Origins of an American Kleptocracy
Some days ago we wondered aloud at the blank check extended to Fannie and Freddie along with the suspiciously convenient timing of those announcements on Christmas Day. Back then we wondered if we had been told the entire story. To wit:
So. Let us summarize:
We do not expect the GSEs to grow their portfolios at all, so we are fixing the bloated portfolio problem by easing the portfolio caps to permit a quarter trillion dollar expansion thereof.
We do not expect either of the GSEs to need more help from the Treasury, so we are responding to the underutilized $400 billion "lifeline" the GSEs have with the Treasury ($111 of which is currently used) by expanding it to... infinity.
Oh, and though they have collectively lost nearly $200 billion, we are paying the CEOs around $6 million each.
Great work team! It's already almost 11:00. Let's go to lunch.
The other shoe having now dropped, Bloomberg has joined in our skepticism:
Taxpayer losses from supporting Fannie Mae and Freddie Mac will top $400 billion, according to Peter Wallison, a former general counsel at the Treasury who is now a fellow at the American Enterprise Institute.
“The situation is they are losing gobs of money, up to $400 billion in mortgages,” Wallison said in a Bloomberg Television interview. The Treasury Department recognized last week that losses will be more than $400 billion when it raised its limit on federal support for the two government-sponsored enterprises, he said.
“It was always safe to buy these notes,” he said. The U.S. government was always going to stand behind them. They’re as good as Treasury notes.”
We are no longer sure this is the most inspiring comparison. Wallison also chimes in via the Wall Street Journal and points to a darker vein shot through the GSE story:
New research by Edward Pinto, a former chief credit officer for Fannie Mae and a housing expert, has found that from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A.
In general, a subprime mortgage refers to the credit of the borrower. A FICO score of less than 660 is the dividing line between prime and subprime, but Fannie and Freddie were reporting these mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a third-quarter 10-Q report in 2008.
But because of Fannie and Freddie's mislabeling, there were millions more high-risk loans outstanding. That meant default rates as well as the actual losses after foreclosure were going to be outside all prior experience. When these rates began to show up early in 2007, it was apparent something was seriously wrong with assumptions on which AAA ratings had been based.
Losses, it was now certain, would invade the AAA tranches of the mortgage-backed securities outstanding. Investors, having lost confidence in the ratings, fled the MBS market and ultimately the market for all asset-backed securities. They have not yet returned.
It has become conventional wisdom, perhaps even cliche, to pin the origins of the credit crisis on the big banks or, AIG or even the practice of financial modeling. Certainly, these actors have received the most play in the media, and have now endured the focus of populist ire for more than a year. We now think that the analysis leading commentators to focus blame on these entities is fatally flawed.
We have seen no credible data that any of the large banks or other underwriters of mortgage backed securities ("MBSs") or collaterized debt obligations ("CDOs") or firms like AIG selling protection on same actually misrepresented the character of underlying collateral. This is in direct contrast to the allegations of Edward Pinto as printed by the Wall Street Journal. If Pinto is correct such that the mis-marking of mortgages by the GSEs and the discovery thereof destroyed confidence in the accuracy of ratings in mortgage backed securities and their derivatives (and it seems probable to suspect that he is) then it seems almost beyond question that the policies (or policy malfeasance) of Fannie and Freddie, and not the actions of large banks or firms like AIG are the proximate cause of not just the credit crisis, but also the continuing multi-act, multi-bailout farce that continues to be passed off to the public as necessary "stimulus."
It takes only a cursory examination to suspect that misdirection plays a key part in the latest act of the ongoing crisis theater of the absurd. Misdirection to distract attention from the key complicity of GSEs in the crisis. Misdirection to deflect scrutiny away from the political personalities from both sides of the aisle responsible. Misdirection to conceal what could only be described as the most damaging acts of accounting and securities fraud in the history of accounting, securities or fraud.
Precious few assumptions are required to come to conclusions laying responsibility for the largest economic disaster in recent memory at the feet of the GSEs.
First, that the GSEs had substantial influence over the mortgage market.
This is a no-brainer with the GSEs either holding or guaranteeing 51% of outstanding home mortgage debt in 2003. To put this in perspective, that figure was around 33% of the GDP of the entire United States in 2003. Read that last line again. Anyone wishing to play in the market had to compete with the rates set by Fannie and Freddie.
Second, that the GSEs artificially depressed rates (read: underpriced risk).
This is equally trivial to find given that this precise mandate has been the express purpose of the GSEs since at least 1993. The GSEs were not tasked with increasing the capacity for mortgage lending. They were tasked with making loans "affordable." They used a number of tools to do so, but the key elements were acting as a proxy for quasi-government guarantees and bundling mortgages into risk tiers to act as a sort of clearing house for securitization pools. It is often said that providing a guarantee (particularly governmental) reduces risk. This is, of course, a fantasy. All that explicitly or implicitly tax dollar backed guarantees do is socialize risk. However, they manage to do so without requiring consolidation of the resulting liabilities on the government's balance sheet. Convenient that, yes? A guarantee is a subsidy. Period. Failing to understand this is what permitted the political class to mislead the American public into thinking that cheap loans for everything from housing to small businesses to education (the next fiscal disaster on the horizon) come with no cost. (Or that cheap debt wouldn't pump up the price of everything from education to housing). Today's pundits seem to enjoy blaming "moral hazard" (by which they mean "corporate moral hazard") for the crisis. Oddly, government guarantees, particularly those that everyone assumes will be costless, are not typically part of this definition.
These assumptions, on their own should be sufficient to indict the GSEs, the totally unqualified and unaccountable recipients of political payoffs who occupied the executive offices of these fiscal singularities1 and their other supporters (including the voters who continued year after year to return these jokers to public office) on charges of gross negligence.
If, as Pinto suggests, we add purposeful misrepresentation of underlying collateral to the mix three things become apparent:
First, absent some intervening criminal act by actors farther downstream (and we may yet find some), we have isolated absolutely the cause of all that followed.
Second, it becomes quite easy to construct a criminal case for literally millions of counts of accounting, securities, wire and mail fraud against the GSEs. To the extent executives at Fannie and Freddie signed off on financial statements disclosing the portion of their balance sheets that held "AAA" securities and these had been purposefully misidentified we should be exploring prosecution for violations under e.g., Sarbanes-Oxley. (Given, however, Rham Emanuel's involvement in Freddie and Fannie, we aren't holding our breath).
Third, given the presence of blatant government price fixing in more than a third of the entire economy, the United States hasn't been anything like a "free market" since before 2003.
It should shock you that literally a third of the U.S. economy should become a playground for the social experiments of any political group of any party affiliation.
It probably will not shock you (since you are reading Zero Hedge) to find what may be the largest example of securities fraud ever directly connected to elected officials of the United States and their cronies.
Taking a step back, it should shock you that power over literally a third of the U.S. economy should ever have been allowed to become concentrated in two entities with blatantly socialist aims and under the control of executives with no relevant qualifications of any note other than loose purse strings on their political contribution satchels.
What should grip readers with even more substantial alarm is the combination of blank checking for Fannie and Freddie backstops, and the shifty manner in which these disclosures were made. Is it possible anymore to doubt that the administration simply lied through its teeth while promising us it expects no need of increased credit lines for the GSEs while simultaneously expanding same literally to infinity?
Given that Fannie, Freddie and the FHA have now taken up the mandate of supporting housing prices at any cost (to the taxpayer via endless bailouts and unlimited credit) is it possible in any way to credit the current "upturn" to fundamentals? When we factor in similar capture of the FDIC and the like, where does this leave us, exactly?
Permit us to ask a few questions:
1. Why are Fannie and Freddie still operating in any way whatsoever?
2. Given that their credibility for reliable (or even remotely non-fiction) financial disclosure nears complete obliteration, who is likely to buy anything from these entities in the future? (If you said "The Fed" you may advance to the bonus round). Surely the conflict of interest implicit in government ownership does nothing to improve the situation. Perhaps the news that the Fed plans to issue securities to shrink its balance sheet and reverse "quantitative easing" describes an attempt to securitize the tattered reputation of the GSEs? Will the Fed simply aggregate its balance sheet and issue tranches? Does that make the Fed simple the collateralized debt obligation ("CDO") of last resort? Who will do the rating? Who will be writing protection on CDO Fed Tranch A-1 (AAA)?
3. Given that neither entity is currently monitored by an Inspector General (despite what used to be statutory language so mandating) and both entities are completely captured by the current administration, how can it be anything other than insanity to expect any result from these entities other than the formation (or expansion) of a ravenous fiscal black hole?
4. Given increasing government control beyond Fannie and Freddie that now extends far beyond 33% of GDP, what can we expect if we continue to permit political parties of any stripe to exercise command and control influence over what is now probably a simple majority of our economy?
There was a time when we hoped that the United States would learn its lesson with respect to permitting political control over large swaths of private markets. Today that time seems very long ago, and somewhat naive.
Perhaps we are being too harsh on the likes of Barney Frank and other GSE proponents. Adopting a slighty more relativistic economic morality, we might count Frank as one of the greatest legislators of all time. Consider:
To the extent Mr. Frank and his ilk self-identify as advocates for low-cost housing for those ill-able to afford it, or beset by poor credit, the last 20 years have represented the largest single wealth transfer (composed primarily of real estate and flat screen TVs) to that sector known to us. Not only that, but given the de facto nationalization of MBS portfolios (we'll give you three guesses who have been the largest MBS buyers over the last several quarters) the GSEs and their supporters have managed to get taxpayers to pay for it all. Of course, had they simply proposed such a measure in Congress it would have been laughed from the chamber. And yet, it almost seems as if these individuals simply wrote a multi-trillion dollar check to their constituents that happened to be drawn on the United States Treasury.
It almost seems this way because it was this way.
- 1. Just consider Fannie Mae's torrid leadership history: James A. Johnson (Fannie CEO 1991-1998, Democratic luminary, Obama fundraiser, John Kerry vice presidential selection committee chair, $21 million in Fannie compensation). Franklin Raines (Fannie CEO 1999-2004, Clinton's Director Office of Management and Budget, $90 million+ in Fannie compensation later the subject of a civil suit) Daniel Mudd (Fannie CEO 2005-2008, $80 million in Fannie compensation) Herbert M. Allison (Fannie CEO 2008-2009, National Finance Chair, John McCain Campaign). Freddie's record is no better.