Bailout Nation (41 page)

It was as a political talking point that the “blame CRA” meme seemed to find new life. (The same occurred with Fannie and Freddie.) It spread among the partisan crowd during the 2008 presidential campaign.

One thing it did was provide a valuable time saving service: Those who mindlessly repeated these talking points—in print, on television, or on radio—identified themselves as partisans, not serious housing or credit analysts. This allowed the informed reader or listener to quickly dismiss the talking heads they might have otherwise wasted time on.

Contrary to another one of these talking points, the government-sponsored enterprises (GSEs) were not a significant factor in causing the mortgage or housing crisis.

They were, however, a mess of an entirely different making.

Understanding the GSE story requires grasping their role within the housing sector.

Fannie Mae was not a government entity, but an independent, publicly traded firm. Fannie and Freddie were allowed to borrow at better rates than banks because they were GSEs. They bought what they did in an attempt to grab share and profits—and they did a lot of dumb things as the housing boom expanded and lending got really silly from 2002 to 2007.

For decades, Fannie and Freddie took advantage of their quasi-government status for access to cheap cash to crank out reliable profits. But for the most part, they followed their charters and only bought conforming mortgages. Fannie and Freddie eventually changed their mortgage-buying rules, allowing each firm to buy lower-quality loans. But by then, the housing boom was already nearing its peak, and the crash was all but inevitable.

Ironically, many of the political hacks focused their energy on the wrong place. Subprime wasn't the GSEs' biggest problem; it was their medium-quality loans that were going bad at an alarming rate. According to
Barron's
, Alt-A mortgages were what caused their demise:

No doubt the GSEs were important cogs in the great mortgage securitization machinery. One might have thought Fannie Mae, a firm that had been in the business of securitizing mortgages since 1938, would have some insight into what was actually going on in the mortgage markets. No such luck.

This was their biggest contribution to the current crisis: Given their expertise, they were ideally situated to identify the massive credit bubble as it was inflating—and they completely missed it.

I was never enamored with Fannie Mae, and my firm started shorting FNM at $42+ later in 2007. (Given the company's penny stock price, I wish we were still short.) There had been all sorts of issues: Fraud, incompetence, and corruption were just starters. Imagine in the era of quantitative mortgage analysis, their computer systems did a poor job analyzing risky loans. And on top of that, from 2004 to 2006, Fannie operated without a permanent chief risk officer.

They were a disaster waiting to happen.

T
he folks who want to place the crisis at Fannie and Freddie's doorstep seem to be focusing on minor factors and irrelevancies. This was not a “grand social engineering” experiment, as the radical right has called it. This was a profit-motivated private company that was poorly managed and rife with extreme shortsightedness.

When Fannie hired Daniel Mudd as its new CEO in 2004, he arrived to find a company in utter disarray. At the time, Fannie Mae was still recovering from a massive accounting scandal in which the company had overstated billions in profits. Senior management had pocketed hundreds of millions in illicit stock option gains based on this phony income.
¹³

This was the GSEs' real crime: simple fraud. Fannie overstated profits by $6.3 billion from 2001 to 2003, and in 2008 the Office of Federal Housing Enterprise Oversight (OFHEO) sued former CEO Frank Raines. The OFHEO recovered $24.7 million of ill-gotten stock option bonuses that were predicated on phony profits.
¹⁴
The stock options that Raines had exercised so profitably between 1998 and 2004 were priced at $77.10; Fannie Mae stock (FNM), now under federal conservatorship, recently traded at 37 cents.

Moreover, CEO Mudd arrived in 2004 to find “the company was under siege,” as the
New York Times
described in an October 2008 autopsy on Fannie's failure:

Those lenders included Countrywide Financial. Their CEO, Angelo Mozilo, was demanding that Fannie start buying the lender's riskier loans. When Fannie resisted, Mozilo threatened to terminate their partnership.

This was no idle threat. Countrywide was the nation's largest mortgage lender, and losing its business might have been fatal to Fannie. That's because by 2004, Fannie had lost 56 percent of its loan-reselling business to Wall Street.

When Mozilo said, “Jump,” Fannie Mae said, “How high?”

Between 2005 and 2008, Fannie purchased or guaranteed at least $270 billion in loans to risky borrowers—more than three times as much as in all of its earlier years combined, the
New York Times
reported, citing company filings and industry data. “We didn't really know what we were buying,” Marc Gott, a former director in Fannie's loan servicing department, told the
New York Times
. “This system was designed for plain vanilla loans, and we were trying to push chocolate sundaes through the gears.”
¹⁶

Meanwhile, over at Fannie's little brother, Freddie Mac:

Poor risk management and poorer timing make for a dangerous combination.

I
t is a tenet of faith among right-wing supporters that abuses by Fannie Mae and Freddie Mac were aided and abetted by Democratic members of Congress, notably Representative Barney Frank. They blame much of the housing and credit crisis on the misuse of GSEs to further the liberal goal of maxing out home ownership for everyone, most notably minorities.

Many adherents of this “blame the Dems” viewpoint point to the 2004 House Finance hearings where then OFHEO director Armando Falcon was harshly treated for daring to so much as criticize the accounting breakdowns at Fannie and Freddie. A YouTube highlight reel of the hearing has received nearly three million hits as of this writing.
¹⁸

The great irony is Fannie and Freddie spread around hundreds of millions of dollars corrupting members of Congress of both parties. A December 2008 AP story detailed Freddie Mac's “multi-million dollar campaign to preserve its largely regulatory free environment, with particular pressure on Republicans who controlled Congress at the time.” Famed conservative Newt Gingrich was a notable recipient of Fannie's largesse.
¹⁹

Indeed, Fannie and Freddie were among the most prolific lobbyists on K Street. For a long time they were successful in preventing closer oversight and in thwarting tighter regulation. The Republicans may have been a less natural ally than the Democrats when it came to Fannie and Freddie, but exonerating the GOP for the GSEs' misdeeds misses the larger point: Like much else in our Bailout Nation, it points to a bipartisan failure.

F
annie has been around since 1938, Freddie since 1968, and the CRA since 1977. Suddenly, all of housing goes to hell in 2006, and then credit collapses two years after—and the best explanation some people can come up with is Fannie, Freddie, and CRA? Gee, isn't that rather odd—especially after 70 years?

While reducing the complexities of economic history into bumper-sticker phrases is politically expedient, it does not help us get to the root cause of our problems. And it gets in the way of helping us fashion a solution for the future. This is why I hold the weasels who are attempting to obscure reality and rewrite history in such disdain.

For the nonpartisan, nonhacks among you, for the policy makers and academics and economists who are truly interested in how this came to pass and what we can do to fix it, the bottom line remains: The CRA was irrelevant to the current crisis, and Fannie Mae and Freddie Mac were mere cogs in a very complex financial machine with many moving parts.

But the primary cause of the mess? Not even close.

—David Lereah, National Association of Realtors' chief economist, December 2005
¹

—Alan Greenspan, October 2006
²

 

 

B
y now, you may have noticed that housing has played a starring role in our Bailout Nation. It is the unifying theme that runs through much of the bailout narrative.

Housing was the prime driver of the economic cycle of 2001 to 2008: It was a disproportionate source of newly created jobs. Mortgage equity withdrawal (MEW) was an outsized contributor to consumer spending. Home mortgages were a huge portion of much of the twenty-first century's consumer debt creation. On Wall Street, the securitization of mortgages was a major factor driving revenue and profits; residential mortgage-backed securities (RMBSs) were bundled by the Street, and then repackaged into collateralized debt obligations (CDOs). Pseudo insurance policies written on all those CDOs were credit default swaps (CDSs), a key element in the demises of Bear Stearns, Lehman Brothers, and AIG.