So the Perpetrators Are Now Our Saviors?

It's no secret that I'm of the opinion that Congressional hearings are often a waste of time, that the politicians on the Senate Banking and House Financial Services Committee are clueless, and that Congress is to blame for mismanaging the Mortgage GSEs.

Lest you think that I simply like bashing politicians for fun and sport, here is a look at some excerpts from the hearings on Fannie (FNM) and Freddie (FRE) after the latter's accounting issues came to light:

(From the WSJ): Rep. Barney Frank (D., Mass.): I worry, frankly, that there's a tension here. The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see. I think we see entities that are fundamentally sound financially and withstand some of the disaster scenarios. . .

Rep. Maxine Waters (D., Calif.), speaking to Housing and Urban Development Secretary Mel Martinez: Secretary Martinez, if it ain't broke, why do you want to fix it? Have the GSEs [government-sponsored enterprises] ever missed their housing goals? 

House Financial Services Committee hearing, Sept. 25, 2003: 

Rep. Frank: I do think I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision]. I want to roll the dice a little bit more in this situation towards subsidized housing. . .  

House Financial Services Committee hearing, Sept. 25, 2003: 

Rep. Gregory Meeks, (D., N.Y.): . . . I am just pissed off at Ofheo [Office of Federal Housing Enterprise Oversight] because if it wasn't for you I don't think that we would be here in the first place.

 Senate Banking Committee, Oct. 16, 2003: 

Sen. Charles Schumer (D., N.Y.): And my worry is that we're using the recent safety and soundness concerns, particularly with Freddie, and with a poor regulator, as a straw man to curtail Fannie and Freddie's mission. And I don't think there is any doubt that there are some in the administration who don't believe in Fannie and Freddie altogether, say let the private sector do it. That would be sort of an ideological position. 

Mr. Raines: But more importantly, banks are in a far more risky business than we are. 

Senate Banking Committee, Feb. 24-25, 2004: 

Sen. Thomas Carper (D., Del.): What is the wrong that we're trying to right here? What is the potential harm that we're trying to avert?

Federal Reserve Chairman Alan Greenspan: Well, I think that that is a very good question, senator.

What we're trying to avert is we have in our financial system right now two very large and growing financial institutions which are very effective and are essentially capable of gaining market shares in a very major market to a large extent as a consequence of what is perceived to be a subsidy that prevents the markets from adjusting appropriately, prevents competition and the normal adjustment processes that we see on a day-by-day basis from functioning in a way that creates stability. . . . And so what we have is a structure here in which a very rapidly growing organization, holding assets and financing them by subsidized debt, is growing in a manner which really does not, in and of itself, contribute to either home ownership or necessarily liquidity or other aspects of the financial markets. . .  

Sen. Richard Shelby (R., Ala.): [T]he federal government has [an] ambiguous relationship with the GSEs. And how do we actually get rid of that ambiguity is a complicated, tricky thing. I don't know how we do it.

I mean, you've alluded to it a little bit, but how do we define the relationship? It's important, is it not? 

Mr. Greenspan: Yes. Of all the issues that have been discussed today, I think that is the most difficult one. Because you cannot have, in a rational government or a rational society, two fundamentally different views as to what will happen under a certain event. Because it invites crisis, and it invites instability. . .

Sen. Christopher Dodd (D., Conn.): I, just briefly will say, Mr. Chairman, obviously, like most of us here, this is one of the great success stories of all time. And we don't want to lose sight of that and [what] has been pointed out by all of our witnesses here, obviously, the 70% of Americans who own their own homes today, in no small measure, due because of the work that's been done here. And that shouldn't be lost in this debate and discussion. . . 

Senate Banking Committee, April 6, 2005: 

Sen. Schumer: I'll lay my marker down right now, Mr. Chairman. I think Fannie and Freddie need some changes, but I don't think they need dramatic restructuring in terms of their mission, in terms of their role in the secondary mortgage market, et cetera. Change some of the accounting and regulatory issues, yes, but don't undo Fannie and Freddie. 

So what's missing from these conversations? A constructive dialogue around the risks to the global economy if the mortgage GSEs were to run into trouble (let alone fail), how best to manage the mortgage GSEs and a frank discussion around their financial health.

After all, shouldn't  these discussions have been focused on financial health and management strategy, with the goal of reducing the risks the GSEs posed to the economy and insuring their on-going financial health? 

So why is it that the dialogue was really about one party believing that the other simply didn't believe in the mission of the GSEs and was just out to destroy them for ideological reasons? Why weren't our politicians able to put aside the political grand standing on homeownership, put away their partisan politics, read the balance sheets of the two companies and focus on the core issue: maintaining the financial health of Fannie Mae and Freddie Mac on a go-forward basis? 

In my view, the answer is that the mortgage GSEs were seen more as vehicles for politician gain then they were seen as vital parts of the global financial system; as long as  home ownership rates were going up, as long as someone felt their community "needed the GSEs" as long as touting the mission of Fannie and Freddie served their purposes they had zero interest in tinkering with the two companies. 

For evidence of this, look no further than the fact that Congress authorized the GSEs to expand the scope of their investment activities after the onset of the credit crunch, despite the fact that both companies began losing money once the housing downturn hit (and even when they did it was due to tax treatment). Again, Congress wasn't especially interested in maintaining the financial health of the mortgage GSEs, they just wanted to appear as if they were doing something to halt the slide in housing prices. 

Apparently speaking honestly with the American people about the fact that housing prices were hyper-inflated during the boom, and that the real estate market was going through a very necessary correction, was simply not an option for them. 

The recent problems with the mortgage GSEs could've been avoided if Congress had reined them in years ago (or at the very least in the wake of the credit crunch), instead of choosing politics over common business sense. After all there were many analysts and notables (such as Warren Buffett) who warned about the risks posed by Fannie and Freddie, so it's not like Congress can say that no one warned them.

While it's fair to deride their executives for running the companies into the ground, the politicians on Congress' banking and financial services committees deserve a large share of the blame as well. 

All of this begs the question: can we really trust politicians to manage entities like the GSEs or any other key private sector investments/companies, et al, if there is a risk that their political aims, partisan politics/bickering, et al could prevent them from making the right decisions? 

Final thought: does anyone else  feel nervous about the fact that the very people who ran the GSEs into the ground are now working on the bailout bill? How about the fact that they will be working on additional solutions to the current crisis, new banking regulations, etc.? 

You can read the transcript excerpts in full here.

Disclosure: None

Comments

[sensibletexan:]

HALLELUA Now that some of us are seeing the light how do we start to make it right. The "bailout" this week is a joke, just another excuse for Washington to line its pockets and forget that the money they are so freely spending we are getting up this morning to earn. It seems to be time to have a new style Boston Tea Party

2008 Oct 03 08:30 AM

[Philip Gvinter:]

The GSEs were the symptom and not the cause of this problem. The issue at hand was not the volume of mortgages originated but rather the quality. While putting in place caps on the portfolio size would have lowered the level of the losses it would in no way have prevented them. The level of leverage and the extremely low capital requirements were what did the GSEs in and no one was discussing this Republican or Democrat. The GSE share of the mortgage securitization market also dropped dramatically as BSC, LEH and others began to act as securitizers for ALT-A and subprime debt that the GSEs would not touch. The real cause of this mortgage crisis are the OCC and the OFTS allowing institutions to drastically lower their credit standards to unsustainable levels along with the relaxation of the leverage limits on investment banks.

2008 Oct 03 08:35 AM

[turkeyeyes:]

Let's not forget, we really have no accurate way of determining the value of these mortgage bundles.

That is a hell of a lot different from saying they have NO value as is alleged by the shorts who basically caused a run on the banks.

Hence, WB is fetching a fine price today and the shares are jumping.

Now it's time to look at FNM and FRE with a fresh eye.

Remember, most of their mortgages were originated WAY before this valuation issue was trumpeted by the buglers of doom.

2008 Oct 03 08:47 AM

[GKM:]

It is antithetical in the extreme to leave the same individuals, who got us to where we are today, in charge. However, the reason they got to be where they are in the first place is the same reason they will stay where they are until something extraordinary happens. It has been the same throughout history and takes a popular, sometimes chaotic movement to usurp those in established positions.

2008 Oct 03 08:54 AM

[Philip Gvinter:]

The short sellers did not cause a run on the bank and the mortgage securities do not have to be worth nothing in order for a bank to be insolvent and ripe for failure. If a bank has a capital ratio of 10% and 30% of its assets turn out to be of dubious quality and only worth 65% of par value that bank is essentially insolvent. This was the case with WM, WB and LEH.

2008 Oct 03 09:08 AM

[turkeyeyes:]

Cuomo in NY is investigating the likelihood that CDS market was manipulated by hedges colluding to weaken the apparent creditworthiness of financials. Could this have happened to many of the banks in peril, or is this unrelated?

See this article:

www.efinancialnews.com...

2008 Oct 03 09:15 AM

[Ruby2sday:]

Where is the public outrage? Where are the congressional (if not criminal!) investigations of Frank, Dodd, Raines, Johnson? Why isn't Frank being forced to step down? Why isn't there more emphasis on organizations like ACORN Housing, who has Obama in its back pocket? I want to know what these frauds did to my taxpayer monies!!

2008 Oct 03 10:52 AM

[Ruby2sday:]

Where is the public outrage? Where are the congressional (if not criminal!) investigations of Frank, Dodd, Raines, Johnson? Why isn't Frank being forced to step down? Why isn't there more emphasis on organizations like ACORN Housing, who has Obama in its back pocket? I want to know what these frauds did to my taxpayer monies!!

2008 Oct 03 10:52 AM

[Dividend Inc:]

Although the regulator (OFHEO) was weak it was doing their job, its just that when they published the article "Systemic Risk: Fannie, Freddie and the role of OFHEO" (www.ofheo.gov/newsroom...) the very next day the head of the agency was fired by the adminstration. Read that report. They predicted what would happen if FNM and FRE failed. So far they've been right on the mark.

2008 Oct 03 10:58 AM

[Smarty_Pants:]

To quote the Mogambo Guru: "We're freakin' doomed."

2008 Oct 03 12:11 PM

[Mr. Stupid:]

FNM and FRE are buys now since the bailout has been voted in. Their portfolios (good and bad) just dramatically jumped in value today. I'm surprised to see them trading down today. Maybe they are just letting folks in at a really good buy point.

2008 Oct 03 03:42 PM

[madasiwannabe:]

Thank you. It's about time someone pointed out how the GSE's got into trouble. It actually started with lawsuits over descrimination. Basic assertion was the new automated computer program profiled minorities. That started the hearings and resulted in the congressional mandate to open the flood gates... After all these are GSE's and it's not good for a government agency to be accused of unfair lending practices.

Need to look into Countrywide's "Friends of Anthony" program. Think you will find that Fannie Mae's biggest sub prime / alt-A customer was Countrywide. Most of these loans were rejected by the GSE's till 2004. A lot of banks took advantage of the reduced requirements too, but regulators have a responsibility to make sure they can't.

The news media is wrong. Today's drop wasn't lack of confidence. If it was, it would have been down all day in spite of the news. Today was a classic pump and dump. The hedgies took advantage of the big gains and positive news to catch everyone leaning and dump their stocks for a profit. It happened across the board so it was a coordinated attack. A lot of people lost a lot of money today when it should have been a big up day for all.

Hopefully the SEC is looking into this.

2008 Oct 03 07:16 PM

[john s. gordon:]

yes the hedgies strike again.

predatory lending & way too much leverage caused the problem.
> jack

2008 Oct 04 08:32 AM

[fireball:]

mark
seems like jefferson tried to warn us about allowing a national bank. and the whole lot of them tried to give us guidelines to keep constitutional money in order to have a stable currency. they told us to have fair trade not free trade. they told us to keep a free market with limited govt. policing to keep it fair. we have done none of those things. now we are suprised that a bunch of politicians that have no clue of what real life business is have brought the biggest strongest economy to the brink of meltdown.
user26737, you need to look back through several decades of presidents, congresses and policies. it is a huge simplification to give bush the blame. he deserves his share for not trying to fix the stupid policies. he might be the worst but he has plenty of competition for that title.
maybe the fannie freddie hybrid creature was more suited to china, russia, and nazi germany than to a country that is supposed to run by free enterprise. let's see first the politicians pointed at speculaters, and big oil. then they pointed at foriegn oil suppliers. then one branch of the socialist party (democrats) started pointing fingers at the other branch (republicans) and vice versa. the last blame was on the free market that i am aware of. there was no free/fair market in the first place. maybe for the short term we will have an illusion of improvement. i will keep in mind the success of the war on poverty, the war on drugs, and the govt. school system and expect similar results for the economy.
sensible texan and GKM--agreement.

2008 Oct 04 10:20 AM

[djsunshine:]

US Sovereign Fund
You can say 600 billion is US Sovereign Fund.
Created to support US housing industry.
It some level it is government’s job (and public policy) to help people have neighborhoods with home ownership. That is what makes our nation strong and our future generation competitive. This homeownership and home equity afforded by this safety net is the only retirement nest egg most common citizens have.

If you wake up and think about it you will end up paying more in taxes to get equivalent result. Inflation caused by this 600 billion is also a kind of tax that you and I will have to pay but in different form. In conclusion ‘Expansion required (not just inflation protection) portion of fed’s mandate’ is what put us apart from our friends in Europe. Thank god for that.

2008 Oct 04 02:41 PM

[milkchaser:]

US Sovereign Fund -- that's good. I like that. It would be funny if it weren't true. That kind of money and power invites corruption. I pray it is administered by saints. Not many saints among the politicians (mostly Democrats) listed above. I rather doubt that the Bush administration punished the head of the OFHEO since it was instrumental in getting them the budget in the first place to properly regulate the GSEs. And the shocking thing about that report is that the worst case scenario they imagined was not as bad what actually happened this summer.

2008 Oct 04 04:23 PM

[Axetogrind:]

The bill passed, the Goverment is going to buy FRE and FNM's bad paper, give them a clean slate with better loan acceptance requirements, I was surprised not to see more people buy stock in these two at this price? Possibly people are not use to buying financials? I have been selling everything and anything to buy more shares. Many small banks investments are in these two, they cannot be allowed to fail. I was surprised not to see them both go up a dollar after the annoucement, Anxiouis to see what happens Monday AM. They both were up in after hours. Seems there is a bottom established.


On Oct 03 03:42 PM User 225305 wrote:

> FNM and FRE are buys now since the bailout has been voted in. Their
> portfolios (good and bad) just dramatically jumped in value today.
> I'm surprised to see them trading down today. Maybe they are just
> letting folks in at a really good buy point.

2008 Oct 04 07:48 PM

[mjmeek:]

Excellent article; Frank, Dodd, H. Clinton, Schumer and anyone in either party who took contributions from FRE &FME should be brought before a grand jury. Raines walking off w/over $200M is a slap in the face to the taxpayers. Hang them all!

2008 Oct 04 09:10 PM

[JT Herch:]

The REAL problem that caused the meltdown of the financial markets is a direct result of the modifications to the Community Re-Investment Act which were enacted under Clinton in 1995. It effectively fined financial institutions if they did ot make sub-prime loans to participants regardless of qualifying. Therefore, the risinf numbers of no-money down, low credit score, no-income loans skyrocketed. Bush warned in 2003 for there to be more regulation of FNM and FRE. However, it was blocked by the dems becuase it lessened low income borrowers from buying a home. Those borrowers who would not normally have qualified are the subprime foreclosures on the market today. If you want to know who set these wheels of disaster into motion...you have no further to look than the 1995 CRA changes and Slick Willy.


On Oct 03 08:35 AM pgvinter wrote:

> The GSEs were the symptom and not the cause of this problem. The
> issue at hand was not the volume of mortgages originated but rather
> the quality. While putting in place caps on the portfolio size would
> have lowered the level of the losses it would in no way have prevented
> them. The level of leverage and the extremely low capital requirements
> were what did the GSEs in and no one was discussing this Republican
> or Democrat. The GSE share of the mortgage securitization market
> also dropped dramatically as BSC, LEH and others began to act as
> securitizers for ALT-A and subprime debt that the GSEs would not
> touch. The real cause of this mortgage crisis are the OCC and the
> OFTS allowing institutions to drastically lower their credit standards
> to unsustainable levels along with the relaxation of the leverage
> limits on investment banks.

2008 Oct 05 12:03 AM