Thursday, October 23, 2008

Inappropriate vilification of Fannie Mae and Freddie Mac

Fannie Mae and Freddie Mac have been unfairly and inappropriately characterized as being culprits in the mortgage mess, while in fact they have been both heroes and victims and continue to be victimized. All was fine on the housing and mortgage-backed security front up through 2000 or so. Then, as the dot-com bubble burst, Wall Street began casting around for new sources of profit and decided that Fannie Mae and Freddie Mac had a very lucrative business. Back in 2002 and 2003, Wall Street ramped up its own MBS business and simultaneously started raising a big stink about how Fannie and Freddie posed a "systemic risk" to the U.S. financial system and should be "reined in." Wall Street and the Republicans pushed for and did manage to get some legislation passed which put significant limits on the business of Fannie and Freddie. There were also trumped-up "accounting scandals" which were really simply the fact that the nature of their business simply did not fit in well with traditional accounting standards, especially given their mission to promote homeownership and their implicit backing by the U.S. government. Such efforts to shackle Fannie and Freddie were only partially effective, so Fannie and Freddie continued to prosper with the securitization of prime or so-called "conforming" mortgages, which were fairly low risk. Having failed to completely push Fannie and Freddie out of the MBS market, Wall Street focused on non-conforming mortgages, including Alt-A and so-called subprime mortgages, as well as jumbo mortgages that Fannie and Freddie were prohibited against from even considering. Then the housing market boomed in 2003 though 2005, with subprime lending really taking off as Wall Street created a huge demand for higher-yield, higher-fee subprime MBS and variants that somehow magically could be rated AAA and almost as "solid" as U.S. Treasury securities. Fannie and Freddie were not a significant player in that subprime boom. They may have had some relatively minor exposure, but their overwhelming focus remained safe, conforming mortgages.

With the housing boom turning to bust and the husing market entering recession, even Fannie and Freddie were starting to see a higher rate of defaults and foreclosures, but nowhere near the levels seen by the non-prime MBS created by Wall Street. Fannie and Freddie were doing reasonably well up through the Spring of 2008.

Then, the hedge funds and others decided to target Fannie and Freddie and short and talk down their stock and bonds, utilizing all manner of rumors and innuendo. Everybody has always known that the U.S. government was implicitly guaranteeing the debt of Fannie and Freddie, but the rumormongerers on Wall Street persisted in claiming that it was not so.

With rising foreclosures earlier this summer, Fannie and Freddie were believed to need to raise additional capital to maintain the reserves that Wall Street had conned Congress into placing on them back in 2002 and 2003. But, with their stock under intense pressure in July and August, raising capital by selling stock began to look less likely.

Fannie and Freddie probably should have sought a capital infusion ("bailout") from the U.S. government back in July, but the truth is that the Republican administration was all to eager to see Fannie and Freddie go the way of the Dodo bird, and the sooner the better.

Finally, with the rest of the financial system on the verge of implosion, the U.S. Treasury did in fact help out Fannie and Freddie by putting them into a conservatorship.

Now, Fannie and Freddie are completely protected from the shortsellers on Wall Street, although even today there are people who talk as if the debt securities of Fannie and Freddie were not fully backed by the U.S. government when they really are.

Ironically, the U.S. Treasury has had to do very little to keep Fannie and Freddie running, despite the mortgage-related disasters everywhere else. In fact, Fannie and Freddie are a key component of the U.S. Treasury's plans to bailout the mortgage market. For example, without any additional capital, Fannie and Freddie have been instructed to buy $40 billion in MBS on the open market every month.

Fannie and Freddie are in much better shape than the shortsellers ever claimed.

To be clear, Fannie Mae and Freddie Mac are not currently a systemic risk to the financial system.

In fact, if the hedge funds and shortsellers had not attacked the stock of Fannie and Freddie, they would both be relatively healthy even today with everything else that has happened in this crisis.

The simple fact is that Fannie Mae and Freddie Mac are two of the remaining pillars of our financial system.

If Wall Street and the Republicans had not sought to shackle Fannie Mae and Freddie Mac and if Wall Street had not gone after non-prime mortgages with such wild abandon, the current financial crisis would have been completely avoided.

Fannie Mae and Freddie Mac did nothing to create the current mortgage mess. Wall Street and its Republican apologists are completely and 100% responsible.

The only thing I do not completely understand is why the Democrats stand by idly as Fannie Mae and Freddie Mac are vilified, when they know that Wall Street and the Republicans are completely responsible. My only answer is that the Democrats are collectively simply too clueless due to the complexity of MBS to be able to tell the difference.

-- Jack Krupansky

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