LF Crisis
Did Fannie Mae know that it was buying junk mortgages?
You might remember in my last post I spoke of how the government abused enforcement of the Community Reinvestment Act (CRA) to force banks to give high risk and "impossible" loans on properties that could never be worth the debt that was being applied to them.
UPDATE: A new study just released from the National Bureau of Economic Research tells how CRA compliance resulted in loans being given that were an impossible risk, all to satisfy government regulators.
The question is, did the government know what was going on? Did President Clinton and Bush know? Did Congress know and did the leadership of Fannie Mae know?
As I said in my previous note:
So how did all of these high risk and impossible loans get issued? The simple fact of the matter is that the government, at the behest of political pressure groups, at first forced banks to issue loans on these houses that were worth very little to high risk applicants. The government actually said that to not issue the kinds of loans described above was racism. President Obama was actually a lawyer for one of the pressure groups forcing the banks to issue these ridiculous loans.
Did they know? The simple truth is that "everyone" at the top knew.
There is a small almost unknown agency that acts as a watchdog over Fannie Mae and Freddie Mac called OFHEO - the Office of Federal Housing Enterprise Oversight. While OFHEO has few enforcement powers they report to committees in the House and Senate and report to the administration. And report they did.
OFHEO had begged Congress year after year to have itself replaced by a new agency with real banking regulators and real enforcement power either under the Federal Reserve or the Treasury Department.
Here is an OFHEO report from 2006 that warned of what was coming. Here is a summary of the report from the OFHEO saying:
The report details an arrogant and unethical corporate culture where Fannie Mae employees manipulated accounting and earnings to trigger bonuses for senior executives from 1998 to 2004.
A large number of Fannie Mae’s accounting policies and practices did not comply with Generally Accepted Accounting Principles (GAAP). The Enterprise also had serious problems of internal control, financial reporting, and corporate governance. Those errors resulted in Fannie Mae overstating reported income and capital by a currently estimated $10.6 billion.
Here is an example from OFHEO's 2007 report:
OFHEO has continued to strongly support enactment of legislative reform to strengthen GSE oversight. During the past year, the agency worked with the Bush Administration, Congress and interested parties on legislation that will provide bank regulator-like powers to a new GSE regulator overseeing Fannie Mae, Freddie Mac and the Federal Home Loan Banks.The House of Representatives passed, on a bipartisan basis, GSE regulatory reform legislation (H.R. 1427) in May 2007 [Barney Frank and Finance Committee Democrat members in both houses of Congress opposed it year after year till 2007 - Editor]. It is a balanced bill that will strengthen the nation’s housing finance system by enhancing oversight of Fannie Mae, Freddie Mac and the Federal Home Loan Banks. It is my hope that the Senate will complete its work on this important legislation soon.
Democrats were able to block the proposed legislative changes in the Senate with a filibuster threat. In the House of Representatives when OFHEO gave its report some in Congress such as House Banking Committee Chairman Barney Frank stated that there is no mortgage problem and even accused OFHEO of persecuting the corrupt head of Fannie Mae, Franklin Raines, who was paid over $90 million for allowing this collapse to happen.
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Most of what is in this news report is true and you can see Alan Greenspan’s Congressional testimony for yourself HERE and HERE. Alan Greenspan:
If we fail to strengthen GSE regulation, we increase the possibility of insolvency and crisis. … As I concluded last year, the GSEs need a regulator with authority on a par with banking regulators, with a free hand to set appropriate capital standards, and with a clear and credible process sanctioned by the Congress for placing a GSE in receivership, where the conditions under which debt holders take losses are made clear.
The administration also pushed for reform repeatedly:
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.”
2002 May: The President calls for the disclosure and corporate governance principles contained in his 10-point plan for corporate responsibility to apply to Fannie Mae and Freddie Mac. (OMB Prompt Letter to OFHEO, 5/29/02)
2004 June: Deputy Secretary of Treasury Samuel Bodman spotlights the risk posed by the GSEs and called for reform, saying “We do not have a world-class system of supervision of the housing government sponsored enterprises (GSEs), even though the importance of the housing financial system that the GSEs serve demands the best in supervision to ensure the long-term vitality of that system. Therefore, the Administration has called for a new, first class, regulatory supervisor for the three housing GSEs: Fannie Mae, Freddie Mac, and the Federal Home Loan Banking System.” (Samuel Bodman, House Financial Services Subcommittee on Oversight and Investigations Testimony, 6/16/04)
2005 April: Treasury Secretary John Snow repeats his call for GSE reform, saying “Events that have transpired since I testified before this Committee in 2003 reinforce concerns over the systemic risks posed by the GSEs and further highlight the need for real GSE reform to ensure that our housing finance system remains a strong and vibrant source of funding for expanding home-ownership opportunities in America… Half-measures will only exacerbate the risks to our financial system.” (Secretary John W. Snow, “Testimony Before The U.S. House Financial Services Committee,” 4/13/05)
The leadership of Fannie Mae knew as well. Not only did OFHEO and the administration warn them repeatedly, the New York Times warned them too. To protect itself from critique Fannie Mae spent $200 million on partisan activities to shield itself from more scrutiny in Congress. Fannie Mae even hired, with your money, every lobbying firm in Washington D.C. so that no one would lobby against them. That money included large contributions to leaders in Congress.
Of course I cannot explain every facet of the mortgage collapse in just two articles, but this is generally how I witnessed it and how I understood the problems to have manifested. For a larger perspective there are two rather excellent books on this subject, Reckless Endangerment by Gretchen Morgenson and Housing Boom & Bust by Dr. Thomas Sowell.
Below is a 30 minute interview with Dr. Sowell describing the events that led to the mortgage collapse:
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