Archive for Sunday, September 7, 2008

Fannie, Freddie blind to bubble

September 7, 2008


— Mortgage giants Fannie Mae and Freddie Mac - despite their robust cadre of economists and mortgage experts - failed to heed warnings that the most dramatic housing bubble in U.S. history would burst.

The companies - particularly Freddie Mac - didn't raise enough cash to reassure Wall Street that they would be able to withstand a severe downturn in U.S. home prices.

Federal regulators - after scouring the companies' books with aid from investment bank Morgan Stanley - believe the companies pushed accounting conventions when calculating their financial cushion against losses, a person briefed on the matter said Saturday. The person declined to be named because details of the government's actions were not yet public.

As their losses started rising at alarming rates over the past year, investors gradually lost confidence, forcing the government's historic takeover of the two companies, which could be announced as soon as today and was expected to include the ouster of top executives.

Feeling jittery

Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee, said in an interview Saturday that the companies' financial picture was better than investors assumed, but "it just plainly became clear that elements of the market wouldn't accept that."

Investors have had reasons to feel jittery.

On Friday, the Mortgage Bankers Association said that more than 4 million American homeowners with a mortgage, a record 9 percent, were either behind on their payments or in foreclosure at the end of June.

Also on Friday, Nevada regulators shut down Silver State Bank, the 11th failure this year of a federally insured bank. In July, regulators seized IndyMac, which had $19 billion in deposits. And earlier this year, the government orchestrated the takeover of investment bank Bear Stearns Cos. by JPMorgan Chase & Co.

Reassuring investors

Treasury Secretary Henry Paulson has been in contact in recent weeks with foreign governments that hold billions of dollars of Fannie and Freddie debt to reassure them that the United States recognizes the importance of the two companies.

Nevertheless, the Bank of China said in late August that it cut back its portfolio of the Fannie and Freddie's debt by about one quarter since the end of June.

Washington-based Fannie and McLean, Va.-based Freddie are the engines behind a complex process of buying, bundling and selling mortgages that remains a mystery to millions of Americans whose home loans pass through this system. Together Fannie and Freddie hold or guarantee about $5 trillion in mortgage debt - about half of the nation's total.

They traditionally backed the safest loans, 30-year fixed rate mortgages that required a down payment of at least 20 percent. But in recent years, they lowered their standards dramatically, matching a decline fueled by Wall Street banks that backed the now-defunct subprime lending industry.

Little foresight

Armando Falcon, who clashed frequently with the companies during his six years as Fannie and Freddie's chief government regulator, said in an interview last month that the companies' woes are similar to the downfall of other major corporate titans like Enron and WorldCom earlier this decade. "It boils down to a whole lot of greed and arrogance," he said.

The companies, he said, took advantage of the perception on Wall Street that the government would stand behind them in a time of crisis, as is now the case.

With that implied government backing, the companies generated large profits for years, but ultimately took on too much risk, causing investors to lose faith in their ability to navigate the historic housing bust.

Economists who long warned the housing boom could not last are baffled that the companies were not better prepared for what they saw as an inevitable downturn.

"How could you look at an enormous rise in prices and not think there was a potential for them to fall?" said Christopher Thornberg, a principal with Beacon Economics in Los Angeles.

Another longtime proponent of the housing bubble concept is Dean Baker, co-director of the Washington-based Center for Economic and Policy Research. He recalls several occasions when he debated top Fannie and Freddie economists, who dismissed the idea that U.S. home prices could decline.

"Even if they didn't want to listen to me, they should have at least thought this could be a possibility," he said.

'Goal is to inject confidence'

Plummeting home prices are the key to Fannie and Freddie's troubles. As prices fall - as much as 25 percent over the past 12 months in Las Vegas, Miami, Phoenix and Los Angeles - the value of mortgages the companies hold on their books drops. That means Fannie and Freddie are recovering far less money through foreclosure sales.

While a government intervention had been expected for weeks, its timing came as a surprise.

The companies had been able to raise money through regular debt sales, but analysts say the Treasury Department likely grew concerned that foreign investors were pulling back.

"The main goal is to inject confidence into the foreign debt markets to ensure that the flow of capital to the mortgage market continues," said Howard Glaser, a Washington-based mortgage industry consultant who has worked for both Fannie and Freddie.

Freddie Mac in particular has had investors and analysts fearful for months. The company, led by CEO Richard Syron, promised to raise $5.5 billion earlier this year to shore up its finances, but failed to do so, and its sinking share price has since made it all but impossible for the company to raise that money from private investors.

Fannie Mae executives are likely to have resisted the proposed takeover because the company's financial condition isn't as dire as its sibling company, said Bert Ely, an Alexandria, Va.-based banking industry consultant.

But the government would still have to take over both companies, he said, to allow them to borrow money at the same rates.

"In order to level the playing field between the two companies, you've got to take over both of them," said Ely, a longtime critic of the two companies.

Fannie and Freddie

Fannie Mae was created by the government in 1938, and was turned into a shareholder-owned company 30 years later. Freddie Mac was established in 1970 to provide competition for Fannie.

While Fannie and Freddie generally had higher standards for lenders than the subprime mortgage companies that started going belly-up at the end of 2006, the duo lowered their standards during the housing boom and bought securities linked to riskier loans.

Even as the subprime mortgage market collapsed, Fannie and Freddie kept backing risky so-called Alt-A loans, which were made to borrowers with solid credit but little proof of their incomes, or small or no down payments.

For Fannie and Freddie, these Alt-A loans made up roughly 10 percent of their portfolios but accounted for more than half of their credit losses in the second quarter. The souring loans were concentrated in California, Florida, Nevada and Arizona, where speculation was rampant, prices soared and homeowners stretched to the financial limit to afford a home.


Godot 9 years, 9 months ago

Bozo, I will not get into a discussion of robber barons of the 19th and 20th century with you because that assumes a grand conspiracy that spans the centuries.There has been a conspiracy of thieves to cover their recent misdeeds, those being the highly educated and well placed thieves in the financial services industry whose tentacles reach deep into the the Congress and the Senate and, no doubt, the White House.We cannot rectify the crimes of past centuries. We can vigorously prosecute the criminals of today, and we must not reward or allow their crimes to continue. I am talking about the Investment Bankers, the Hedge Fund operators, the insurance companies, the mortgage lenders, the speculators. They are not Republicans or Democrats, they are The Greedy, and they must be brought down.

Godot 9 years, 9 months ago

The execs of Fannie and Freddie earned multi-million dollar bonuses on top of their million dollar salaries even as the value of the assets dropped. Those GSE's are the center of power and corruption on Capitol Hill.

Godot 9 years, 9 months ago

There are some good things in this action, if you want to find a way to put lipstick on a pig. The CEO's of both organizations are toast. Dividends on stock will be eliminated (but stock will not be wiped out). Mortgage backed securities already in place will not be guaranteed.More bad: will take on $20 Billion a month in debt, plus whatever else is necessary, to execute this bailout.

just_another_bozo_on_this_bus 9 years, 9 months ago

"Who are we bailing out? Bank of America, Citibank, PJ Morgan, Goldman Sachs, PIMCO, hedge funds and their investors, and the governments of China and Japan. "Yep-- but they own and run the economy. Until that changes, they've got a rope around our collective necks, and if they go down, they take us with them. Until we get rid of that rope, we'll continue to bail them out until the house of cards finally collapses of its own weight.

just_another_bozo_on_this_bus 9 years, 9 months ago

"this is about the Investment Banks, the Hedge Funds, and the Very Rich Elite who demand high returns on their investments, and who orchestrate a scenario where the American taxpayers make them whole when their high risk bets go bad."That's precisely who I mean with the "corporate welfare state." I agree that the mom and pop LLC's and S corporations are not part of that problem.But the rape of the taxpayers began long before the fall of 2007-- it's been going on clear back to the days of the robber barons of the 19th century, with some attempts to reign it in along the way, although that was completely turned back, starting with the Reagan Administration, through Bush I and Clinton, and greatly accelerated under Bush II.

Godot 9 years, 9 months ago

The blame does go all around; those of us who played absolutely no part in it, those of us not in the mortgage or real estate industry, who do not operate hedge funds, who do not create and sell mortgage backed securities, who did not buy houses that we could not afford, who did not lie on our mortgage applications, who made and continue to make our mortgage payments on time, who pay our bills, and save money, we are the ones who are going to pay the price for this.Who are we bailing out? Bank of America, Citibank, PJ Morgan, Goldman Sachs, PIMCO, hedge funds and their investors, and the governments of China and Japan. We are, as of today, doubling the national debt. Frank and Dodd are the ones who worked with Paulson and Bernanke and Bank of America to write H.B. 3221 that gave the Treasury a blank check to bail out the GSE's. They, and Congress, and the President, abdicated their responsibility over power of the national purse with that act. They are the ones who loaded the pistol for this game of economic Russian roulette.This is the one piece of legislation that had overwhelming bi partisan support - and the result is overwhelmingly disastrous.

monkeyhawk 9 years, 9 months ago

Interesting how the domestic car makers are now requesting a huge "loan" from the government. I guess they figure Uncle Sam is now in the bailout business and they want to get their entitlement. Of course, they would never want to admit that their workers have been putting out products that nobody wants.

Godot 9 years, 9 months ago

The term "draconian" suggests malice. There is no malice in letting those who reaped the profits to now pay the price.

just_another_bozo_on_this_bus 9 years, 9 months ago

"We taxpayers have been very, very poorly served by the Congressional committees charged with oversight of the Federal Reserve and the GSE's. Barney Frank and Chris Dodd are prime offenders. They must be held accountable."Godot, this mess has been many years in the making, and during those years, neither Frank nor Dodd were running these committees. Does that mean they have no responsibility? No, but the prime responsibility lies with BushCo and a Republican congress that removed all meaningful government regulations and turned the housing mortgage market into a Wall Street crap game.

Godot 9 years, 9 months ago

That might just happen, anyway. Why would they want to hold bonds backed by a treasury that just doubled its debt, and agreed to take on toxic junk from Freddie, Fannie and FHLB's in trade for cash, unless the bonds paid a much higher rate of interest than they do now? Rate for risk, you know.

Godot 9 years, 9 months ago

The headline is disinformation at work. Fannie and Freddie were not blind to the "bubble," they caused both the housing bubble and the credit crisis.These GSE's should be completely dissolved; the management team of both agencies should be put on trial for fraud and market manipulation. Many members of Congress should be investigated for colluding in this fraud. Treasury Secretary Paulson and Federal Reserve President Ben Bernanke should be forced to resign in disgrace. Alan Greenspan should be investigated for his role in the explosion of Adjustable Rate Mortgages and in keeping loan rates artificially low.We taxpayers have been very, very poorly served by the Congressional committees charged with oversight of the Federal Reserve and the GSE's. Barney Frank and Chris Dodd are prime offenders. They must be held accountable.

just_another_bozo_on_this_bus 9 years, 9 months ago

The reason is that they are just invested in the house of cards (or perhaps you prefer ponzi scheme) that is the world economy. If it collapses, they're screwed, too. But if they think it's going down anyway, they might take what they can get, while they can get it, even if that precipitates the crash.

volunteer 9 years, 9 months ago

Not sure if this is relevant to the topic, but here goes: I don't know about Freddie or Fannie, but I did I work for FHLB for several years and the wages were very good and the benefits out of this world: good 401K plus excellent pension plus excellent profit sharing as well as good health insurance and lots of leave/vacation time.Not many of us in the real world or in government get that generous a wage/benefits package. I wonder if Fannie and Freddie treat their employees as generously as FHLB.And if so, I wonder if this is a reflection of a generally less-than-prudent fiscal attitude.I later worked at Citi for five years and when things got tough after 9/11, the Government would call to see the dollar value that Citi's "cardmembers" had charged the previous day. I don't know if it is sad or smart that our government has to call giant multinationals to get a grip on what is happening with the economy. I do know that Citi's stock price today is less than half what it was in the late 90's, a reflection perhaps of mismanagement, extending credit where it should not have been extended.

just_another_bozo_on_this_bus 9 years, 9 months ago

What it is, Godot, is the same policies we've had for decades-- socialism for the wealthiest corporations and individuals, and a tough-love "free market" for everyone else.While I can agree with you that we should "just say no" to these economic bandits, you offer no way of doing so without causing a complete economic and political collapse on a worldwide scale. These economic warlords are not going to go down without taking the rest of us with them, and they've structured the system to make sure of that.So, do you have any less draconian solutions?

Godot 9 years, 9 months ago

Why drag it out? Let those who took the risks pay the price, get it done and overwith now. There is not enough money in our economy to make everyone whole. Money was loaned and resold that simply did not exist. Fraud, on a massive scale, was perpetrated. We cannot tax our way out of this.The attempts at staving this off began a year ago - nothing has worked. The more money the government throws at the problem, the more money and power these organization acquire, while the rest of us, who neither took risks nor profited from them, are left holding the bag.

Godot 9 years, 9 months ago

Bozo, this is particular travesty is more than "corporate welfare," because there are thousands of corporations owned by mom and pop operations that receive absolutely no benefit from the federal or state governments.The rape of the American taxpayers that began in the fall of 2007 has been orchestrated to save the financial corporations, and, in particular, the operators of the hedge funds. This is not about corporate America, this is about the Investment Banks, the Hedge Funds, and the Very Rich Elite who demand high returns on their investments, and who orchestrate a scenario where the American taxpayers make them whole when their high risk bets go bad. They claim "systemic risk," when, in reality, it is "systemic corruption" in The Hamptons.

Godot 9 years, 9 months ago

Bozo, do you realize what just happened? Do you realize that the treasury has just guaranteed over 5 trillion dollars in loans, a huge percentage of which are already non-performing or that are expected to fail in the near future, that were sold as investments, at an interest rate higher than the Fed receives for its loaned funds? What was the budget deficit before this happened? Something like $500,000,000,000?Now this years' deficit is $5,500,000,000,000. And our national debt doubled to $11,000,000,000,000. And the year isn't even over. We still have September and October to go. Who knows who will be the next beneficiary of government largesse, with money that does not exist.On my list of beneficiaries of this bailout, I left off two biggies: Soros and Buffet.

Sigmund 9 years, 9 months ago

This isn't the end of the world as we know it, probably isn't even as bad as the Saving's and Loan Crisis in the 80's and 90's. Still, it shows once again that both democrats and republicans willingness to put aside free market capitalism in an election year."The S.& L. debacle cost upwards of $100 billion, and the economy is more than twice the size today than it was in the late 1980s," he said. "I don't think this will turn out to be as serious as that, when over 2,000 banks and thrifts failed between the mid-1980s and mid-1990s." Herald Tribune, "Mortgage crisis has Washington putting aside free-market ideology," September 7, 2008.Can't wait to see The Economist analysis on this nonsense.

Sigmund 9 years, 9 months ago

There is plenty of blame to go around, but let's not forget you cannot bail out "the little guy" without bailing out the "big bank" that lent them the money. Personally, I would let both the little guy and the big banks take the hit and bail neither out.

just_another_bozo_on_this_bus 9 years, 9 months ago

This isn't just about Fannie and Freddie (which are not government owned)-- it's an industry-wide problem, and it happened because of the idiocy of thinking that they could run without regulation-- a concept that came from free-market proselytizers.

Godot 9 years, 9 months ago

I predicted several months ago that we are on the track to have the Government become the largest holder of presonal, residential real estate in the US. This is the next to last step for that to happen. The government now holds 80% of the mortgages in the US. It is a given that thousands of those mortagages will default in the next two or three years. As they default, the mortgage holder becomes the owner.Billowrieley, Freddie and Fannie were created as government agencies in the 1930's. In the late 60's, because of the drain the Viet Nam war put on the budget,the Johnson administration sold stock in them to raise money. They are now not really private companies, they are a very odd marriage of a government agency and private investors. They were a disaster waiting to happen. This is not the issue over which to waste your time on on partisan bickering. This "nationalization" of trillions of dollars of debt was a truly bi-partisan accomplishment.

just_another_bozo_on_this_bus 9 years, 9 months ago

"Why drag it out?"I guess we could do as you suggest, and just let the whole thing collapse of its own weight. I expect that in a few decades, the kids of today might begin climbing out of their caves again.

Godot 9 years, 9 months ago

Congress has already promised the auto makers $25 bln for "green cars." The precedent set by the Bear Stearns buy out, the BOA bailout of its purchase of Countrywide, and the Fannie/Freddie stick save, the auto makers are emboldened to demand another $50 bln - for GREEN cars, of course.When will the insanity stop? It will stop when everyone realizes that all this money, all this luxury, all this excess, was just an illusion.

Godot 9 years, 9 months ago

The FDIC has already asked the Treasury to come to its aid as banks are failing faster than the FDIC can rebuild its funds. Many banks own Fannie and Freddie stock that is now nearly worthless, and they counted on the dividends for operating funds. Where will the money come from to make good the truly guaranteed bank accounts when more troubled banks go under?

Sigmund 9 years, 9 months ago

Marion Lynn (Marion Lynn) says: "Hey, seriously, what do you all think about the future of the stock?"The shares you can buy are worthless, zero, nada, zilch. After they reorganize and issue new shares who knows?just_another_bozo_on_this_bus (Anonymous) says: "This isn't just about Fannie and Freddie (which are not government owned)- it's an industry-wide problem, and it happened because of the idiocy of thinking that they could run without regulation- a concept that came from free-market proselytizers."Never said they were government owned, they are privately owned but government backed. Specifically, they are a GSE, Government Sponsored Entity. There was no reason to check the loans they were making because taxpayers were on the hook, heads I win, tails you lose. and Fannie own or guarantee about half of the U.S.'s $12 trillion mortgage market, they ARE the industry. Although they guarantee or own half of the mortgage market, because the subprime mortgage crisis has caused almost all other lending sources (PRIVATE COMPANIES) to pull out of the market, they are responsible for more than 80% of new mortgages being made in 2008. should fail without bailout by the taxpayers, the banks, funds, and individuals that bought their junk mortgages should take their lumps, and the homeowners who are in trouble should either pony up or file bankruptcy.

just_another_bozo_on_this_bus 9 years, 9 months ago

"There was no reason to check the loans they were making because taxpayers were on the hook, heads I win, tails you lose."I don't think they have any sort of guarantee from the government, other that the same one that BearStearns got-- they are "too big to be allowed to fail."Personally, I agree that they should be allowed to fail-- but I think it's absurd to think that this crisis was created by anyone other than free market devotees who just couldn't pass up a good scam.

just_another_bozo_on_this_bus 9 years, 9 months ago

"The term "draconian" suggests malice. There is no malice in letting those who reaped the profits to now pay the price."Are you proposing the nationalization of every major industry, financial and otherwise, and every pension fund, since that's what would be required if "making them pay" is to really be accomplished?

Sigmund 9 years, 9 months ago

BTW Bozo, the US auto makers are looking to Congress to bail them out. Last President who did that was Jimmy Carter, a democrat. As it turns out, it was a wise investment, the US government made a profit out of the deal.

just_another_bozo_on_this_bus 9 years, 9 months ago

I'm sure glad this is just a simple little blip that can be rectified merely by a purification rite of holy capitalism.

just_another_bozo_on_this_bus 9 years, 9 months ago

I totally agree, Godot, but for now, the illusion is all we have. Until there is the political will to start dismantling the corporate welfare state (the imperial "war on terror" is a big part of that,) which is at the very heart of this problem, we're headed for a very ugly crash.

Godot 9 years, 9 months ago

"The Greedy," will not be punished by increasing taxes. They will laugh at increased taxes. "The Greedy," will always, always, have the means to bypass the tax laws and increase their wealth while the masses suffer under onerous tax laws.Buffet, for example, the baron of the insurance industry, must surely relish the prospect of higher taxes on income, and higher taxes on inheritances. Why? Because wealthy people will purchase billions of dollars of insurance to avoid trillions of dollars of taxes.

just_another_bozo_on_this_bus 9 years, 9 months ago

BTW, among those who would have to pay would be the Chinese, the Japanese, the Saudis and others who have invested heavily in US debt. What would happen if they lose confidence and want repaid all their $trillion in chits, immediately?

Sigmund 9 years, 9 months ago

just_another_bozo_on_this_bus (Anonymous) says: "I don't think they have any sort of guarantee from the government, other that the same one that BearStearns got- they are "too big to be allowed to fail."Well yes and no? You are correct, Freddie and Fannie do not enjoy "full faith and credit" type backing, but they are "Government Sponsored Entity" and most investors believe they are a "moral obligation" of the US Government, whatever that is. If not explicit, the corporations and their securities are widely believed to be "implicitly" backed by the U.S. government.There is a wide belief that FNMA securities are backed by some sort of implied federal guarantee, and a majority of investors believe that the government would prevent a disastrous default. Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA "implicitly taxpayer-backed agencies." The Economist has referred to "[t]he implicit government guarantee" of FHLMC and FNMA. In testimony before the House and Senate Banking Committee in 2004, Alan Greenspan expressed the belief that Fannie Mae's (weak) financial position was the result of markets believing that the U.S. Government would never allow Fannie Mae (or Freddie Mac) to fail.Further, the GSEs, Fannie Mae and Freddie Mac because of their government sponsorship are also exempt from capital/asset ratio requirement that private companies must maintain. They can, and often do, maintain a capital/asset ratio less than 3%. The additional leverage allows for greater returns in good times, but put the companies at greater risk in bad times. They are also exempt from state and local taxes. What other "private bank mortgage broker" do you know that enjoys such favorable status?As a result of therelationship with the US Government they were able to sell "high rate/sub prime" mortgages because investors believed the US taxpayers would step up and pay them off in the event of default. No other private mortgage broker or bank could do that. Maybe the best description would be "government sponsorship and too big to fail." But I agree, with no explicit "full faith and credit" backing I think the taxpayer needs to stay out of it and let Fannie and Freddie fail. In the long run everyone is better off, but in the short term it too much of a risk for the politicians of both stripes in an election year.

Sigmund 9 years, 9 months ago

just_another_bozo_on_this_bus (Anonymous) says: "I'm sure glad this is just a simple little blip that can be rectified merely by a purification rite of holy capitalism."Freddie and Fannie went broke because the were not free market capitalist private companies. Freddie and Fannie made these risky loans BECAUSE the Federal Government backed these mortgages so there was no reason to check their quality! Heads I win, tails you lose. Country Wide Mortgages (you may have heard of them Bozo, I know Obama has) sold their very worst loans to Fannie!While it is apparent that neither party wants to let Big Banks and Little guys suffer the results of their acts via the free markets, had this been a free market capitalistic private company without government backing this likely wouldn't have happened to begin with.

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