bush
administration attempts to strengthen fannie and freddie
regulation from 2001 onwards
some facts about fannie
mae and freddie mac
some history
of fannie mae and freddie mac
on
the vast size of fannie mae and freddie mac
11september
2003 - fighting against fannie and freddy regulation
accounting and influence
peddling at the fms
end notes
“Just the Facts: The Administration's Unheeded
Warnings About the Systemic Risk Posed by the GSEs
“For many years the President and his Administration
have not only warned of the systemic consequences
of financial turmoil at a housing government-sponsored
enterprise (GSE) but also put forward thoughtful
plans to reduce the risk that either Fannie Mae
or Freddie Mac would encounter such difficulties.
President Bush publicly called for GSE reform 17
times in 2008 alone before Congress acted. Unfortunately,
these warnings went unheeded, as the President's
repeated attempts to reform the supervision of these
entities were thwarted by the legislative maneuvering
of those who emphatically denied there were problems.
“2001
April: The Administration's FY02 budget declares
that the size of Fannie Mae and Freddie Mac is "a
potential problem," because "financial
trouble of a large GSE could cause strong repercussions
in financial markets, affecting Federally insured
entities and economic activity.”
Etc....
some facts about fannie mae and freddie mac
Fannie Mae and Freddie Mac are
GSEs [goverment-sponsored enterprises]. They do not
provide mortgages to house buyers but, instead, buy
mortgages from various institutions that do provide
mortgages to home owners. This allows the mortgage
providers to carry on with their business of lending.
These GSEs were designed to bundle
up the mortgages and sell them into the market (see
Mortgage-backed Security - MBS and Collateralized
Mortgage Obligation - CMO). [1] Since they were converted into a public-private hybrids
by Lyndon Johnson, they have become ever more powerful,
and irresponsible, to the extent of playing the market
from their immensely privileged position.
- Fannie Mae is tax-exempt.
- Fannie Mae are allowed to hold
only 2.5% capital reserves (banks normally have
to hold about 10%). This allows Fannie Mae much
greater leverage.
- Fannie Mae receives preferential
low interest rates because of implicit Fed. (government)
guarantees. This allows the GSEs [government sponsored
enterprises] Fannie Mae and Freddie Mac, to go head
to head with other institutions, while having ginormous
competitive advantages.
- Fannie Mae is exempt from SEC
[Securities and Exchange Commission] regulation.
This is allowing Fannie Mae to bundle up mortgages,
which are then rated AAA with no requirement to
make clear what is in the bundle.
This is what has allowed toxic instruments, that
have been sold across the world. It has also created
a situation where money institutions do not know
whether potential inter-bank business partners are
holding these boiled babies on their books, complete
with a golden stamp on the wrapping, rather than
safe instruments. This is inclining banks to a natural
caution, to be chary of lending good money to other
banks against these ‘assets’.
some history of fannie mae and freddie mac
- 1930s: Franklin Roosevelt’s New Deal
Fannie Mae started as the Federal National Mortgage
Association. Fannie Mae provided local banks and
thrifts with money needed to finance home mortgages.
- 1968: Lyndon Johnson converted
Fannie Mae into a public-private hybrid called a
“government-sponsored enterprise” [GSE].
- 1970: Freddie Mac, was created
so Fannie Mae would not monopolise mortgage buying
(but they have, in fact, marched in concert).
- 1977: Under Jimmy Carter, the
Community Reinvestment Act [CRA] compelled banks
to make loans to poor borrowers.
- 1999: Under Bill Clinton, banks
were given strict numerical quotas for forcing sub-prime
loans.
on
the vast size of fannie mae and freddie mac
“the taxpayers are
living under an enormous rock suspended by a single
rope.” on fannie mae, august 2002 [In
5 ‘pages’.]
August 2002
“ That means if housing prices crash or either
company stumbles, the taxpayers could be on the
hook for hundreds of billions. It's as if the public
had cosigned Fannie and Freddie's debt, says Lawrence
White, a New York University business-school professor
and former Freddie Mac director. To pay for a very
small cut in mortgage rates, White says, the taxpayers
bear the risk of a massive bailout.”
—
“Shays broke a political rule in Washington:
Don't mess with Fannie Mae. Wealthier than most
nations, Fannie Mae is known to try to devour anyone
who crosses it. That's fine with Fannie Mae's supporters,
who say it has helped millions fulfill the dream
of homeownership by combining public spirit and
private innovation. Critics contend that Fannie
Mae's public face of heartwarming largess masks
plenty of private greed. Fannie, they claim, is
a company with the lowliest of missions: to juggle
politicking and public relations so that its blend
of subsidies and privileges remains intact.
—
“A creature of Franklin Roosevelt's New Deal,
Fannie Mae was born as the Federal National Mortgage
Association. In an era of unemployment and foreclosures,
FDR's brainchild provided local banks and thrifts
with money needed to finance home mortgages. Almost
70 years later, Fannie Mae is one of the world's
biggest financial-service companies. Eight
trillion dollars pass through its coffers yearly.”
—
“The government has come to Fannie's rescue
before: Fannie lost $1 million a day during the
early 1980s, requiring tax relief and other interventions.
A few years later, taxpayers bailed out the Farm
Credit System, a government-sponsored enterprise
for agricultural loans. Together, Fannie
Mae and Freddie Mac have a trillion and a half dollars
in assets--more than the gross domestic product
of every country but Japan, Germany, and the United
States. Their combined debt--also measured
in the trillions--is poised to outpace that of the
US government. Says Republican Representative Richard
Baker of Louisiana, who chairs the House subcommittee
overseeing Fannie and Freddie: "The taxpayers
are living under an enormous rock suspended by a
single rope. Once it breaks, there's no recovery."
“Some observers think the rope is fraying.
Earlier this year, the Wall Street Journal editorial
board likened Fannie and Freddie to failed energy
trader Enron, attacking the two companies' exploding
debt and "terrible" financial disclosure.
The Economist called Fannie and Freddie "arguably
the most worrying concentrations of risk in the
global financial system." ”
—
“ [...] It also stokes their[the nation's
mortgage lenders] greatest fear: that Fannie and
Freddie want to exploit their cheaper borrowing
costs to monopolize the housing-finance industry
[...].”
—
“On March 2, 2000, a story in the Washington
Post suggested that Fannie and Freddie's policies
were harming the ability of African-Americans and
Hispanics to obtain mortgages. The bombshell came
from William Apgar, then a top official at the Department
of Housing and Urban Development, now a professor
at Harvard's Kennedy School of Government. [...]
the gist of the Post story was correct. Fannie's
good intentions aside, for years HUD has found that
Fannie and Freddie lag behind private lenders in
serving African-American borrowers and other underserved
communities.”
—
“ "It's all a matter of know-who, not
know-how," complains Ralph Nader about Fannie's
higher ranks. "They've perfected all the techniques
of lobbying and pay massive salaries for Rolodex
hiring to ensure against any change." Nader's
favorite example: Fannie Mae vice chair Jamie Gorelick,
a well-connected Washington lawyer who earned almost
$1 million in her first eight months on the job
after serving as counsel to the Defense Department
and deputy to former attorney general Janet Reno.”
—
“In June, the [Wall Street] Journal's board
argued that taking on Fannie
and Freddie would be President Bush's biggest challenge
after toppling Saddam Hussein.”
—
“ "It's grant payola," says Nader.
"Fannie sprinkles millions around the District
and then calls on those groups when the company
needs to neutralize dissent.”
—
“Peter Wallison of the American Enterprise
Institute thinks the government should be fighting
Fannie and Freddie's monopoly power just as it went
after Microsoft's. Wallison claims "it's hard
to know whether the government controls Fannie and
Freddie or they control the government." Some
say the two companies treat OFHEO,
the agency that monitors them, like a lap dog.
“Fannie's increasing size and debt also worry
regulators. Says one top official: "Every financial
institution this leveraged has gotten into trouble
[...].”
“Despite all the noise,
Raines says, "the ratio of action to criticism
is very low. If something were really wrong, wouldn't
someone in the government do something?" ”
[Quoted from washingtonian.com]
“New Agency Proposed to Oversee Freddie Mac
and Fannie Mae
“The Bush administration today recommended
the most significant regulatory overhaul in the
housing finance industry since the savings and loan
crisis a decade ago.
“Under the plan, disclosed at a Congressional
hearing today, a new agency would be created within
the Treasury Department to assume supervision of
Fannie Mae and Freddie Mac, the government-sponsored
companies that are the two largest players in the
mortgage lending industry.
“The new agency would have the authority,
which now rests with Congress, to set one of the
two capital-reserve requirements for the companies.
It would exercise authority over any new lines of
business. And it would determine whether the two
are adequately managing the risks of their ballooning
portfolios.”
—
“Significant details must still be worked
out before Congress can approve a bill. Among the
groups denouncing the proposal today were the National
Association of Home Builders and Congressional Democrats
who fear that tighter regulation of the companies
could sharply reduce their commitment to financing
low-income and affordable housing.
“ ''These two entities -- Fannie Mae and
Freddie Mac -- are not facing any kind of financial
crisis,'' said Representative Barney Frank of Massachusetts,
the ranking Democrat on the Financial Services Committee.
''The more people exaggerate these problems, the
more pressure there is on these companies, the less
we will see in terms of affordable housing.'' ”
The effort to put in regulation
failed.
accounting and influence peddling at the fms
11 September 2003
“The plan is an acknowledgment by the administration
that oversight of Fannie Mae and Freddie Mac --
which together have issued more than $1.5 trillion
in outstanding debt -- is broken. A report by outside
investigators in July concluded that Freddie Mac
manipulated its accounting to mislead investors,
and critics have said Fannie Mae does not adequately
hedge against rising interest rates.” [Quoted
from nytimes.com]
20 June 2005
“In late 2004, the leadership of the Federal
National Mortgage Association (FNMA or Fannie Mae)
was accused of having engaged in a series of questionable
accounting practices that led to an overstatement
of its earnings and an understatement of its risk.
Although Fannie Mae’s top officers denied
the accusations, a careful review by the U.S. Securities
and Exchange Commission confirmed the allegations.
Within a few weeks, Fannie Mae conceded the charges
and its top officers were forced to resign. Any
doubts about the seriousness of the company’s
shaky finances were laid to rest on January 19,
2005, when Fannie Mae cut its dividend in half to
bolster its cash reserves.”
—
“Both Fannie Mae and Freddie Mac have proven
exceptionally adept at lobbying Congress to preserve
and enhance their privileges. Any effort that relies
on new regulations will likely perpetuate the risk
to the financial market and preserve their dominant
influence. Indeed, if Armando Falcon, director of
the Office of Federal Housing Enterprise Oversight
(OFHEO), had not courageously persisted in exposing
Fannie Mae’s suspect operations, often in
the face of congressional hostility, former Fannie
Mae President Franklin Raines would still have his
job and Fannie Mae’s shaky finances and fabricated
earnings would still be hidden.”
—
“Fannie Mae was created in 1936 during the
Great Depression to provide a secondary market to
encourage greater use of the innovative long-term,
fixed-rate, level-payment, fully amortized mortgages
that the newly created Federal Housing Administration
(FHA) was insuring against loss of principal and
interest. The exercise was a success, and this type
of innovative mortgage became the standard means
of financing the postwar housing boom that raised
the homeownership rate from 44 percent in 1940 to
69 percent by 2004.”
—
“ The evidence reveals that Fannie Mae’s
management team appears to be the chief beneficiary
of the federal privileges and the accounting irregularities
that were recently uncovered. For example, in 2003,
749 members of Fannie Mae’s management team
received a staggering $65.1 million in bonuses,
a portion of which was attributable to the overstated
earnings that followed from the accounting irregularities.[16]
Over the past five years, the top 20 Fannie Mae
executives reportedly received combined bonuses
of $245 million...” [Quoted from heritage.org]
Good reading for background - longish.
11 July 2008
“Former U.S. Treasury Secretary John Snow
said that Fannie Mae and Freddie Mac have relied
on leverage to fund their businesses in the same
fashion as a hedge fund, and that the government
should avoid taking them over.”
—
“Congress created Freddie Mac and expanded
Fannie Mae in 1970 to promote home buying in the
U.S. The companies' charters give the Treasury the
authority to buy as much as $2.25 billion in each
of their securities in the event of possible default,
implying the government will stand behind the companies'
debt.”
—
“Fannie Mae and Freddie Mac ``have an enormous
political organization, lots of reach into many
congressional districts, and they had a storyline
that at the time worked -- they were really promoting
housing,'' he said.” [Quoted from bloomberg.com]
end notes
- derivatives
This area gets technical
and even complicated if you want to dig deeper.
In this note, I’ll only give you enough to
dig deeper should you wish. There are several others
of these ugly government-private hybrid GSEs, such
as Farmer Mac, Sallie Mae [for student loans] and
Ginnie Mae [an insurer like AIG, not publicly traded].
Enough of that.
Fannie Mae takes varying numbers of mortgages, packages
them together and sells them into the market. CMOs
[collateralized mortgage obligation] are legal entities
formed by usually packaging several MBSs [mortgage-backed
security] together. This legal entity can then sell
off the collateral or the interest or share as separate
entities [derivatives].
Others, such as AIG [American International Group],
one of the world’s biggest corporations -
ranked in the top twenty, can offer insurance against
collateral losses, or changes in interest payments.
AIG was one of the first entities to get into deep
trouble and start sucking up government tax funds
in support.
Why is the system falling apart? Under Fannie Mae
and Democrat pressure,
home loan companies were forced and persuaded into
unsafe loaning policies. Thus, loans were made to
people with no visible means of support; loans at
over the value of the property (a sweetner/bribe
to the purchaser), under the theory that house prices
would rise for ever into the far stratosphere; loans
at growing multiples of the borrowers’ income,
often with small print increasing the interest rate
a few years down the road, and even unlawful loans
to illegals. Naturally, this pool of free money,
without proper regulation, attracted sharks and
the barely honest from hundreds of miles around.
When, inevitably, the housing markets turned around
(slowing, going down) - I’m told that this
has happened at least six times previously, even
in the American market - then came the cascade.
The more dubious ‘borrowers’ just walked
away from the properties, thus driving property
prices lower and leading more borrowers into default
and negative equity,
in a nasty positive feedback.
Thus operations like AIG ran out of money paying
off the insurance claims. Meanwhile, no one knows
clearly the values of the CMOs or their derivatives.
These derivatives have been traded throughout the
world and no one knows who’s holding what
and thereby how secure a co-operating
bank may be. And thus there is a strange reluctance
to lend money.
Incidently, you may hear fossil media scribblers
and talking heads wittering on about how nobody
understands these instruments,
however they are widely understood by the institutions
trading them. It is just the punditocracy that is
confused. It is the valuations that are in question,
this is not some esoteric branch of quantum physics.
Just to add to the devil’s brew, the idiots
at Fannie Mae hoped to get in on the act and started
trading in the instruments, along with their privileged,
competitive advantages.
- Negative equity
is when the marketable price of a property falls
below the amount of the outstanding loan.
- Warren
Buffet on the OFHEO [link from DVH]
“"QUICK: If you imagine where things
will go with Fannie and Freddie, and you think about
the regulators, where were the regulators for what
was happening, and can something like this be prevented
from happening again?
“Mr. BUFFETT: Well, it's really an incredible
case study in regulation because something called
OFHEO was set up in 1992 by Congress, and the
sole job of OFHEO was to watch over Fannie and
Freddie, someone to watch over them. And they
were there to evaluate the soundness and the accounting
and all of that. Two companies were all they had
to regulate. OFHEO has over 200 employees now.
They have a budget now that's $65 million a year,
and all they have to do is look at two companies.
I mean, you know, I look at more than two companies.
“QUICK: Mm-hmm.
“Mr. BUFFETT: And they sat there, made
reports to the Congress, you can get them on the
Internet, every year. And, in fact, they reported
to Sarbanes and Oxley every year. And they went--wrote
100 page reports, and they said, 'We've looked
at these people and their standards are fine and
their directors are fine and everything was fine.'
And then all of a sudden you had two of the greatest
accounting misstatements in history. You had all
kinds of management malfeasance, and it all came
out. And, of course, the classic thing was that
after it all came out, OFHEO wrote a 350--340
page report examining what went wrong, and they
blamed the management, they blamed the directors,
they blamed the audit committee. They didn't have
a word in there about themselves, and they're
the ones that 200 people were going to work every
day with just two companies to think about. It
just shows the problems of regulation.
“QUICK: That sounds like an argument against
regulation, though. Is that what you're saying?
“Mr. BUFFETT: It's an argument explaining--it's
an argument that managing complex financial institutions
where the management wants to deceive you can
be very, very difficult."”
- An instrument, in financial
jargon, is just a lump of value. A bank note or
a share in a company is an instrument. You can take
your bank note and, normally, exchange it for something
of value. Holding a share means that you own that
proportion of the company’s value. Owning
an MBS or CMO means that you own the value of the
mortgage debts contained within.
Derivatives can be just
about anything whose value is in some way based
upon a previous instrument (that is, derived from).
For example, a forward contract that says you can
buy ten MBSs for two weeks on Sunday at seven pence
each. You can then have derivatives on derivatives.
All of these are instruments - from the ‘simple’
bank note to the most obscure compound derivative.
Whichever one you own, it just means you have a
bit of paper that you can exchange for something
(else) of value. For those who want to get more
philosophical about this see fiat
money and inflation.
- Banks widely co-operate,
borrowing from one another as needs and opportunities
occur. Bank co-operation is particularly necessary
in providing very large loans to governments and
large infrastructure projects like, for instance,
a Channel Tunnel or an Aswan Dam.
This not only gathers together large resources,
but also spreads risks.
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