Perilous Pursuit of Subprime Loans

 |  Includes: FMCC, FNMA
by: Barry Ritholtz

"In 2006 and early 2007, the industry, many analysts and market observers were generally not predicting a downturn in the housing and credit markets to the magnitude of what has since emerged, and outlooks for particular market segments at that time varied significantly." - Fannie Mae chief Daniel H. Mudd

That is the excuse given by Fannie Mae (FNM) CEO Daniel Mudd as to why the GSE bought into so much ruinous paper (and at the peak of the market to boot).

One would imagine that the people running the biggest purchaser of mortgages in the world would have their own independent expert view, would understand housing, and might be familiar with the real estate cycles in the United States.   

One would be wrong.

I find it amusing that some lying liars argue that the Fannie Mae (FNM) and Freddie Mac (FRE) were "forced" to purchase sketchy mortgages by some government HUD or CRA mandate. As the Washington Post reveals, that turns out to be completely false. Rather, it was a mad grab for growth that sent Fannie into the arms of the most risky mortgages.

Fannie was supposed to be buying mortgages and then securitizing them itself. Instead, Fannie Mae thought itself a large hedge fund, and was investing in RMBS and derivatives packaged by others. According to regulatory data, as far back as 2002, Fannie Mae had invested in "tens of billions of dollars of such securities."

The risk reach by Fannie is detailed in a number of the internal Fannie memos that describes this as part of their growth oriented business model: 

In January 2007, as years of loose mortgage lending were about to send the nation's housing market into devastating decline, Fannie Mae chief executive Daniel H. Mudd wrote a confidential memo to his board.

Discussing the company's successes, Mudd said one of Fannie Mae's achievements in 2006 was expanding its involvement in the market for subprime and other nontraditional mortgages. He called it a step "toward optimizing our business."

A month later, Fannie Mae outlined plans to further expand its activities in the subprime market. The company recognized the already weak performance of subprime loans but predicted that they would get better in 2007, according to another Fannie Mae document.

Internal documents show that even late in the housing bubble, Fannie Mae was drawn to risky loans by a variety of temptations, including the desire to increase its market share and fulfill government quotas for the support of low-income borrowers.  

One last factor: WaPo adds that during the housing boom years, Fannie was "distracted by an accounting scandal and its fallout. For much of 2006, the company was focused on a continuing effort to correct years of false financial reports, a massive project that cost more than $1 billion and ultimately revealed that Fannie Mae had overstated past profits by $6.3 billion."

I didn't think companies could overstate REVENUES by more than six billion dollars, and these clowns were overstating profits by that amount. (Why aren't a lot of people in jail over this?)

There's more at WaPo...

William Ackman on Fannie & Freddie (July 2008)

Even More Writedowns Coming  (July 2008)

Fannie's Perilous Pursuit of Subprime Loans
David S. Hilzenrath
Washington Post, August 19, 2008; Page D01