fannie mae

Government Promoted the Risky Non-Traditional Mortgages that Triggered the Financial Crisis

by Hans Bader on July 26, 2011 · 1 comment

in Bailout Watch, Economy, Politics as Usual, Regulation, Zeitgeist

Ed Pinto, who was an executive at Fannie Mae long before it went into the toilet and nearly took the financial system down with it, notes that “the financial crisis resulted from an unprecedented accumulation of weak and risky Non-Traditional Mortgages (NTMs)” promoted by both the government and the government-sponsored mortgage giant Fannie Mae. “Each type of NTM featured increased borrower leverage and risk.”

In Government Housing Policy: The Sine Qua Non of the Financial Crisis, he describes in detail how government housing policy explicitly promoted massive increases in leverage and moral hazard by both borrowers and investors and chronicles the central role played by Fannie Mae and Freddie Mac as the clearly-acknowledged kings of moral hazard and leverage. As he points out, government involvement included the facts that (1) Congress, at the behest of community advocacy groups, forced Fannie and Freddie to replace conservative underwriting with flexible underwriting knowing that banks would follow suit; (2) Fannie vowed to transform the housing finance system using flexible underwriting, in an effort to protect its charter privileges bestowed by Congress; and (3) HUD, after a decade of effort, proudly took credit for a revolution in affordable lending. This revolution then led directly to the 2008 financial crisis, which precipitated a $160 billion bailout of Fannie Mae and Freddie Mac, the nation’s two government-sponsored mortgage giants.

(Unlike the private banks, which repaid their bailouts with interest, Fannie Mae and Freddie Mac are not expected to repay taxpayers, and their bailout tab may rise to $1 trillion, according to Bloomberg News. The Obama administration earlier lifted the $400 billion limit on bailouts for Fannie Mae and Freddie Mac, so that they could continue to buy up junky mortgages at taxpayer expense, and showered their executives with $42 million in compensation. In May 2010, the administration and its congressional allies blocked efforts to reform Fannie Mae and Freddie Mac.)

[click to continue…]

Barney Frank Used Influence with Fannie Mae, the Failed Mortgage Giant Bailed Out by Taxpayers

by Hans Bader on May 26, 2011

in Bailout Watch, Economy, Legal, Property Rights

Former House Banking Committee Chairman Barney Frank (D-Mass.) tenaciously opposed efforts to reform Fannie Mae and Freddie Mac, the government-sponsored mortgage giants that were bailed out at a cost to taxpayers of between $148 billion and $363 billion. Now it turns out that he got his boyfriend a “handsomely rewarded gig at Fannie Mae” while Frank “was helping to inflate the housing bubble” by pushing affordable housing mandates and policies that encouraged Fannie Mae to buy up risky mortgages.

Fannie Mae and Freddie Mac engaged in massive accounting fraud and other abuses. But Fannie Mae’s collapse was not entirely due to bad policies of its own making. Pressure from liberal lawmakers like Frank to buy up risky mortgages was also a factor in triggering the mortgage crisis, judging from a story in the New York Times. For example, “a high-ranking Democrat telephoned executives and screamed at them to purchase more loans from low-income borrowers, according to a Congressional source.” The executives of government-backed mortgage giants Fannie Mae and Freddie Mac “eventually yielded to those pressures, effectively wagering that if things got too bad, the government would bail them out.”

Despite his key role in causing the financial crisis, Frank became even more influential after President Obama took office. As the New York Times noted, the massive financial overhaul later passed in response to the financial crisis is “largely the product of extensive conversations” between the Obama administration and “Representative Barney Frank of Massachusetts and Senator Christopher J. Dodd of Connecticut.” That law, known as the Dodd-Frank Act, harms the economy, and violates both the Constitution’s separation of powers, and private property and equal-protection rights.

Frank’s co-sponsor of the Dodd-Frank Act, Senator Chris Dodd, left office in disgrace after ethical lapses. As Victor Davis Hanson notes, Dodd “got a sweetheart deal on an Irish ‘cottage’ from a crooked stock-trader,” “receiving it for hundreds of thousands of dollars less than its market value,” “got two preferential discount mortgage interest deals from the now-bankrupt Countrywide,” “got a sweetheart profit deal from a condo joint-buy with crook Edward Downe, Jr.,” “intervened with the Clinton administration to get the felon Downe pardoned,” and “misrepresented the value of his Irish cottage that he obtained via the agency of the dubious Mr. Kessinger.”

Peter Diamond’s Nomination to Fed Benefits from Double Standard

by Hans Bader on April 16, 2011

in Bailout Watch, Economy, Legal, Politics as Usual, Zeitgeist

Liberal economist Peter Diamond is likely to be confirmed to a powerful position, despite issues far more severe than those that blocked the confirmations of highly-respected conservatives. It smacks of a big double standard.

Diamond was nominated to one of the most powerful positions in the land — the Federal Reserve’s Board of Governors, which sets monetary policy. (The Fed is now printing hundreds of billions of dollars to buy up government debt and inflate the money supply, in a controversial policy known as “quantitative easing” or QE2, which some economists have predicted will lead to substantial inflation.)

By law, the Board is supposed to be balanced regionally, but it isn’t: its members come almost entirely from the East and West Coast. So does Diamond, a professor at the Massachusetts Institute of Technology (MIT). He has lived in Massachusetts since 1960.

The Obama administration nominated Diamond for a seat on the Board representing a district in the Midwest, claiming he is from Chicago because he has lectured at Northwestern University. But as economist Mark Calabria notes, Diamond is really from Massachusetts, which already has a representative on the Fed (Fed Board member Dan Tarullo). That violates Section 10-1 of the Federal Reserve Act, which says a new Fed member may not come from a district that already has a representative. If Diamond is confirmed, every single member of the Fed’s Board will come from a coastal state, and none from America’s heartland.

[click to continue…]

Fannie Mae Backers Unrepentant Despite Its Fraud and Colossal Bailout

by Hans Bader on January 29, 2011 · 4 comments

in Bailout Watch, Economy, Politics as Usual, Sanctimony, Zeitgeist

Fannie Mae and Freddie Mac were bailed out at a cost to taxpayers of between $148 billion and $363 billion. Their recklessness and wrongdoing was so obvious that even Treasury Secretary Geithner admits that “Fannie and Freddie were a core part of what went wrong” in the financial crisis. The two government-sponsored mortgage giants engaged in massive accounting fraud, and their allies in the Obama administration have now spent $160 million in taxpayer money defending them against various charges.

Yet, their longtime defenders, like the Washington Post’s Steven Pearlstein, are completely unrepentant. They continue to suggest that only right-wing ideologues could want to eliminate scandal-plagued Fannie and Freddie. Pearlstein long dismissed warnings from conservatives like the Wall Street Journal’s Paul Gigot about the dangers these mortgage giants posed to our financial system.

Incredibly, Pearlstein still believes that what’s good for Fannie and Freddie is good for America. In the January 23 Washington Post, Pearlstein showed he has learned nothing from the financial crisis.  Pearlstein called House Republicans “free-market ideologues” for wanting to rein in the two companies. He praised “low-income-housing advocates and the Obama administration” for opposing this reform effort.  He suggested that access to mortgages (and thus, homeownership) would suffer without Fannie and Freddie, ignoring the fact that homeownership rates are higher in countries like Chile and Italy that have nothing like Fannie or Freddie.

The last thing America needs is to keep Fannie and Freddie around to help spawn the next financial crisis. Fannie and Freddie helped spawn the current mortgage crisis by buying up risky mortgages and repackaging them as prime mortgages, thus creating an artificial market for junk: “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.” As Government-Sponsored Enterprises, they were not subject to the sort of capital requirements that apply to private entities, so they did not have enough reserves to cover their losses when their mortgages started defaulting.

Congressional Democrats last year blocked a GOP amendment that would have reformed the  government-sponsored mortgage giants, Fannie Mae and Freddie Mac.  The Obama administration lifted a $400 billion limit on bailing them out and showered their executives with $42 million in pay.

At the direction of the Obama administration, Freddie Mac ran up more than $30 billion in losses to bail out mortgage borrowers, some of whom had high incomes. Federal regulators sought to make Freddie Mac hide the resulting losses from the SEC and the public.

Obama received $125,000 in contributions from Fannie Mae and Freddie Mac executives as a senator, second only to the Senator Chris Dodd, who was forced to retire last year over financial improprieties (such as his real estate gift from a lobbyist and “sweetheart mortgage from Countrywide Financial“), yet was the chief drafter of the Dodd-Frank financial “reform” law.  (Dodd-Frank harms the economy, and violates both the Constitution’s separation of powers, and private property and equal-protection rights).

Despite the devastating financial impact of Fannie Mae and Freddie Mac’s mistakes, their defenders are as unrepentant, and perhaps as influential, as ever.  Don’t expect their allies in the Obama administration to endorse any meaningful reforms.

Repeal Senseless and Job-Destroying Volcker Rule from Dodd-Frank

by John Berlau on January 18, 2011 · 1 comment

in Bailout Watch, Deregulate to Stimulate, Economy, Precaution & Risk, Regulation

On Tuesday, the Financial Stability Oversight Council may issue its recommendations for implementing the Volcker Rule, the provision of the Dodd-Frank financial legislation that bans so-called proprietary trading by banks.

Initial reports indicate that the council may try to assuage some concerns about the rule’s economic effects by attempting to draw a line between long-term investing from short-term trading. Congress, however, should still repeal this senseless rule that is already showing signs of doing lasting damage to the economy and which will most likely add, not lessen, systemic risk.

The Volcker rule is based on the faulty premise that a financial institution making a loan — any loan — is somehow inherently more dangerous than investing or trading. It was that premise that led to the enactment of Glass-Steagall in the Depression that separated “commercial” from investment banking.

After evidence of the damage that Glass-Steagall was doing to U.S. competitiveness plus empirical studies that showed it did not protect the financial system from systemic risk, the Clinton administration and a large bipartisan majority in Congress largely repealed it in 1999.

Yet bad ideas have a way of coming back to life, and Glass-Steagall’s repeal was falsely blamed for the financial crisis — a crisis primarily causes by lax lending standards on traditional mortgage loans — loans bought by the quasi-government entities Fannie Mae and Freddie Mac and encouraged by laws such as the Community Reinvestment Act.

As Peter Wallison, fellow at the American Enterprise Institute and a commissioner on the congressionally-created Financial Crisis Inquiry Commission, has written, the commercial banks that imploded all went bust “by investing in bad mortgages or mortgage-backed securities, not because of the securities activities of an affiliated securities firm.” (Wallison and some of his fellow commissioners are expected to detail the amount of bad loans influenced by government rules in their final FCIC report, which may be written as a dissent.)

The Volcker rule restricts banks, and in some cases insurance holding companies, from ”proprietary trading” — which it defines as trading for the institution itself rather than for its customers. But this is based on a similarly false premise.

There is nothing inherently more risky about trading — short-term or long-term — than making loans. Supporters of the Volcker rule say banks shouldn’t be “gambling” with taxpayer money, and indeed deposit insurance should be reformed and gradually phased out so that all institutions as well as savers and investors are more risk-conscious.

But policymakers must recognize that every time a financial institution engages in an economic transaction — whether a loan or a trade — it is making a “gamble” that it will never get its money back. Limiting a bank’s ability to take equity in a firm by saying it can lend but not invest to that particular firm will result in less, not more, protection from risk.

And already, the Volcker rule may be hindering economic recovery. John Maggs reports in Politico that banks are losing top traders to hedge funds, because of uncertainty about the rule. Banks ability ”make markets” for investors by buying a particular security may be sharply restricted, which in turn could slow down the formation of new businesses that create new jobs.

And even though this supposedly was taken care of by giving regulators more flexibility, there is still concern that the rule will affect many insurance companies investments in blue-chip stocks. These are investments that are encouraged and even required by state insurance commissioners as a way for companies to diversify their investments for solvency.

Hopefully, the recommendations of the council will blunt some of the rules worst economic effects. But due to unnecessary restriction and uncertainty that will still linger, Congress should repeal the misguided Volcker rule and move on to the Dodd-Frank “financial reforms” glaring omission — the behemoths Fannie Mae and Freddie Mac, which were at the center of the crisis.

Administration Allies Float Trillion Dollar Bailout to Offset Rising Savings Rate

by Hans Bader on November 1, 2010

in Bailout Watch, Economy, Stimulus to Nowhere

Alarmed by the rising savings rate, which liberal Keynesian economic theory views as potentially bad in a weak economy, intellectuals with close ties to the Obama administration, such as Matthew Yglesias, and liberal commentators such as Noam Scheiber, are floating the idea of a trillion-dollar bailout at taxpayer expense, using government-controlled mortgage giants Fannie Mae and Freddie Mac. The bailout would involve Fannie and Freddie writing off part of the mortgage balances of many people who are perfectly capable of making their mortgage payments, not in order to prevent defaults, but just in order to increase borrowers’ purchasing power so that they can spend more money. (The bailout would not cover all Americans, only many of the loans held by Fannie and Freddie.)

The cost of this bailout — perhaps a trillion dollars — would be borne by taxpayers, since Fannie and Freddie are already insolvent, and are expected to need as much as $363 billion more in taxpayer bailouts, even if this massive bailout proposal is not adopted.  (Democrats in Congress blocked GOP proposals to reform Fannie and Freddie or wind them down in May.)

This entire proposal, like many of the administration’s stimulus proposals, is based on the faulty assumption that weak consumer demand is the primary reason for the slow recovery. In fact, personal consumption has resumed rising, while private investment has fallen and remains low. Private investment is way down compared to past recoveries, driven partly by lack of confidence in the administration (a well-deserved lack of confidence given the administration’s anti-business policies).  The savings rate has only increased slightly and remains lower in the U.S. than in most of the world.

Matt Yglesias of the Center for American Progress (CAP) is one of the people floating this proposal. CAP is widely credited with “shaping the agenda of the new Obama administration.”

Yglesias concedes that this proposal may not even be legal, and that “there are real doubts as to whether the Housing and Economic Recovery Act of 2008 actually authorizes this.”  But legalities are unlikely to stand in the way for this administration, which showed little reluctance to take actions in the past that were deemed illegal by many commentators, like the multi-billion dollar auto bailouts, which were criticized for flouting federal bankruptcy laws, the TARP statute, and the Constitution.

Behind such radical proposals are the false assumption that we are in a recession due to “a collapse” in private consumption.  But as Mark Calabria notes, “private personal consumption” is “actually up and higher than at any point during the boom, after reaching bottom in the Spring of 2009.”  Meanwhile, “unlike consumption, which has largely rebounded, investment today is about 20% below its peak.” It’s investment that needs to increase dramatically, not consumption.

There is no reason to think this proposal would help the economy even in the short run.  As Yglesias concedes, this proposal would not be costless even under liberal assumptions: “if the US government deliberately takes on a trillion dollars in additional debt, that may lead the interest rate the US government needs to pay on its debt to rise. Rising interest rates on treasuries will increase interest rates throughout the economy and hurt growth.””

Other bailout proposals have ended up harming rather than helping the economy.  A $75 billion Obama mortgage bailout program is actually harming the economy, the housing market, and the construction industry, economists and real estate experts say.  Many other Obama administration jobs programs have backfired, like a biofuels program that wiped out jobs, and a green-jobs program in the stimulus package that ended up funneling money mostly to foreign firms.  The stimulus package wiped out jobs in America’s export sector, and even the Congressional Budget Office, which claims it will help the economy in the short run, admits it will reduce the size of the economy in the long run.

There are additional problems with the trillion-dollar bailout proposal that its floaters don’t recognize.  The increased national debt it produces would lead to higher taxes and interest payments in the future — crowding out private investment in the future, and thus shrinking the economy in the long run.  And most of the bailout might be saved rather than spent by its recipients, preventing it from increasing consumption in the short run.

Another Reason Why Fannie Mae and Freddie Mac Need to Go

by Alex Schibuola on October 26, 2010

in Bailout Watch, Economy

The monthly payments a home mortgage has depend on two variables (among others): the initial down payment and interest rates. A larger down payment means a lower mortgage balance; this results in lower monthly payments. Lower interest rates lead to lower monthly payments.

A 2006 study by Fannie and Freddie finds that, by virtue of their existence, homeowners pay 30 basis points (bps) less on interest rates (e.g., a 5 percent interest rate = 500 bps).* The study also highlights how they permit greater homeownership by offering mortgages that require lower down payments. Further, they “estimate the total savings to homeowners from Freddie Mac and Fannie Mae activities reach the $18.8-26.9 billion range.”

That’s an interesting number. But what does this mean for an individual homeowner? I created an amortization table to see:

In World A^, without Fannie and Freddie, a homeowner purchases a $200,000 home with a $40,000 down payment and takes out a $160,000 mortgage with a 5 percent interest rate.

World A monthly payment: $858.91

In World B^, with Fannie and Freddie, a homeowner does the same as in World A, except he or she pays a 4.7 percent interest rate instead (30 bps lower because Fannie of Freddie exist).

World B monthly payment: $829.82

In World C^, with Fannie and Freddie, a homeowner purchases the same home with a lower $20,000 down payment and takes out an $180,000 mortgage at a 4.7 percent interest rate.

World C monthly payment: $933.55

Between World A and World B, which have different interest rates but the same down payment, the homeowner saves $29.09 per month ($349.09 per year). This is ludicrous. At the individual level, one cannot justify saving $29 per month after incurring losses of hundreds of billions of dollars at the expense of all taxpayers.

Between World A and World C, our prospective homeowner is actually worse off because of Fannie Mae and Freddie Mac. Because the down payment is smaller, the mortgage balance is larger thus increasing monthly payments. The homeowner ends up paying an extra $74.64 per month ($895.68 per year) because of Fannie and Freddie. This is super-ludicrous.

Not to be naïve, the homeowner in World C, might not be a homeowner at all, because he or she may not be able to raise $40,000 to buy a home in today’s World A. However this person would be better off renting and saving up for a down payment in the future. In either event, given that the micro-level effect of Fannie Mae and Freddie Mac’s existence is so small or even harmful, they need to go.

*The Federal Reserve estimates (Passmore 2005) that it’s actually only a 7 bps advantage bestowed by Fannie and Freddie. I’m being nice, though, and giving Fannie and Freddie the benefit of the doubt.

^Assumptions: 30-year fixed-rate mortgage. $200,000 is purchase value of home. 5 percent and 4.7 percent are annual interest rates which are then adjusted for 12 monthly periods.

Bailout of Fannie and Freddie Will Cost Double Earlier Estimates

by Hans Bader on October 22, 2010 · 5 comments

in Bailout Watch, Deregulate to Stimulate, Economy

The bailout of Fannie Mae and Freddie Mac will cost double earlier estimates, and could cost $363 billion over the next three years, report NBC and the Associated Press.

Fannie Mae and Freddie Mac are the corrupt government-sponsored mortgage giants that contributed to the mortgage crisis by engaging in fraud and misrepresenting subprime mortgages as prime.  Earlier, the Obama administration showered their executives with $42 million in pay, even as Obama’s pay czar was ordering productive private-sector banks to chop the pay of their executives and traders (leading one bank to dump a profitable trading operation), and imposing new taxes and burdens on private banks (but not Fannie and Freddie).

As Professor Roy C. Smith noted, because of the Obama administration’s attempt to restrict bank employee pay, “Citigroup agreed to sell its profitable Phibro unit at an extremely low price of only one or two times earnings in order to avoid having to pay a talented trader a $100 million contractual share of the profits he had earned. The most successful of the remaining employees of Citigroup, AIG and Bank of America have been given an incentive to leave their posts, and the firms will be constrained in hiring replacements.” Meanwhile, Bank of America’s stock has fallen over the last six months from over $19 to less than $12,  shrinking many Americans’ 401(k)s, as it has been injured by new rules and red tape such as the Dodd-Frank Act (which also is wiping out most free checking accounts).

While the taxpayers have lost a huge amount of money on the government-sponsored mortgage giants, they have actually made money on many private banks that accepted government bailout funds and then returned the money with interest.  (Healthy banks that never wanted a bailout and repaid their “bailout“ in full with interest, like BB&T, were pressured by the Treasury Department into accepting bailout money along with their unhealthy competitors, so that the public would not know which banks really needed a bailout; the Treasury Department feared that such knowledge would result in a run on those banks.)

Say Goodbye to Free Checking

by Hans Bader on October 20, 2010

in Bailout Watch, Deregulate to Stimulate, Economy, Regulation

“Say goodbye to traditional free checking, as banks feel squeeze from new regulations,” reads the AP headline. “Free checking, a mainstay of American banking in recent years, will be nearly unheard of” at the banks that do business with most of the households in America.

“Almost all of the largest U.S. banks are either already making free checking much more difficult to get or expected to do so soon, with fees on even basic banking services. It’s happening because of a raft of new laws enacted in the past year, including the financial overhaul package, have led to an acute shrinking of revenue for the banks.”

Bank of America just wrote off $10 billion in losses due to the recently-passed Dodd-Frank financial overhaul law, and its stock value has shrunken over the last six months from over $19 to less than $12 per share, shrinking the value of millions of 401(k)s that Americans rely upon for their retirement.

Citibank is now charging Ted Frank $15 a month for his previously-free checking account, along with $0.50 per check written.

While imposing heavy new burdens on self-supporting, productive private banks, the Dodd-Frank Act harms the economy, reduces liquidity and the ability to hedge against risk, and does nothing to reform the corrupt government-sponsored mortgage giants, Fannie Mae and Freddie Mac, which helped spawn the mortgage crisis by engaging in fraud,  misrepresenting subprime mortgages as prime, and creating artificial demand for those junky mortgages (and now are collecting a bailout that may reach $400 billion).

Obama’s Broken Pledge to Cut Wasteful Spending

by Hans Bader on September 16, 2010

in Bailout Watch, Deregulate to Stimulate, Economy, Politics as Usual, Sanctimony, Zeitgeist

When Obama was elected, he claimed he would “go through our federal budget– page by page, line by line–eliminating those programs we don’t need.” But as president, he seems to have forgotten about this pledge. The Cato Institute reminds him of it in a full-page advertisement in today’s Washington Post and other newspapers, identifying $525 billion he could cut annually from the federal budget by eliminating unnecessary or harmful programs.

For example, it notes that “Federal interference in housing markets has done enormous damage to our cities and the economy at large. HUD subsidies have concentrated poverty and fed urban blight, while Fannie Mae and Freddie Mac stoked the financial crisis by putting millions of people into homes they couldn’t afford. Getting the government out of the housing business will save $45 billion annually.” It also notes that “Federal workers enjoy far greater job security than their private sector counterparts—and far better total compensation: an average of $120,000 a year in wages and benefits. Cut federal compensation by 10 percent to save $20 billion annually.”

In 2008, Obama pledged to implement a “net spending cut,” but he has instead exploded government spending.  Federal domestic spending increased by a record 16 percent in 2010.  In 2010, the Congressional Budget Office concluded that “President Obama’s policies would add more than $9.7 trillion to the national debt over the next decade.”

The Obama administration’s housing spending is particularly wasteful.  It is now using regulations and billions in tax dollars to promote more of the risky lending that led to the financial crisis.  It is ratcheting up affordable-housing mandates that created markets for junk sub-prime mortgages (thus spawning the mortgage meltdown, as even the liberal Village Voice has conceded), and it is increasing regulatory pressure on banks to make risky loans.  A $75 billion federal mortgage bailout program harmed the very real estate markets it was supposed to help.

← Previous Entries