Why Is AIG Backing Fannie / Freddie 'Enhanced' Mortgages?

Bernanke laid it on the line today. I heard him say that the Fed and Treasury were going to provide debt and equity capital to many of the Nation's banks. Failure to do so was not an option. He pledged that the Risky Lending Standards of the past would be eliminated. He promised to ‘fix’ the errors that had been made by the misguided bankers.

It sure sounded good. The market even liked it. It is bunk. The following is an example of how Lending Standards are set in DC. You decide. Are these good lending standards? Is this good business practice? The following is happening on a very regular basis. The numbers are big.

Fannie Mae (FNM) and Freddie Mac (FRE) have always had terms for a Conforming mortgage. A Conforming mortgage requires 20% equity from the buyer. That makes for a good borrower. That is a ‘good’ lending standard.

Many years ago the Agencies and the insurance industry created a carve-out to the Conforming mortgage definition. If an 'approved’ insurance company was willing to take a first loss on the loan portion that was in excess of 80% then the Agencies would buy the mortgages. No more 20% down.

This practice morphed. It started with 10% equity, 10% mortgage insurance. It ended with –3% equity, 23% insurance. These are terrible lending standards. The borrowers have no risk. Fannie Mae and Freddie Mac bought as much of this “enhanced” paper that they could. The yields were great and how could they lose if the likes of AIG (AIG) were going to guarantee the first loss?

This of course ended very badly. The insurers got crushed. It is not clear what their claims-paying abilities are any longer. Fannie and Freddie are big losers on the enhanced book of business as well. The losses on the enhanced mortgages far exceeded the 10–20% that was insured. The only ones who made out were the regional banks that originated and sold the risky loans to the Agencies. FNM recently reported that its default rate on enhanced loans was five times larger than on loans that had the traditional 20% down. Bad lending standards make for bad loans.

These questionable standards are 'business as usual' today at Fannie and Freddie. They continue to buy pools of mortgages where the required equity of a borrower has been replaced with an insurance company's promise to pay. The incredible part is that one of those “approved’ insurers continues to be AIG.

Twenty-two percent of Fannie's 08 business was enhanced. AIG was one of the biggest providers of the PMI coverage.

AIG owes its existence to the taxpayers. Yet they are writing first loss insurance on high risk mortgages. With this questionable promise to pay attached, the loans can be sold to another ward of the state, FNM. These are terrible lending standards and it is bad business practice. The taxpayers are at risk to both sides of this transaction. If history is a guide 'we' will ultimately suffer losses from both AIG and FNM on this business.

The PMI/AIG/FNM connection is understood by Geithner. Lockhart and Bernanke. They are aware of the entire PMI time bomb within the Agencies. That they are allowing this to continue today does not evoke much confidence in Bernanke’s claim to end the Reckless Lending Standards of the past.

Comments

[Blues Gal:]

Should we be surprised by this behavior on the part of our government agencies? Probably not. It's just more of the same.

Feb 25 09:04 AM

[Glen L.:]

AIG just came back to the government saying it needs how many billions to continue operating? And Bernanke himself talked today about possible "systemic failure" if very large insurance companies go under. Ergo, AIG gets its money and continues to insure bad loans. This is "change". hahahahahaha

Feb 25 12:41 PM

[OldLimey:]

You're not alone. Here in the UK Bubbles Brown and his team are giving GBP14 billion of future taxpayers' money to the failed Northern Rock bank in the hope they can reflate the residential property market in time for next year's election. They're insisting on 'prudent lending', of course, which they define as 90%LTV. Given that many observers (other than in the property industry, needless to say) see further across-the-board price declines in the 10-20% range this is the sort of behaviour only a politician seeking re-election would see as 'prudent'.

The economic model that has for decades kept the political elite in power and made their wealthy backers richer is utterly kaput. But there is no 'Plan B' for these people, so they cling to what they know best.

Feb 25 02:41 PM

[Glen L.:]

As an addendum, I heard a caller on a radio talkshow that was discussing Obama's speech say that she received an internal email at her bank that said all of the TARP funds directed toward homeowner mortgage relief will go to Fannie and Freddie backed mortgages -- and no other mortgage companies. At this time this is a rumor until I see something else to back it up.

Feb 25 05:41 PM