Streetwise Professor

October 20, 2011

Occupy Fannie and Freddie, Why Don’t You?

Filed under: Uncategorized — The Professor @ 12:06 pm

It is passing strange–or maybe not–that the OWS crowd/mob is giving Fannie Mae and Freddie Mac a pass.  They are the best example of an unseemly nexus between government and business.  Look at the guys who were their CEOs and board members over the years.  Democratic Party stalwart–and Obama BFF–James Johnson, who walked away with a cool $200 mil.  Former Clinton appointees Jamie Gorelick and Franklin Raines.  Bill Daley.  All of whom did very, very well feeding at the GSE teat.

Us?  Not so much.  For those of you keeping score at home, the tab for F&F is now $169 billion.  And the meter is still running: current estimates are for an additional $51 billion in losses over the next 10 years.  That’s $220 billion for you OWS types who majored in sociology.

The.  Biggest. Losers.  (I mean F&F, not OWS–but the race is a close one!)  But nary a has been hippie or wannabe hippie in sight camping out at those places.  Twinkles down, dudes.

Many economists on the left–notably Krugman, DeLong, and Thoma–deny, deny, deny that F&F were primarily culpable for the subprime crisis.  As I said in an earlier post, Krugman et al evaluate the F&F pudding by claiming that the ingredients were A-OK: specifically, they claim that F&F did not take on much subprime or Alt-A risk, but that banks did.  Hence, the banks did it.

There are two problems with this.  First, as former FNMA chief credit officer Edward Pinto has shown, the F&F puddings were in fact pretty well stuffed with low credit quality mortgages.

Second–and more importantly–loss follows the risk.  If F&F lost a lot on subprime and Alt-A, it is because they were exposed to its risks in massive amounts.  As the biggest losers, they were collectively the biggest risk takers.  The biggest suppliers of risk capital to the low-credit end of the housing market.

As I said in my earlier piece:

The proof of the pudding is in the eating.  We are now eating F&F’s losses.  They demonstrate, quite forcefully, that their brand of pudding was rotten.  Going on and on about statistics allegedly demonstrating the quality of the ingredients doesn’t mean squat if the first bite makes you puke.

And we’re still puking.  To the tune of $169 billion, with billions more on the way.

Krugman et al have never–ever–confronted this simple fact.  Their stirring defense of the GSEs has no credibility whatsoever until they can show how F&F lost such huge sums without being exposed to the housing price and credit risks inherent in subprime and Alt-A.

Clarifying question, guys (you can’t see my hand with my fingers cupped in the shape of a C, but it is!):  if they were exposed to these risks, and in huge amounts larger than any other single entity, and in larger amounts than the total represented by multiple non-GSEs, how is it possible to say that they were not a major contributor to the housing boom and bust?

The failure of Krugman et al to answer that question is very revealing.  I don’t see how it is possible to square the fact of the huge loss with their contention that F&F were bit players in the boom and bust.

And until the OWS people OFF, they are just adding additional proof–as if any is needed–that they are truly clueless about the truly outrageous nexus of corruption in US finance.  So folks, either OFF–or F-off.

Update: F&F are very similar to the kinds of corporations that Adam Smith and the Founders disliked and distrusted.  Specially chartered corporations that were give extraordinary privileges and used to dispense political favors.  Companies that grew large because of artificial advantages conferred by the Federal government, not as a result of prevailing in competition in the marketplace.

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  1. You forgot Rahm Emanuel at Wasserstein and Freddie. Yea, most of the money was made at Wasserstein, but he steps out of the White House, pockets $17 million in 2 1/2 years and then goes back into politics. I mean, REALLY? While on the Board at Freddie the campaign contribution and accounting “irregularities” were ongoing. Do we REALLY think he had the chops to pull in $17mil in 2 1/2 years or do we think the $17mil was payment for past and future favors.

    Fannie and Freddie have been used for YEARS as the private playground of the Washington political class (and don’t even get me started on Barney Frank and his boyfriend who was in charge of devising new loan programs at Fannie Mae. Conflict of interest? Of course not.)

    Comment by Charles — October 20, 2011 @ 1:33 pm

  2. If the level of sub-prime/alt A lending would have been the same with or without F&F (as Krugman et al seem to suggest) wouldn’t it still have been better to have had the banks do it? They were subject to much higher capital requirements than F&F, and so would have had more to support the risks that were taken on. The bank shareholders would have eaten more of the loss instead of the taxpayers, no?

    Comment by John Lehman — October 20, 2011 @ 2:27 pm

  3. I really think we need to pay less attention to the circus freaks at Zucotti Park by now. There is just nothing there of any substance to comment on, except analyze their antics as a form of theater of the absurd.

    They will dissipate when they get tired of their stuff getting stolen, or when they’re tired of fearing they’ll get raped in their tents (as happened in Cleveland’s OWS), or simply when the weather gets cold.

    The one single positive side effect is that the undecided voter in the middle will associate these clowns with Obama, and will surely gravitate to the Republican alternative come next year.

    Comment by Finnpundit — October 20, 2011 @ 3:08 pm

  4. Yes! And F&F caused AIG’s losses too! And in fact, if the CRA hadn’t forced, yes forced, Countrywide and other mortgage brokers to refuse to examine the creditworthiness of minority borrowers, that fine institution would still be with us today!

    Comment by a — October 20, 2011 @ 3:15 pm

  5. “Just as FDR’s attacks against “malefactors of great wealth” contributed to the regime uncertainty that retarded recovery in the Great Depression,”

    So true, good Professor, so true. By 1934, the US GNP had only grown from $56.4 billion to $66 billion, and to only $73.3 billion by 1935. If Coolidge had still been president, I’m sure that the US GNP would have exceeded 1929’s $103.6 billion by 1935 at the latest.

    The length of the Great Depression had nothing to do with the fact that the US GNP had declined from $103.6 billion to $56.4 billion between 1929 and 1933. Nothing at all.

    And anyone who says it did will be blotted out of Our Christmas card list!

    Comment by a — October 20, 2011 @ 3:27 pm

  6. The F&F story is more tragic than most realize: there was no reason for what happened to have happened except for the drive to get bonuses out of these companies for their political bosses, as well as to “cement relationships” between F&F employees and the street. I could go on forever about this but will limit myself to a couple of observations and a brief history

    The basic mechanics of the way these were supposed to operate is very simple, and has to do with the creation of modern mortgage banking. Prior to the late 1960’s mortgage banking was an arcane way of getting money from one place – generally the Northeast, to another – the Sunbelt. In addition to local institutions, MB’s did two basic things – they took FHA and VA guaranteed loans (and I mean the entire package of docs, in their trunks), and would get on a train, go north and sell them to local Savings Banks and S&L’s. My mentor in the business did this all the time. The advantage of the FHA insurance was that there was a guarantee, and the fact that someone other than the local buyer had looked at the docs and passed muster. They needed to be reviewed but not re-underwritten. On the conventional (non FHA/VA) side, long relationships were developed with large investors, often insurance companies, and would originate and service the loans to their standards- this cut costs for the investors to site visits and periodic reviews. As late as 1987 I did due diligence on servicing operations that still had whole loan FHA and conventional portfolios that they were still servicing. Economically this cut information costs and thus transaction costs – thank you Ronald Coase.

    With the creation of GNMA MBS, no longer did the notes and docs have to travel – cost less. With the FNMA MBS and FHLMC PC, the same benefits began to be applied to conventional Loans. Without going into excruciating detail GNMA charged 4 bps to wrap government loans while FNMA and Freddie charged guarantor fees based on rates negotiated with seller servicers, or on spread earned on whole loans bought directly (through “the open window”), and then resold. This is a classic example of minimizing information costs.

    The Reason for two conventional lenders was that GNMA was broken out of the original FNMA, which was then charged with increasing liquidity in the conventional market (the preserve of thrifts) Since FNMA had dealt with primarily Mortgage Bankers, the FHLB system set up Freddie to serve their constituents (thrifts). Once launched however, both began competing with each other in all markets.

    All of these agencies were set up to improve liquidity in the market: the fly on the ointment for the conventional market was that both Fannie and Freddie held Loans themselves: In 1980 – 1984 this nearly bankrupted Fannie as they borrowed short and lent Long. As the Bull market in bonds that ran from 1981-2007 ran on, both could make huge one way bets.

    Working with the Street meant that real money could be made by people jumping from one to another. Being large with their own portfolios meant that they could be used by politicians as policy vehicles, having their standards and practices manipulated to serve political ends, as well as serving as a source of payoffs to politicians looking to make a killing – See Jamie Gorelick. Having portfolios funded of off guaranteed money meant that a lot of bodies could be buried while growth continued. Having an imprimatur to lend meant that pet projects and innovation could be wrapped and sold under the US flag – helping the Street. Being publicly traded meant that as long as they could show growth, everyone got rich on stock options.

    The list of abuses is too long and depressing, but let’s look a t a few.

    – Bad and fraudulent accounting for losses.
    – Buying entire deals (all tranches) from the street – why not buy the collateral and save the 2-5% in structuring and placement costs?
    – Fraudulent accounting for “excess” fees by recognizing a gain for these large fees based on discount rates that produced price values well in excess of what the excess would have gotten in the market.
    – Innovations (so called) that increased liquidity but were really nothing more than de-genericizing pass-throughs to widen spreads on the trades.
    – Bloating portfolio balances with deliberately poorly underwritten loans to increase spread income.
    -Hiring political hacks as payoffs.
    -Having third parties hire hacks to pressure the Agencies.

    Remember, the charge of these Agencies was to help the home-buyer by reducing mortgage costs- this goal was lost a long time ago. And the downfall was systematic fraud – ignored because it was inconvenient. What drove the fraud was the need for volume – money was made on transactions, not the performance of the loans. Note that in the original pass through model, it was in the interests of the Agencies to have good loans – good loans mean no expenses. The motivation and compensation of the agencies’ political masters destroyed that. CRA had a major roll to play but it was not the only driver – deterioration in underwriting standards began before it, though not enough to wreck it. For example, limited doc loans showed up in 1987, though usually with full recourse for losses to the seller servicer. CRA did serve as a good cover story to drive volume.

    This is really too depressing for me to continue, but let me give one statistic that illustrates the issue of bad paper. Traditionally an investor loan (loan on a 1-4 family houses not owner occupied) were always considered more risky. Two years ago a friend of mine and I were looking over some agency delinquency stats: it turned out that the investor loans, which were fully documented, had lower delinquency rates than the owner occupied. This was unheard of: the difference was that the investor loans were traditionally underwritten – full docs and verifications, while the so called owner occupied were not. This was true in almost all markets, including California and Michigan.

    Whether this is still true, I do not know: a corollary of Gresham’s Law may apply, Bad loans drive out and ultimately wreck good ones. Please remember how simple this business was – package loans, charge a fee. The benefit was lowering the cost of information. Everything since 1993 (when Andrew Cuomo the CRA Superman went into HUD and the Agencies became the political plaything of the Clinton White house) has served to take this model and destroy it.

    Sorry about the length and jargon.

    Comment by Sotos — October 20, 2011 @ 4:34 pm

  7. Once again, this blog will never connect the dots between Soros funding of leftist zombies to steer angry college kids in the appropriate direction for the Ruling Class (‘tax the rich!’ Ignore that crazy old uncle rambling about the Federal Reserve) and Soros’ funding of the Orange/Rose Revolutions. SWP…not…gonna…go…there. Because it violates the notion that Soros is always a creature of the ‘Left’ rather than simply a conduit for money to go wherever the globalist powers that be want it to go, even if some of their investments ala Tymoshenko/Saakashvili don’t turn out so hot. But who cares? Countries are just playthings, and they dump losing leaders faster than they nakedly short sell other people’s stocks.

    Comment by Mr. X — October 20, 2011 @ 8:22 pm

  8. What a crazy twist just to fill a Kremlin stooge’s minimum quota for bashing Saakashvili.

    Comment by Ivan — October 21, 2011 @ 12:23 am

  9. I thought F&F WERE occupied by OWS types. Are you saying they DON’T sit around smoking pot and discuss laying waste to the rich at F&F? Quite surprising.

    Comment by pahoben — October 21, 2011 @ 10:33 am

  10. Read a similar argument on today:

    Comment by Steven Christopher — October 21, 2011 @ 11:55 am

  11. The White House, Senate leadership, Justice department, Department of Education, and particularly the EPA are all staffed by OWSers or people with views virtually indistinguishable from OWSers.

    Comment by pahoben — October 21, 2011 @ 12:43 pm

  12. @Steven–I’ve been saying F&F delenda est for several years now.

    The ProfessorComment by The Professor — October 21, 2011 @ 1:14 pm

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