Instead of focusing on Bernie Madoff and Goldman Sachs, we ought to be paying more attention to the role of our government leaders:
By the end of 2008, Fannie and Freddie held or guaranteed approximately 10 million subprime and Alt-A mortgages and mortgage-backed securities (MBS)—risky loans with a total principal balance of $1.6 trillion. These are now defaulting at unprecedented rates, accounting for both their 2008 insolvency and their growing losses today. Since 2008, under government control, the two agencies have continued to buy dicey mortgages in order to stabilize housing prices.
There is more to this ugly situation. 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.
So it wasn’t good enough for Fannie and Freddie to make risky loans using other people’s money. Our money. No, they had to compound that error and commit systemic fraud, which turns out to be much, much worse.
In general, a subprime mortgage refers to the credit of the borrower. A FICO score of less than 660 is the dividing line between prime and subprime, but Fannie and Freddie were reporting these mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a third-quarter 10-Q report in 2008.
An Alt-A mortgage is one in which the quality of the mortgage or the underwriting was deficient; it might lack adequate documentation, have a low or no down payment, or in some other way be more likely than a prime mortgage to default. Fannie and Freddie were also reporting these mortgages as prime, according to Mr. Pinto.
It is easy to see how this misrepresentation was a principal cause of the financial crisis.
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. Of the 26 million subprime and Alt-A loans outstanding in 2008, 10 million were held or guaranteed by Fannie and Freddie, 5.2 million by other government agencies, and 1.4 million were on the books of the four largest U.S. banks.
In addition, about 7.7 million subprime and Alt-A housing loans were in mortgage pools supporting MBS issued by Wall Street banks—which had long before been driven out of the prime market by Fannie and Freddie’s government-backed, low-cost funding. The vast majority of these MBS were rated AAA, because the rating agencies’ models assumed that the losses that are incurred by subprime and Alt-A loans would be within the historical range for the number of high-risk loans known to be outstanding.
But because of Fannie and Freddie’s mislabeling, there were millions more high-risk loans outstanding. That meant default rates as well as the actual losses after foreclosure were going to be outside all prior experience. When these rates began to show up early in 2007, it was apparent something was seriously wrong with assumptions on which AAA ratings had been based.
Losses, it was now certain, would invade the AAA tranches of the mortgage-backed securities outstanding. Investors, having lost confidence in the ratings, fled the MBS market and ultimately the market for all asset-backed securities. They have not yet returned.
By the end of 2007, the MBS market collapsed entirely. Assets once carried at par on financial institutions’ balance sheets could not be sold except at distress prices. This raised questions about the stability and even the solvency of most of the world’s largest financial institutions.
Read the whole thing.
Obviously, Fannie and Freddie are corrupt organizations, with systemic fraud from top to bottom, and they need to be disbanded. Barney Frank is the chairman of the Financial Services Committee. All of this rampant criminal activity occurred on his watch. And unless he’s a friggin’ idiot, he had a series of nice paydays from it, too.
But they will never be disbanded, of course. That would be horribly inconvenient for Barney Frank’s bottom line. And the bottom lines of probably thousands of other rent-seekers, too.
Barney Frank was the captain of this Titanic. And he recently pushed through a financial regulation bill that authorizes up to $4 TRILLION dollars in bailouts. Just what we need, more guidance from the government that got us into this mess, and more promises of paying money that it doesn’t have.
To review, government is responsible for the following steps in the mortgage meltdown:
- forcing banks to make risky loans
- using taxpayer money to buy those loans
- re-packaging those loans in a fraudulent manner by calling them prime
- thereby, passing on obscene risk to the financial system at large
So, where is the outrage at the government?