All The Devils Are Here: Unmasking the Men Who Bankrupted the World (11 page)

There was a certain formula to these offices. They were staffed by someone close to power—the son of a senator, a governor’s assistant, a former congressional staffer. They held ribbon-cutting ceremonies, always with a politician present, to announce, for instance, that Fannie was going to put millions into a senior citizen center. There were as many as two thousand ceremonies a year in partnership offices all over the country. Members of Congress may not have understood how the secondary mortgage market contributed to homeownership, but they certainly understood the dispensation of pork.

Fannie Mae also funneled money to politicians. In addition to campaign contributions, Fannie set up a foundation that made contributions to politically useful causes. The foundation had existed in a small way since 1979, but in 1996 Johnson contributed $350 million of Fannie’s stock and handed over responsibility for advertising to Fannie’s foundation. Over the years, the foundation became one of the largest sources of charitable donations in the country. It made heavy donations to, among others, the nonprofit arms of the Congressional Black Caucus and the Congressional Hispanic Caucus.

Fannie hired key insiders to plum jobs. Tom Donilon, who had been the chief of staff to Secretary of State Warren Christopher, joined Fannie Mae when he left the government; so did Jamie Gorelick, who had been the deputy attorney general in the Clinton administration. Sometimes, when it suited his purposes, Johnson even hired Republicans, such as Arne Christensen, who had been the chief of staff to Newt Gingrich, the former House majority leader. “It was like the local Tammany Hall operation—a jobs program for ex-pols!” says one close observer.

Fannie and Freddie spent a staggering amount of money lobbying: $170 million in the decade ending in 2006, just a little less than the American Medical Association. But even the dollar tally understates Fannie’s reach. Money alone couldn’t have gotten a politician’s barber to call him when Fannie Mae wanted something from Congress, as the
Washington Post
once reported. When one of Fannie Mae’s few congressional critics, Jim Leach of Iowa, who succeeded Gonzalez as House banking committee chairman, proposed taxing Fannie and Freddie’s debt issuances, rumors began circulating that he was going to be stripped of his chairmanship. That was Fannie’s doing as well. “What do you think a Fannie pack is?” asks one critic. “Whenever there was a hearing, anyone involved would get a Fannie pack, which would
consist of every single loan originated in their district that Fannie Mae had purchased in the last four or five years.” Says former Louisiana congressman Richard Baker: “They ran a battle plan that would make Patton proud. It was twenty-four/seven and never anything left to chance.”

And those who persisted in criticizing Fannie Mae? They learned to regret it. When some of Fannie’s large competitors, worried about its growing dominance, launched an organization called FM Watch to keep tabs on the GSEs, Fannie openly threatened them. GE Capital CEO Denis Nayden told the
Wall Street Journal
that GE was on the “receiving end of multiple communications from Fannie Mae indicating that GE would suffer financial consequences if GE remained a member of FM Watch.” Said Hank Greenberg, the chief executive of AIG: “They use their muscle to threaten competitors, and that’s an outrage.” Soon, FM Watch stopped disclosing the names of its members.

When the Congressional Budget Office published a report in May 1996 estimating that about 40 percent of Fannie and Freddie’s profits were due to their implied government support, Fannie Mae denounced the report, calling it the work of “economic pencil brains who wouldn’t recognize something that works for ordinary home buyers if it bit them in their erasers.”

When the General Accounting Office wrote in a letter to house majority leader Richard Armey that the GSEs received a government subsidy amounting to $2.2 billion in 1995, the letter’s author, James Bothwell, says that he received a call from Franklin Raines, who was then the vice chairman of Fannie Mae. According to Bothwell, Raines demanded that he take out the line about the subsidy—and if he didn’t, Raines would make a call that might cost Bothwell his job. Bothwell refused. In the end, he didn’t lose his job. (Raines denies the incident.)

And when, in 1996, the Treasury Department was preparing to issue a tough report on the GSEs, Fannie somehow managed to get it watered down—and turned into a largely positive report—before it ever saw the light of day. The early draft, for instance, said that if the GSEs were privatized, “Fannie Mae and Freddie Mac would be exposed to the full discipline of private capital market investors, rather than the weakened and distorted discipline resulting from GSE status.” That sentence was gone from the final report. The draft also contained a paragraph that cited several reasons why ending government sponsorship “should also improve the safety and soundness of the housing finance market.” That was gone from the final report, too. The fifth chapter of the draft disappeared entirely. It had been entitled
“Policy Options for Altering the Relationship Between the Federal Government and the GSEs.”

No one who’s talking can prove what happened, but those who know about the rewrite have long speculated that Johnson put in a call to his friend Bill Clinton or to Treasury Secretary Robert Rubin, another friend. Johnson has denied calling either man. The mystery was never solved.

The ferocity of Fannie Mae’s response to criticism was strange, in a way. After all, Fannie Mae and Freddie Mac
did
play an important role in homeownership. Their guarantees allowed more people to buy homes. Over time, they made it possible for mortgage originators like Countrywide to overtake the dying S&L industry as the country’s primary mortgage lender—thus keeping the mortgage spigot open even as the thrifts were shutting down.

And Fannie and Freddie had far more friends than critics, including some powerful Republicans. Republican senator Phil Gramm, an ardent champion of free markets, was in as good a position as any to cause Fannie and Freddie trouble; he became the chairman of the Senate banking committee in 1994. But Gramm always gave Fannie and Freddie a pass. Why? Because, like Johnson, Gramm saw the political fruit that homeownership could bear. According to a former banking committee staffer, the Republicans studied what it was that made people vote Republican. “The number one predictor of voting Republican was a job in the private sector,” he said. “Number two, and it’s a close second, is that you own your own home.” He adds, “Gramm preached that gospel to all who would listen.”

Then again, maybe Fannie’s tendency, as Maloni later put it, “to throw one brick too many rather than one brick too few” wasn’t so surprising after all. When you got right down to it, there was something about the GSEs’ business model that made no sense. Nobody in his or her right mind would establish a company whose competitive advantage was built on a guarantee that was nowhere written down and that no one could say for sure even existed. Yet that was the premise upon which Fannie Mae and Freddie Mac had built their dominance. Their advantages were based in large part on the belief by investors that the government would never let the GSEs default.

When Fannie dealt with investors, it encouraged that perception. (It once claimed that its securities were even safer than triple-A-rated bonds because of the “implied government backing of Fannie Mae.”) Yet whenever anyone in government brought it up, Fannie Mae went mildly berserk. To admit that it had government backing would mean admitting that taxpayer support was the key source of Fannie’s huge profits—and that taxpayers would be on
the hook if anything went wrong. And that was something Fannie could never concede. That’s why even the most muted criticism was treated as life or death—because Fannie Mae always felt that it
was
life or death. Some former lobbyists used to compare Fannie to the old Oakland Raiders, whose motto in the seventies was “Just win, baby.”

There was another reason why Fannie Mae was so quick to push back against its critics. Over time, the bulk of its profits were being generated from an activity that critics said—correctly—had nothing whatsoever to do with helping people buy affordable homes.

The business of stamping mortgages with its guarantee and turning them into mortgage-backed securities was a good, steady business. It gave Fannie Mae and Freddie Mac immense power in the marketplace. But while profitable, it wasn’t off-the-charts profitable; it didn’t generate the kind of profits that put companies in the upper echelon of American business. For that, Fannie and Freddie turned to another activity: they began to build up their own portfolios of mortgages and mortgage-backed securities, which they held on their own books, instead of selling them to investors.

Although owning a portfolio of mortgages had almost bankrupted Fannie in the early 1980s, the company never got rid of its portfolio entirely. “We always viewed it as a core part of the business,” says Maxwell. Fannie’s mantra was “Good times and bad,” meaning it would be in the market when investors were eager to buy mortgages, as well as when they were uninterested—and the only alternative was for Fannie to hold the mortgages in a portfolio. Maxwell, typically, had kept the portfolio fairly small so it wouldn’t attract too much attention.

Johnson, also typically, expanded it exponentially. The core idea behind the portfolio reflected, once again, the advantages of being a GSE. Fannie and Freddie would issue some of that low-cost debt their implied government backing made possible, use that money to buy higher-yielding mortgages, and pocket the difference. “The big, fat gap,” Federal Reserve chairman Alan Greenspan used to call it disparagingly, a phrase that perfectly captures the almost moronic simplicity of the strategy. By the end of 1998, Fannie had a $415 billion portfolio of mortgages, up from just $156 billion in 1992. In its 1996 report to Congress, the Congressional Budget Office estimated that the profit margin on this business was four to five times higher than the guarantee business. By the end of the decade, it accounted for most of Fannie’s profits.

This business also helped make Fannie even more of a force on Wall Street.
Over the years, it paid Street firms hundreds of millions of dollars worth of fees to issue all the debt. “People dealt with them [Fannie and Freddie] as if they were sovereign credits,” says one former Wall Streeter. “You just knew better than to get on the wrong side of them.”

By the end of the decade, Fannie Mae had become America’s third largest corporation, ranked by assets. Freddie was close behind. The companies were ranked one and two respectively on
Fortune
’s list of the most profitable companies per employee. Fannie’s stock price had soared. Its market value under Johnson went from the $10.5 billion he’d inherited from Maxwell to over $70 billion. “There is no other financial institution in America with such a significant share of such a huge market,” Johnson said in one speech, and he was exactly right.

Here’s the great irony of the mortgage market in the 1990s: to the extent that lower- and moderate-income Americans were being swept along in the rising tide of homeownership in the 1990s, it was happening not because of Fannie and Freddie, but despite them. The replacement of the S&L industry by the new mortgage origination companies; the toughening, in the 1990s, of the Community Reinvestment Act, which forced banks to make loans to people in poorer neighborhoods; even the rise of the subprime industry (though it was more focused on refinancings than new home loans)—these were all factors in helping poorer people own homes. Fannie and Freddie may have been given a federal mandate to help lower- and moderate-income Americans buy homes, but the GSEs were cautious about the credit risk they took. They preferred to game their housing goals rather than meet them, using methods that Fannie referred to internally as “stupid pet tricks.” They wanted nothing to do with subprime. Subprime loans didn’t conform. And anyway, there was so much money to be made elsewhere.

Many affordable housing activists found this infuriating. For all its sanctimony about its mission, they complained, the GSEs did very little for those who truly needed help. Both John Taylor, the CEO of the National Community Reinvestment Coalition, and Judy Kennedy, the former Freddie lobbyist in charge of the National Association of Affordable Housing Lenders, complained bitterly about Fannie and Freddie. Repeated studies by HUD showed that the GSEs’ purchases of loans made to lower-income borrowers lagged the market.

That’s not to say Fannie and Freddie did nothing. When Countrywide ginned up its program to provide low-income mortgages, it sold them to Fannie through a special program Fannie had set up to handle such loans. But back then, programs like Countrywide’s were small and highly controlled—experiments, really, and valid ones at that, because they sought an answer to an important question. As Dan Mudd would later ask, “Do you want to live in a country where someone who has a blemish on their credit, or someone who happens to be a minority, can’t get a home? Where do you draw the line?”