Tuesday, April 7, 2009

Fun with Aunt Fannie and Uncle Freddie

It’s hard to find a starting place sometimes, especially when you tackle something big. Remember the “whitewater” scandal when it first broke? Nobody could make sense of it for a long time, and to this day we still don’t have any answers. When I decided to write about the mortgage crisis and the bailouts, it seemed that the more I looked, the more the different directions it started to run off in. Now depending on which news channel you watch or what newspaper or blog you read, you will have a different culprit in your mind than your neighbor. I think to date no one has really gotten it right. We have blamed banks, speculators, the SEC, shady mortgage brokers, congress, ACORN, Bush, Paulson, etc, etc.

But we may have all been misled. There is one, make that two entities that we think of as victims of this crisis. That would be the Federal National Mortgage Association, better known as Fannie Mae and the Federal Home Loan Mortgage Corporation, also known as Freddie Mac. While we seem to be just now coming to the realization that we will have to bail them out, maybe we should have started there to begin with.

American’s all showed outrage at AIG’s government funded executive compensation, but no one batted an eyelash when they announced the bonuses of the Fannie/ Freddie execs, and that was even after the government had to step in and take them over, a few years after the large accounting scandal that struck both. They must be in bed the right people.

This is an institution with a shady past of political patronage that dates back to its inception. An entity that serves two masters: congress and the shareholders. The good folks in our congress have been using Fannie and Freddie for years. If you are a legislator with a poor, urban demographic then you lean on your people at Fannie to buy and back risky mortgages in order to give back to your constituents. Or you help someone refinance their second home for more than its worth and after they pocket the cash you get a nice campaign contribution. If you think that doesn’t go on, then you are both naive and stupid. Start checking financial records.
But how could these two quasi-government institutions have wreaked so much financial havoc? Wasn’t that someone else’s fault? Maybe not if you look back into the past. Our current mortgage crisis was caused by bundled Mortgage Backed Securities (MBS). If a bank or financial institution bundles its mortgages into securities it would fall under government rules. There would be scrutiny, and if it was too risky they would have problems selling them and they would later earn a natural, capitalistic death.

The Feds have claimed that these MBS’s fall outside of regulations. That should not be case, unless they were bundled by Fannie/ Freddie. You see they are both government –sponsored enterprises. And as such, they gain the following perks: capital requirements for securities are less than half that required for private mortgage backed securities, GSE securities are eligible for unlimited investment by government insured thrifts, and Housing GSE securities fall outside the realm of having to register with the SEC.

Over the past several decades these two enterprises have been federally subsidized, and while doing so have backed the purchase of enough housing to dwarf the two largest thrifts combined mortgage portfolios. Not only that, but they used the MBS as capital to purchase and bundle more securities, and became a self-perpetuating machine. Along the way they used a sliding scale to determine the credit worthiness of the people they backed mortgages for, and bought mortgages from. Alt-A, Interest only, Negative Amortization, they backed every kind of shady deal there was, to the tune of around 1 trillion dollars. All of these loans were bundled up and sold, and the proceeds used to back and buy up more. You can see where this is going can’t you?
Funding for these two monsters skipped around the normal congressional appropriations process. Instead good friends like Chuck Schumer, added earmarks to existing bills giving more money to these failing enterprises. That alone is testimony to the power of their lobbying efforts. Remember, government funded lobbying of government. Your money at work, thanks Chuck. In 2005, Congress attempted to pass legislation forbidding GSE’s from holding portfolios of mortgages or MBS, BUT Democratic opposition shot that one down. There you can see which side they spent more money lobbying to.

Somewhere in this twisted process, we all take the hit. Now we will have to bailout the institution that we funded all along, that took taxpayer dollars, gave it to risky buyers, bundled them up and made a killing off them. The government knew about this as far back as 2003, when the accounting scandal hit after Enron. But Barney Frank publicly stated that since Fannie had fired a few people everything was okay. How much money did they give him?

So you can pick at any one of these dangling threads and see where it takes you. How far down the rabbit hole do you want to go? I traveled halfway around the internet and burned through several toner cartridges just to print out relevant material. Maybe you will to and maybe learn who is to blame for this terrible mess. I blame everyone mentioned in this post, and a few to be named later…

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