Thursday, December 22, 2011

Fannie and Freddie in the dock

The exceedingly weak meme that the financial crisis was the fault of weak regulations of rapacious bankers continues to unravel. I've posted about this a couple of times here and here

It is becoming clear even to the Securities and Exchange Commission that the central blame for the crisis lies with the various affordable housing mandates handed out to Fannie Mae and Freddie Mac, coupled with fraud by the politically connected heads of those two darlings of Washington:

That's the story revealed Friday by the SEC's civil lawsuits against six former Fannie and Freddie executives, including a pair of CEOs. The SEC says the companies defrauded investors because they "knew and approved of misleading statements" about Fan and Fred's exposure to subprime loans, and it chronicles their push to expand the business.
Here's what happened:  (1) The government privatized the two mortgage giants while providing implicit and explicit cover for any losses they might experience (privatized profits and socialized losses).  (2) Congress then continually ramped up the target shares of mortgages Fannie and Freddie had to hold that were given to lower-income home buyers.  (3) To meet these targets, Fannie and Freddie partnered with private mortgage providers like Countrywide to push increasingly dubious subprime mortgages, which would then be sold on to Fannie and Freddie. (4) Fannie and Freddie then lied about their holdings of subprime mortgages.  For example:
The SEC says Fannie executives also failed to disclose the company's total exposure to risky "Alt-A" loans, sometimes called "liar loans," which required less documentation than traditional subprime loans. Fannie created a special category called "Lender Selected" loans and it gave lenders "coding designations" to separate these Alt-A loans from those Fannie had publicly disclosed. By June 30, 2008, Fannie said its Alt-A exposure was 11% of its portfolio, when it was closer to 23%—a $341 billion difference.
The Wall Street Journal sums it up nicely
Far from being peripheral to the housing crisis, the SEC lawsuit shows that Fan and Fred were at the very heart of it. Private lenders made many mistakes, but they could never have done as much harm if Fan and Fred weren't providing tens of billions in taxpayer-subsidized liquidity to lend on easy terms to borrowers who couldn't pay it back.

Congress created the two mortgage giants as well as their "affordable housing" mandates, and neither the financial system nor taxpayers will be safe until Congress shrinks the toxic twins and ultimately puts them out of business.