It is good that the commission, after several months, is finally visiting the role of Government-Sponsored Enterprises, but the setup of today’s hearing is still providing a far from adequate investigation. Former CEO Daniel Mudd came late in the game from 2005 to 2008, and the commission must call Mudd’s predecessor, Franklin Raines, to give testimony about his tenure as CEO in which so many expansions were made and policies were put in place that contributed significantly to the crisis. Having Mudd testify without Raines, would be like hearing only from Ben Bernanke but not Alan Greenspan about the activities at the Federal Reserve.
Still, because of the facts brought forth in Greenspan’s testimony on Wednesday, and the diligent questioning of commissioners< Peter Wallison and Keith Hennessey some revealing facts came out that demonstrate that Fannie and Freddie played an even more significant role in the financial crisis than previously known. These findings could not have come at a better time, as both Obama and lawmakers like House and Senate Banking Committee Chairmen Barney Frank and Chris Dodd want to sweep the GSE’s problems under the rug.
Amazingly, they have no immediate plans to rein in Fannie and Freddie, despite their admonitions of how urgent it is to ram through “financial reform” that would hit a broad swath of financial and nonfinancial companies. And the Obama administration’s “Christmas bailout” of the GSE’s – the December 24 order removing the caps of $200 billion dollars that the Treasury was authorized to spend on each of the two mortgage underwriters – exposes the American taxpayer to unlimited liability for the entities and their potential new missteps.
One of the most important moments of the hearing came in a little-notice moment on Wednesday, during the second panel after the much-discussed testimony of Greenspan. This was when Commissioner Wallison asked Patricia Lindsey, former Vice President of Corporate Risk for now-bankrupt subprime mortgage originator New Century Financial Corporation, about her firm’s dealing with Fannie.
Lindsey confirmed that Fannie directly bought many of New Century’s bad mortgages all through the last decade. This is one more piece of evidence that directly refutes the notion that Fannie and Freddie were late to the subprime party, and pushed there by private sector competitor. One the contrary, it shows that the GSEs were important drivers of the subprime party. (This part of the hearing can be viewed here — http://www.c-span.org/Watch/Media/2010/04/07/HP/R/31521/Financial+Crisis+Inquiry+Cmsn+Public+Hearing.aspx – and occurs at about the 50-minute mark.)
Greenspan himself provided facts that whatever one may think of his other actions – and I think he does bear significant blame for keeping interest rates too low for too long – no one has refuted. He pointed out that the firms purchased 40 percent of all private-label subprime mortgage securities during 2003 and 2004. “To purchase these mortgage-backed securities, Fannie and Freddie paid whatever price was necessary to reach their affordable housing goals,” he said. And Greenspan also noted that “the enormous size of purchases” by the GSEs during this time was not revealed until Fannie reclassified in September 2009 a large part of its prime mortgage portfolio as subprime.
Indeed, According to housing expert Edward Pinto, Fannie’s former chief credit officer who has presented his findings before Congress and should himself be asked to testify before the commission, millions of mortgages to borrowers with credit scores of less than 660 – considered by prominent researchers to be the dividing line for subprime loans — had been labeled by Fannie and Freddie as prime going back as early as 1993. In his writings for the American Enterprise Institute, Commissioner Wallison noted that this misrepresentation by the government-backed mortgage giants could have itself been a major factor in inflating the housing bubble. “Market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system in late 2006 and early 2007,” he wrote.
Competitive Enterprise Institute President Fred Smith had long warned about the systemic risk Fannie and Freddie posed to the financial system, warning as early as 2000 that their implosion could cause a taxpayer bailout of as much as $200 billion. That turned out to have greatly underestimated the $400 billion the bailout has already cost taxpayers and the possibly hundreds of billions more it will cost them, since the Obama administration removed the cap on Treasury Department assistance.
But at the time, Smith’s was a voice in the wilderness as members of Congress pooh-poohed the notion of Fannie and Freddie ever slipping up. In 2003, Rep. Barney Frank, D-Mass., now chairman of the House Financial Services Committee, even publicly called for the mortgage entities to “roll the dice” on less credit worthy borrowers.
The Bush administration also pushed policies that tilted incentives toward home ownership, and the mistakes of politicians of both parties should be examined in thorough hearings. Unfortunately, it still looks as though politicians are still giving a pass to the fat cats from Washington. But hopefully the rallying cry after these hearings will be “Fix Fannie and Freddie First.”