But by the time Mr. [Daniel] Mudd became Fannie’s chief executive in 2004, his company was under siege. Competitors were snatching lucrative parts of its business. Congress was demanding that Mr. Mudd help steer more loans to low-income borrowers. Lenders were threatening to sell directly to Wall Street unless Fannie bought a bigger chunk of their riskiest loans.
So Mr. Mudd made a fateful choice. Disregarding warnings from his managers that lenders were making too many loans that would never be repaid, he steered Fannie into more treacherous corners of the mortgage market, according to executives.
For a time, that decision proved profitable. In the end, it nearly destroyed the company and threatened to drag down the housing market and the economy.
Dozens of interviews, most from people who requested anonymity to avoid legal repercussions, offer an inside account of the critical juncture when Fannie Mae’s new chief executive, under pressure from Wall Street firms, Congress and company shareholders, took additional risks that pushed his company, and, in turn, a large part of the nation’s financial health, to the brink.
This is an excellent article—and a good corrective to current partisan blather about the origins of the mortgage debacle.
Fannie Mae and Freddie Mac enjoyed extraordinarily lucrative government benefits for which they did little in return. The law exempted them from securities registration and state and local taxes. It exempted their securities from the usual limits on the extent to which banks and pension funds could invest in the shares of any one firm. It gave them a line of credit at the U.S. Treasury. Most importantly, investors’ perception that the government stood behind Fannie and Freddie enabled them to borrow trillions of dollars at interest rates close to those paid by the Treasury itself—rates significantly lower than those paid by the strongest AAA-rated corporations. This was so even though Fannie and Freddie operated with minimal shareholders’ equity.
Fannie and Freddie did little in return for these subsidies. Fully private firms (e.g., GE Capital) stood ready to securitize mortgages just as such firms securitize car loans, credit card accounts receivable, and a wide range of other financial assets. Those firms neither sought nor needed government subsidies. FDIC-insured banks and FHA had long done more far for affordable housing than Fannie and Freddie. Fannie and Freddie should have been privatized long ago (i.e., had their government subsidies phased out), just as Sallie Mae was privatized during the 1990s. Fannie and Freddie recognized that their critics had strong arguments on the merits. The two firms accordingly made preservation of their subsidies their central political preoccupation.
The congressional pressure to which the article refers occurred in the context of the broader debate about subsidies. Liberals like Senator Reed were saying, in effect, “what will you do in return for the valuable benefits you receive.â€
The article does not adequately convey the extent to which Fannie and Freddie were political bullying-and-influence machines long before people like Mudd arrived on the scene: Fannie since the early 1980s; and Freddie since 1989.
How can political elites of either party be brought to understand the disastrous consequences of this type of governmental meddling in markets? I despair.
Here’s Bill Clinton, a Democrat, on what his fellow Democrats did with regard to FM/FM:
http://www.youtube.com/watch?v=XsynspIqAoE
In retrospect the whole premise that the government should be in the business of assuming private sector risk was just counter to the very notion of a free market economy, and the politicians (primarily Democrats but some liberal Republicans too) must be held accountable for that. Neither Wall Street nor the shareholders created these companies, they just profited from them, because that’s the way the politicians set them up. That Barney Frank and Chris Dodd in particular still sit atop Democratic leadership after their obscenely poor and perhaps even corrupt judgement gives the American public little confidence that they’ve learned their lesson (they’ve yet to admit their mistake, let alone apologize or ask for forgiveness). And they sit there wondering why they have a 10% approval rating….
This is a good article, one that makes a genuine attempt to look at the bigger picture. It recognizes that the problem was caused by the interaction of multiple factors. But there are two areas that need much further exploration.
First is subprime. In all the media discussion of subprime the term is rarely defined. True subprime loans are those to people with credit scores down to 500 or even below. The loans are typically short-term fixed, such as 2/28 or 3/27, and they are issued by lenders such as Chase or Wells subprime, New Century, Option 1, Ameriquest, 1st Franklin, etc. Fannie/Freddie never made or guaranteed these types of loans, although it may be that some lenders found some loopholes (or used fraud) to sell some true subprime to F/F. Some confusion may arise from programs such as Fannie’s Expanded Approval series; they did allow lowered credit and income standards, but they were still well above the low limits of true subprime. It also may be that political pressure noted by the author led to unqualified borrowers getting regular F/F loans. Regardless, the categories and origins of F/F troubled loans are not clear, nor is the extent to which those troubled loans are simply part of a larger-scale real estate pullback.
Another major factor barely touched is the extent to which political contributions or even corruption thwarted all efforts at reform. F/F political contributions are a matter of record. The largest Senate recipient is Chairman Dodd, $165k. In 2d place is Sen. Obama, $126k. This surprising prominence for a 1st-term senator is likely explained by his long-time association with ACORN (as attorney, trainer, and beneficiary), a major source of pressure for increased loans to low-income and minority neighborhoods.
But the money was widespread and across party lines. E.g. in 2006, S.190, sponsored by Sens. Hagel, Dole, and McCain, would have drastically reformed Fannie/Freddie. It came out of committee with unanimous Republican support (and Democratic opposition) but never made it to a floor vote due to procedural maneuvers.
It has also come to light recently that key politicians were given special loan treatment. E.g. Sen. Dodd received a loan from Countrywide that, as a “friend of Angelo (Mozilo)”, was 1% below market. This was a cash benefit to Dodd of $75-200k from Mozilo, who, as noted in the article, powerfully fought any reform of F/F.
In the end it appears that money, power, and greed, along with a dose of good intentions doomed any chance at reforming Fannie/Freddie.