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fanny mae and freddie mac -
a history

It is totally false to claim that the banking collapse caused by Fannie Mae and its relations was not foreseen. President George Bush, Senator McCain, and Fed. bosses Greenspan and Benanke all fought strenuously to head off the shipwreck, while the Democrat Party opposed them at every step.

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Fannie Mae and Freddie Mac

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fanny mae and freddie mac - a history
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fannie mae / freddie mac - a round-up/summary
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supply-side economics - laffer curves and 'trickle down'

the mechanics of inflation : The great government swindle and how it works

the sum of a geometric sequence: or the arithmetic of fractional banking
on stimulus spending and multipliers

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
end notes

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bush administration attempts to strengthen fannie and freddie regulation from 2001 onwards

“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.

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.”


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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’.

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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.

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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]

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11 september 2003 - fighting against fannie and freddy regulation

“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.

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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]

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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.

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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

  1. derivatives
    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 co-operating 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.

  2. Negative equity is when the marketable price of a property falls below the amount of the outstanding loan.

  3. 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."”

  4. 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.

  5. Banks widely co-operate, borrowing from one another as needs and opportunities occur. Bank co-operation is particularly necessary in providing very large loans to governments and large infrastructure projects like, for instance, a Channel Tunnel or an Aswan Dam.

    This not only gathers together large resources, but also spreads risks.

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