Fan and Fred: Frauds by Design?
If the previous statement seems extreme, consider this shocking revelation carried in the Wall Street Journal last week — a tidbit that also, strangely enough, has barely gotten any notice in the rest of the establishment media:
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.
Before Pinto’s bombshell, we knew that Fan and Fred were used as instruments to “encourage” loans to undeserving borrowers. We knew that this “encouragement” was enforced through the Community Reinvestment Act (CRA), a law originally passed in the 1970s that was “progressively” given threatening teeth in ensuing years.
We have known for some time, as described in my September 2008 column, that Fan and Fred lowered the qualifying standards for conventional and subprime loans they would buy from participating lenders roughly as follows (quoting from that column):
The credit score threshold for conventional mortgages, which had generally been 670 or more, dropped to about 630. In the real world, a score of 630 indicates that you’re having trouble with your debt load, paying your bills on time, or a little of both.
More ominously, the credit score threshold for subprime mortgages, which had generally been 630 or more, fell to about 590. A score of 590 is the credit scoring equivalent of barely having a pulse.
We know that in doing this, Fan and Fred, as well as those who underwrote or bought securities backed by these conventional and subprime mortgages, were taking a huge risk by hoping that borrowers with mediocre or poor credit histories would somehow keep up with their mortgage payments. The chart from Fair Isaac, which shows the chances of going seriously delinquent (90 days or more late) for various credit score ranges based on lenders’ experience through the mid-2000s, shows how serious that risk assumption was:
In lowering the conventional score threshold, Fan and Fred hoped that borrowers with scores between 630 and 670 would defy all reasonable expectations that they would fall seriously behind on their mortgages at three or more times the rate of those whose scores exceeded 670. In lowering the subprime score threshold, they dreamed that the default rates would be far below the experience-based average of about one-third. They passed these hopes and dreams on to both their stockholders and those who invested in mortgage-backed securities. These judgments have proven horribly wrong.
Incredibly, the Pinto paragraph above takes things one step further. It’s bad enough that Fan and Fred lowered the loan approval thresholds. Pinto’s point is that for 15 years, they doubled down by “routinely” misclassifying approved loans, effectively telling the capital markets and the public that these loans weren’t as risky as they really were. Because of this, securities backed by these mortgages carried lower interest rates than they would have if the risks had been properly disclosed. Some of the offerings should probably never have been issued or should have been given junk bond pricing. Further, misrepresented loans Fan and Fred kept on their books enabled the two entities to continually make false claims of financial health.
Enron’s perpetrators were aggressively prosecuted and shamed, while Fannie Mae’s and Freddie Mac’s executives, officers, and directors made and kept millions in undeserved salaries and bonuses, even during years-long periods when their books were unauditable. Up to and including Rahm Emanuel, President Obama’s chief of staff, many if not most of them are still influential and respected players within the government and the Democratic Party.
Meanwhile, the government has gained a firm and seemingly indefinite grip on goings-on in the housing and mortgage markets. We’re supposed to believe that this statist result is merely the product of extraordinary incompetence and greed with no grander design. Excuse me for being skeptical.
Yep. It’s the the Cloward/Piven strategy.
Really stupid.
Tom,
The reason the loans were “misclassified” wasn’t to make Freddie and Fannie look better, it was so they could be sold at all. Without a BBB+ rating, most pension funds etc. couldn’t invest in them and you couldn’t have given that junk away. I’m still looking for the ‘perp walk’ out of the ratings agencies for their collusion in all of this.
Zerohedge.com carried an posting on 1/1/2010 titled, Origins of an American Kleptocracy in which the author states:
“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.”
One of the points made is that in depressing interest rates on home mortgages, and in relaxing lending standards, and in jawboning mortgage originators to lend to anyone with a pulse no matter what their financial condition (over 50% of home loans made in 2007 were to sub-prime borrowers), government assumed a risk for which there was a cost, and should have been reserves set aside to cover.
To the politically-driven members of Congress overseeing Fannie and Freddie, these were detached and abstract concepts, and they were ignored. We have YouTube video of Franklin Raines telling Congress that since home values never go down, it was perfectly safe to lower the reserve levels of the GSEs down to 2%.
But no matter how you slice it, the roots of this crisis lay in the expansion of credit, which means the creation of money out of thin air to push into the economy. As economist Ludwig von Mises said long ago, this causes the “appearance of prosperity”. One other side of this same coin is to confuse money with wealth.
Government, and fractional reserve banks under license from government can create money out of thin air. But that does not change the level of wealth in the economy, nor the amount of net wealth being created by people working. The only solution is for government to stop attempting to create the appearance of prosperity, and the appearance of “affordable housing” and to return to sound money, and sound financial policies. Above all, to stop creating money out of thin air no matter how it is done, by allowing banks to do it, government to do it, or GSEs to do it.
Thanks for the article. I only wish there were a way to bring the whole of this scandal to the distracted American public. It is too technical for the Sesame Street attention span of the independents and leads to blasphemous conclusions for the left – namely free market instincts are better than social engineering.
Pay no attention to the State behind the curtain
The State is bankrupt, and will do _anything_
it thinks it can get away with to increase revenues;
Watch the Web, and repeat as indicated:
“we’re mad as Hell, and we won’t take it any more !”.
They couldn’t care less what happens to Fannie/Freddie. They can run it into the ground and make something else into a public utility. The same losers will be in charge of it and make millions.
As #4 stated, thank you for the article. Just further fuel for my wife and me to buy a bigger boat to live on. Preferably a power yacht whereas we’ll put these a sshats abaft or ‘aft’.
Add the statement “and the markets” to the end and this quote from the Leftist icon tells you everything you need to know in order to understand what you see going on around you.
This is the playbook of the statist Left:
1. Use govt to interfere in a particular market (housing, health care, drugs, etc.).
2. Eventually that interference distorts said market either through collapsing it (housing) or price inflation (health care, drugs).
3. Claim that a “crisis” is at hand and that the only solution is more govt control and regulation.
paul_unalaska at post #7 touches on one point that illustrates the point of the article. Second homes qualified for being classified as ‘conforming loans’, meaning they could be securitized and sold on the secondary market just like loans for primary residences. I recently found out from a person who works inside the mortgage business that boats having certain features, such as at least one ‘head’ (a boat toilet), a ‘galley’ (no matter how small) and a place someone could sleep qualified as a home for purposes of being able to secure a normal mortgage. Since this insider frequents the Lake of the Ozarks, he explained it was one of the main reasons for the surge in sales of large boats. Of course, when the plug was pulled on those mortgages, the market value of large used boats fell tremendously, putting a lot of loans “underwater”, so to speak.
The more I learn about this whole debacle, the more I lay blame at the feet of government. Blaming banks and mortgage companies for it, especially in light of the regulatory pressure under the CRA to lend to people with low credit scores and no other assets, is like blaming gravity for a person’s death when they get pushed off a tall bridge.
Barney Frank is eager to “roll the dice” with other people’s money–and anyone who objects is just a “hater”.
When I was in business school in the mid-90′s, our finance prof when on and on about the dangers of these specific GSEs. He predicted that someday the taxpayer would be bailing them out.
He was one of two Republicans on the facility. Who would have thought?
Well said theBuckWheat @ #3
“Government, and fractional reserve banks under license from government can create money out of thin air. ”
Government is a huge part of this problem as you so clearly state, but so too is fractional reserve banking a huge part of our problem. And note that fractional reserve banking is controlled NOT by government, but by a private banking cabal; Central Bankers, a la our Federal Reserve. Our financial elites and our government are in bed together (read oligarchy) and both are rotten to the core. This isn’t just political rot, but also economic rot.
Btw, who all understands where money comes from, and fractional reserve lending? This is why debt = money, and why our government is trying to to shoot the moon w/ creating debt. A systemic ponzi scheme all started (for Americans at least) w/ the creation of the Federal Reserve in 1913.
These GSE’s are only part of a much much larger and deeper problem.
There’s another angle to this. Where does one warehouse political party “necessaries” when one’s out of power? Never have there been more professional political sycophants to employ and make wealthy so they can afford to continue being political activists 24/7. The universities have become congested with cronies. The non-profits nowhere near as flush as they used to be and can’t carry the burden. The investment banking community can’t do for all what it did for Rahm Emanuel. Nope. They need more GSE with unlimited access to funds and layers of faux oversight to provide permanent “progressive” employment. There must be a revolving door to somewhere when power changes hands. They use public money to stockpile stores of cheese and oil. GSEs are perfect for doing the same with out of power political elite. The money to lavish these out of power political elite has to come from somewhere. We should not ignore the dual role and political necessity of the GSE and the advocacy non-profit. I am fascinated by how few progressives and postmodern Democrats in the Obama administration have held significant employer positions in American industry serving both shareholders and employees while creating profits and value added.
I still have a strong suspicion that the sudden financial collapse of Fannie Mae and Freddie Mac just when it happened was not an accident. Democrats mounted an October surprise before the 2000 and 2004 elections designed to embarrass Republicans and give them no time to respond. It is also quite a coincidence that the financial meltdown just happened to occur right when McCain had taken the lead in the polls, while Fannie and Freddie were packed with Obama supporters. Someone should at least investigate the possibility of a deliberate sabotage of the system, I have no doubt Obama supporters would do such a thing if they could. Obviously, the problems were building for years before 2008. The financial system was a tinder box waiting to go up in flames, but who lit the match??
Before our presidential election last year, there were YouTube videos of Barney Frank rudely dismissing the idea that we should institute banking controls.
Those videos weren’t viewed by many.
Now there are (according to YouTube’s counters) millions of views.
And yet Barney Frank says nothing. And no one asks.
theBuckWheat is right on in the analysis. No matter how you look at this, government has to take the rap for much of the housing bubble with the incentives that were out there. With Congressman Barney Frank pushing the social policy of “making housing more affordable”, with CRA, with the Fed’s loose money policies (which influenced low ARM teaser rates), and with changes to the tax code that distorted investments toward housing, we had the making of a perfect storm in home prices. Home ownership rates went from the low 60% range to a peak of around 69%, so of course housing prices were inflated by the surge in demand.
Fannie and Freddie are currently on the hook for about half the total U.S. mortgage market, in excess of $5.5 trillion. As more and more homes go underwater, the rate of default will increase as homeowners walk away from their loans. As taxpayers, we guaranteed implicitly (and now explicitly) that the lenders were protected. This disaster is going to make TARP and the $787 stimulus bill look like chump change before we are through.
I remember reading about Democrat insider Jamie Gorelick making big money with Fanny Mae. She was responsible for the “Gorelick wall” that helped bring about 911 by preventing the CIA and FBI from communicating about terrorist threats.
Chuck Schumer pulled the pin on that grenade in July ’08.
Why keep up the pretense. Fannie and Freddie are US governmental agencies masquerading as quasi-public companies. And, like every other US governmental agency, their ability to explain their financial condition via GAAP-compliant financial statements is an impossibility.
So don’t bother. Seize both of them, wipe out their shareholders and acknowledge their true status. At least his way they won’t have to create “capital.”
Any other strategy is doomed to headline after headline about bailout after bailout.
Mkelley, you bring up an interesting point – Jamie Gorelick is at least indirectly responsible for TWO trillion dollar disasters. That is one hell of an accomplishment.
She is currently working at the law firm of WilmerHale. If I were an attorney there working with her, I would keep my head on a swivel.
When you find it difficult to decide whether incompetence or malevolence can explain disaster, evil is the reasonable answer. The reality is, if you buy property which you cannot afford, you will make your life worse, and if the gummint tries to render this impossible, everyone’s life will be made worse.
The US government was never designed to play God with the economy. Can we grow up out of the fairy tales, or are we bound to become children for life?
Think about it: children can be abused because they are defenseless. How much do enjoy being defenseless? How intense is your desire to be abused?
Would George Washington had have any followers if the Americans of his time had been hoping for the benevolence of some Barney Frank?
It’s surprising that so many are surprised about the way fannie and freddie are being operated and the governmental shoveling of resources to them. Remember, neither of those enterprises were really in danger of collapse when they were taken over. The administration was even open that it was taking them away from shareholders to prevent both from tightening credit requirements in response to the market events.
The most frightening thing is that fan and fred have not abandoned this travesty. Not to mention the huge bonuses they get for destroying the economy.
Let’s talk fraud:
Since 2007 Glenn Beck’s Mercury Radio Arts corporation has fallen behind on its New York City business income taxes and has been cited for filing errors related to its obligations under Texas franchise tax and New York state workers’ compensation insurance rules.
You may want to look at Infowars and consider what Alex is trying to tell the world.When you start looking at recent events while considering the plausibility of his beliefs,it makes all of these things look like a part of The Fall Of The Republic.
#24. The Dems using Fannie and Freddie to totally hose our economy is OK because Glenn Beck is behind on his taxes. Whew. Now I feel much better.
There is an additional substantive problem with Fannie and Freddie.
They are no longer controlled by independent shareholders. They are completely controlled by the Federal government and are acting as its agents and instrumentalities. Despite the formality of a conservatorship, there is no conceivable state of affairs where they can regain their solvency or independence.
Under any system of accounting rules, where one entity is completely owned and controlled by another, the owner must show the subsidiary’s obligations on the owner’s balance sheet as the owners liabilities.
The US government has not done this with F&F. Their more than T$5 of obligations must be added to the US Governments outstanding debts of T$12. The result is a an increase in national debt of about 40% of GDP, which kicks us well over 100% of GDP.
The PIGS countries welcome us to the club.
24. Thank you for pointing out the fact that the tax code is so insanely complicated that it’s easy to make errors. A rational tax code would be simple enough that any high school graduate could figure it out.
The Democrats have been driving this since Clinton got in office. We are going to create a world where 12.9% of all homes in America are owned by black people. Freddie and Fannie have been used as tools to achieve this aspect of “social justice”. Republicans are damned if they object, being labeled as racists and bigots who want to hold down black people. When Bush saw the handwriting on the wall, he tried to reign in Fannie and Freddie and was immediately filibustered by Senate Democrats. If he pushes the matter, Republicans get to become hate mongering racists. Along comes Chuck Schumer and lets the cat out of the bag in order to destroy the economy to help the Democrats win the election. Schumer gets a pass because he is a Democrat and is a great believer in “social justice”. The economy collapses, we still have Fannie and Freddie practicing the same things they have for 18 years and nothing is being done about it. Now the REAL unemployment rate in America exceeds 17% and instead of go after the culprits, Obama is punishing us with a health care plan that is even worse than anything Fannie and Freddie can do. We will never get this turned around with Obama because Obama thinks “social justice” is so important that Harry Reid can say whatever he wants about Obama’s race and be excused simply because he believes in “social justice”. So that is blind leading the blind. Republicans know what to do about Fannie and Freddie, but they don’t have the guts to say anything for fear of being labeled as racists and neanderthals by Democrats and the media. We are being screwed by “social justice”.
Well,F&F and the Democratic congressmen were not all of the conspiracy. [I am the least conspiracy-minded of people, but enough is enough.] The Federal Reserve Bank of Boston was right in the middle of the scam, and I assume the whole FRB system was on board.
FRB Boston published a booklet in 1998, “Closing the Gap: A Guide to Equal Opportunity Lending.” This booklet contains a neat summary of all the pertinent law dating back to the Community Reinvestment Act (CRA) 1997, Carter Admin. The Clinton Admin embraced Boston FRB’s position as a statement of adminstration policy.
More to the point, “Closing the Gap” contains detailed instructions on how to make unqualified persons appear to be qualified for the purpose of mortgage loans. The instructions are quite explicit, and violate fiscal integrity, civil law, ECON 101, and common sense. Worth a read, access through Google, Dogpile, Yahoo, whatever.
Great article.
It is clearly time to stock up on tar and feathers, pitchforks and torches.
And wooden beams.
Barney Frank is an insufferable liar of galactic proportion.
Tax Cheat Glenn Beck:
Marvelous canard. Worthy of a liberal.
What position does Glenn Beck occupy in government?
Oh that’s right. None!
Well, the feds and pseudo feds may have deliberately put the economy of the entire world at risk, and caused Great Depression II, but I’m ready to entrust the health of my family to them.
What could go wrong?
Drooling Barney is there to protect us.