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All Da King's Men

Fannie-Freddie: A History Of Corruption

By Da King Published: September 24, 2008

The FBI has announced an investigation of mortgage giants Fannie Mae and Freddie Mac, along with AIG, Lehman Brothers and others in the wake of the mortgage industry collapse.

This isn't the first time Fannie and Freddie have come under investigation. They both have been plagued by corruption and scandal for years. From Bloomberg.com:

Fannie Mae paid a $400 million fine to the SEC and its regulator in 2006 to settle charges that executives fraudulently used ``cookie jar'' reserves and other accounting gimmicks to hide $10.3 billion in losses from 2002 through 2004 and maximize bonuses. Freddie paid $125 million in fines in 2003 and restated earnings from 2000 through 2002 after it replaced long-time auditor Arthur Andersen and discovered errors related to derivatives. Regulators accused the company of manipulating its accounting to push some $5 billion in earnings to future quarters. Freddie ousted Chief Executive Leland Brendsel in June 2003 and Fannie's Franklin Raines left in December 2004.

In spite of it's past indiscretions, Fannie-Freddie weren't subject to any new regulations or oversight. Regulation was proposed by both the Bush administration and by Republicans in Congress, including a bill co-sponsored by presidential nominee John McCain, but those measures never made it out of Congress. In fact, the bills never made it to the Senate. They were killed in the House Of Representatives, and sometimes killed in committee.

How did Fannie-Freddie avoid closer scrutiny after it was already known back in 2003-2004 that they were operating in an unethical manner by distorting their books ? Why weren't the proposed regulations passed ?

Answer: Fannie-Freddie paid over $200 million in the past decade on lobbying and campaign contributions. Here's a July 16th story from Yahoo, before the Fannie-Freddie takeover:

The two government-chartered companies run a highly sophisticated lobbying operation, with deep-pocketed lobbyists in Washington and scores of local Fannie- and Freddie-sponsored homeowner groups ready to pressure lawmakers back home. They’ve stacked their payrolls with top Washington power brokers of all political stripes, including Republican John McCain’s presidential campaign manager, Rick Davis; Democrat Barack Obama’s original vice presidential vetter, Jim Johnson; and scores of others now working for the two rivals for the White House. Fannie and Freddie’s aggressive political maneuvering has helped stave off increased regulation and preserve special benefits such as exemption from state and local income taxes and the ability to borrow at low rates. When their stock prices took a dive last week, their government allies extended another helping hand with a plan for the Treasury Department, the Federal Reserve and, possibly, Congress to shore up the companies.

Yahoo insinuated that McCain was one of those bought off by Fannie-Freddie, but that is false. McCain tried to reign in Fannie-Freddie. McCain's attempt was thwarted, primarily by Democrats, but with the help of some Republicans too. For those who pay attention, Yahoo is attempting to elect Barack Obama, so that explains the skewed nature of the article. As for the bill McCain co-sponsored, The Federal Housing Finance Reform Act of 2005, all you have to do is examine the text of the debate on it to know the Democrats killed it. I can't give you a roll call vote, because it was killed in the House by a voice vote.

But Yahoo's overall point is correct. Fannie-Freddie were connected. They were connected to power, and protected by power until it was impossible to protect them any longer, when the whole financial house of cards fell down. The FBI shouldn't only be investigating Fannie-Freddie, they should be investigating Congress as well, because Congress looked the other way.

Fannie Mae and Freddie Mac, who hold half the mortgages in the country, are at the center of the mortgage meltdown. CNN Money reported warnings from former Federal Reserve Chairman Alan Greenspan back in 2005:

"The Federal Reserve has been unable to find any credible purpose for the huge balance sheets built by Fannie and Freddie other than the creation of profit through the exploitation of the market-granted subsidy... The strong belief of investors in the implicit government backing of the GSEs does not by itself create problems of safety and soundness for the GSEs but it does create systemic risks for the U.S. financial system as the GSEs become very large...Indeed, only such highly liquid portfolios would be consistent with (government-sponsored enterprises') mission of providing primary mortgage market liquidity during a crisis, particularly a financial crisis."

CNN Money went on to say:

Over the past few years Greenspan has moved from some gentle nudging of Fannie Mae and Freddie Mac to Thursday's outright criticism. In particular, he singled out Fannie's and Freddie's giant portfolios of mortgage-backed securities as being too risky to back up the mortgage finance system in the event of a crisis, and argued that only ultra-safe, ultra-conservative U.S. Treasury bonds would do the trick. The outcome of this debate has important implications for consumers. In the short-term, if Congress reins in Fannie and Freddie by putting stricter limits on the size of the portfolios they can build, the amount of mortgage financing they can issue, and the kinds of securities they can hold in, this could -- all else being equal -- mean their cost of borrowing would rise and the cost of home mortgage loans could go up, resulting higher mortgage rates for home buyers. In the longer run, if such a move were to make Fannie's and Freddie's investment base less risky, it could mean that the U.S. financial system would be able to weather storms such as a recession or a big pullback in the housing market without any kind of meltdown.

Bloomberg sums it up:

The economic history books will describe this episode in simple and understandable terms: Fannie Mae and Freddie Mac exploded, and many bystanders were injured in the blast, some fatally. Fannie and Freddie did this by becoming a key enabler of the mortgage crisis. They fueled Wall Street's efforts to securitize subprime loans by becoming the primary customer of all AAA-rated subprime-mortgage pools. In addition, they held an enormous portfolio of mortgages themselves. In the times that Fannie and Freddie couldn't make the market, they became the market. Over the years, it added up to an enormous obligation. As of last June, Fannie alone owned or guaranteed more than $388 billion in high-risk mortgage investments. Their large presence created an environment within which even mortgage-backed securities assembled by others could find a ready home. The problem was that the trillions of dollars in play were only low-risk investments if real estate prices continued to rise. Once they began to fall, the entire house of cards came down with them.

We would have had a pullback in the housing market anyway. It would have cost the financial companies a lot of money. But with the actions of Fannie-Freddie, and the inaction of Congress, this became a full-blown crisis. Now the taxpayers are on the hook for a couple trillion dollars, and now we are relying on the government to fix it. The same government whose failures let it happen. Not exactly a warm and fuzzy feeling, it it ?

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