such as Farmer Mac, Sallie
Mae [for student loans] and Ginnie Mae [an insurer like AIG, not
publicly traded]. Enough of that.
Fannie Mae takes varying numbers of mortgages, packages them together
and sells them into the market. CMOs [collateralized mortgage obligation]
are legal entities formed by usually packaging several MBSs [mortgage-backed
security] together. This legal entity can then sell off the collateral
or the interest or share as separate entities [derivatives].
Others, such as AIG [American International Group], one of the world’s
biggest corporations - ranked in the top twenty, can offer insurance
against collateral losses, or changes in interest payments. AIG
was one of the first entities to get into deep trouble and start
sucking up government tax funds in support.
Why is the system falling apart? Under Fannie Mae and Democrat
pressure, home loan companies were forced and persuaded into
unsafe loaning policies. Thus, loans were made to people with no
visible means of support; loans at over the value of the property
(a sweetner/bribe to the purchaser), under the theory that house
prices would rise for ever into the far stratosphere; loans at growing
multiples of the borrowers’ income, often with small print
increasing the interest rate a few years down the road, and even
unlawful loans to illegals. Naturally, this pool of free money,
without proper regulation, attracted sharks and the barely honest
from hundreds of miles around.
When, inevitably, the housing markets turned around (slowing, going
down) - I’m told that this has happened at least six times
previously, even in the American market - then came the cascade.
The more dubious ‘borrowers’ just walked away from the
properties, thus driving property prices lower and leading more
borrowers into default and negative equity,
in a nasty positive feedback.
Thus operations like AIG ran out of money paying off the insurance
claims. Meanwhile, no one knows clearly the values of the CMOs or
their derivatives. These derivatives
have been traded throughout the world and no one knows who’s
holding what and thereby how secure a cooperating bank may be. And
thus there is a strange reluctance to lend money.
Incidently, you may hear fossil media scribblers and talking heads
wittering on about how nobody understands these instruments,
however they are widely understood by the institutions trading them.
It is just the punditocracy that is confused. It is the valuations
that are in question, this is not some esoteric branch of quantum
physics.
Just to add to the devil’s brew, the idiots at Fannie Mae
hoped to get in on the act and started trading in the instruments,
along with their privileged, competitive advantages.
- Negative equity is when the marketable
price of a property falls below the amount of the outstanding loan.
- Warren
Buffet on the OFHEO [link from DVH]
“"QUICK: If you imagine where things will go with Fannie
and Freddie, and you think about the regulators, where were the
regulators for what was happening, and can something like this be
prevented from happening again?
“Mr. BUFFETT: Well, it's really an incredible case study
in regulation because something called OFHEO was set up in 1992
by Congress, and the sole job of OFHEO was to watch over Fannie
and Freddie, someone to watch over them. And they were there to
evaluate the soundness and the accounting and all of that. Two
companies were all they had to regulate. OFHEO has over 200 employees
now. They have a budget now that's $65 million a year, and all
they have to do is look at two companies. I mean, you know, I
look at more than two companies.
“QUICK: Mm-hmm.
“Mr. BUFFETT: And they sat there, made reports to the Congress,
you can get them on the Internet, every year. And, in fact, they
reported to Sarbanes and Oxley every year. And they went--wrote
100 page reports, and they said, 'We've looked at these people
and their standards are fine and their directors are fine and
everything was fine.' And then all of a sudden you had two of
the greatest accounting misstatements in history. You had all
kinds of management malfeasance, and it all came out. And, of
course, the classic thing was that after it all came out, OFHEO
wrote a 350--340 page report examining what went wrong, and they
blamed the management, they blamed the directors, they blamed
the audit committee. They didn't have a word in there about themselves,
and they're the ones that 200 people were going to work every
day with just two companies to think about. It just shows the
problems of regulation.
“QUICK: That sounds like an argument against regulation,
though. Is that what you're saying?
“Mr. BUFFETT: It's an argument explaining--it's an argument
that managing complex financial institutions where the management
wants to deceive you can be very, very difficult."”
- An instrument, in financial jargon,
is just a lump of value. A bank note or a share in a company is
an instrument. You can take your bank note and, normally, exchange
it for something of value. Holding a share means that you own that
proportion of the company’s value. Owning an MBS or CMO means
that you own the value of the mortgage debts contained within.
Derivatives can be just about anything
whose value is in some way based upon a previous instrument (that
is, derived from). For example, a forward contract that says you
can buy ten MBSs for two weeks on Sunday at seven pence each. You
can then have derivatives on derivatives.
All of these are instruments - from the ‘simple’ bank
note to the most obscure compound derivative. Whichever one you
own, it just means you have a bit of paper that you can exchange
for something (else) of value. For those who want to get more philosophical
about this see fiat money
and inflation.
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