Why the Mortgage Crisis Happened
By M. Jay WellsJune 2000
Fred L. Smith Jr., writing in Investor's Business Daily, recalls testifying before the House Financial Services Committee that GSE "special privileges create a serious hazard to the market, to taxpayers [and] to the economy." He warned that these GSEs were "strange organizations, neither private-sector fish nor political-sector fowl" and that "as a result, no one is quite sure how these entities should be evaluated or held accountable." These new debt portfolios "will certainly increase the likelihood of a Fannie-Freddie default."
Rep. Paul Kanjorski (D-Pennsylvania): "Mr. Smith, that is almost a fallacious argument," adding that rapid growth of GSE debt holdings was nothing to worry about as it simply reflected "inflation and the growth of population. "Everything, proportionately, is that much larger."
Rep. Marge Roukema (R-New Jersey): "very few banks or S&Ls could, even in this day and age, even now, meet the stress-testing requirements which Fannie and Freddie are required to meet."
Rep. Carolyn Maloney (D-New York) regarding the Treasury Department line of credit: "It is really symbolic, it is obsolete, it has never been used." "Would you explain why it would be important to repeal something that seems to be of little use?"
Smith: "as long as the pipeline is there, it is like it is very expandable. . . . It is only $2 billion today. It could be $200 billion tomorrow."
Because of Democrat obfuscation, Smith's "tomorrow" arrived in 2008 when Treasury Secretary Henry Paulson put Fannie and Freddie into conservatorship.
April 2001
Fiscal Year 2002 Budget declares that the size of Fannie Mae and Freddie Mac is "a potential problem," because "financial trouble of a large GSE could cause strong repercussions in financial markets, affecting Federally insured entities and economic activity," says a White House release.
July 2001
Subcommittee hearing on a bill proposed by Rep. Baker to transfer supervisory and regulatory authority over Fannie Mae and Freddie Mac to the Board of Governors of the Federal Reserve System and abolish the OFHEO.
Rep. Paul Kanjorski (D-Pennsylvania) responded: "This bill would dramatically restructure the current regulatory system for Fannie Mae and Freddie Mac. In my opinion, it also represents a solution in search of a problem. Nearly a decade ago, Congress created a rational, reasonable, and responsive system for supervising GSE activities, and that system with two regulators is operating increasingly effectively. H.R. 1409 would unfortunately interrupt this continual progress."
March 2002
Business Week interview with Fannie Mae Vice-Chairman Jamie Gorelick about the prospects for the coming year:
Gorelick: "we are expecting a very, very strong 2002."
Gorelick: "We believe we are managed safely. . . . Fannie Mae is among the handful of top-quality institutions. . . . . And we have consistently exceeded every standard that the examiners have set for us."
May 2002
In an OMB Prompt Letter to OFHEO, the President calls for the disclosure and corporate governance principles contained in his 10-point plan for corporate responsibility to apply to Fannie Mae and Freddie Mac.
February 2003
OFHEO reports that "although investors perceive an implicit Federal guarantee of [GSE] obligations . . . the government has provided no explicit legal backing for them," warning that unexpected problems at a GSE could immediately spread into financial sectors beyond the housing market, according to a White House release.
2003
Rep. Richard Baker (R-Louisiana), chairman of the House Financial Services subcommittee with GSE oversight over Fannie Mae and Freddie Mac, was informed by OFHEO "on the salaries paid to executives at both companies," according to the Washington Post. Reportedly, "Fannie Mae threatened to sue Baker if he released it, he recalled. Fearing the expense of a court battle, he kept the data secret for a year." "The political arrogance exhibited in their heyday, there has never been before or since a private entity that exerted that kind of political power," he said.
June 2003
Freddie Mac reported it had understated its profits by $6.9 billion. OFHEO director Armando Falcon Jr. requested that the White House audit Fannie Mae.
July 2003
Sens. Chuck Hagel (R-Nebraska), Elizabeth Dole (R-North Carolina) and John Sununu (R-New Hampshire) introduced legislation to address Regulation of Fannie Mae and Freddie Mac. The bill was blocked by Democrats.
September 2003
In an interview with Ron Insana for CNN Money, Rep. Baker warned, "I have concerns that if appropriate resources aren't allocated for internal risk management, the consequences will be far more severe than just a real estate slowdown. The losses would fall quickly through the capital these companies have and down to shareholders and taxpayers. These companies have some of the lowest capital margins of any financial institution in the nation, yet, at the same time, they are two of the largest. The concern is that if something doesn't work out the way they predict, the American taxpayer could be called on to pay off the debt in some sort of bailout."
The New York Times reports that the Administration recommended "the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago," calling for new supervision of Fannie Mae and Freddie Mac by the Treasury Department. Reportedly, Congressional Democrats "fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing."
Treasury Secretary John Snow testifies that Congress enact "legislation to create a new Federal agency to regulate and supervise the financial activities of our housing-related government sponsored enterprises" and set prudent and appropriate minimum capital adequacy requirements, says a White House release.
Rep. Barney Frank (D-Massachusetts): "I do not think we are facing any kind of a crisis. That is, in my view, the two government sponsored enterprises we are talking about here, Fannie Mae and Freddie Mac, are not in a crisis. . . . I do not think at this point there is a problem with a threat to the Treasury. . . . I believe that we, as the Federal Government, have probably done too little rather than too much to push them to meet the goals of affordable housing and to set reasonable goals.
Rep. Barney Frank (D-Massachusetts): "These two entities - Fannie Mae and Freddie Mac - are not facing any kind of financial crisis. . . . The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing."
Rep. Melvin Watt (D-North Carolina): "I don't see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing."
October 2003
Fannie Mae discloses $1.2 billion accounting error.
November 2003
Council of the Economic Advisers Chairman Greg Mankiw warned, "The enormous size of the mortgage-backed securities market means that any problems at the GSEs matter for the financial system as a whole. This risk is a systemic issue also because the debt obligations of the housing GSEs are widely held by other financial institutions. The importance of GSE debt in the portfolios of other financial entities means that even a small mistake in GSE risk management could have ripple effects throughout the financial system," from a White House release.
Mankiw explains that any "legislation to reform GSE regulation should empower the new regulator with sufficient strength and credibility to reduce systemic risk." To reduce the potential for systemic instability, the regulator would have "broad authority to set both risk-based and minimum capital standards" and "receivership powers necessary to wind down the affairs of a troubled GSE," says a White House release.
February 2004
Fiscal Year 2005 Budget again highlights the risk posed by the explosive growth of the GSEs and their low levels of required capital, and called for creation of a new, world-class regulator: "The Administration has determined that the safety and soundness regulators of the housing GSEs lack sufficient power and stature to meet their responsibilities, and therefore . . . should be replaced with a new strengthened regulator," reports a White House release.
Mankiw cautions Congress to "not take [the financial market's] strength for granted." Again, the call from the Administration was to reduce this risk by "ensuring that the housing GSEs are overseen by an effective regulator," says a White House release.
June 2004
Deputy Secretary of Treasury Samuel Bodman spotlights the risk posed by the GSEs and called for reform, saying "We do not have a world-class system of supervision of the housing government sponsored enterprises (GSEs), even though the importance of the housing financial system that the GSEs serve demands the best in supervision to ensure the long-term vitality of that system. Therefore, the Administration has called for a new, first class, regulatory supervisor for the three housing GSEs: Fannie Mae, Freddie Mac, and the Federal Home Loan Banking System," the White House reports.
September 2004
OFHEO reported that Fannie Mae and CEO Raines had manipulated its accounting to overstate its profits. Congress and the Bush administration sought strong new regulation and authority to put the GSEs under conservatorship if necessary. As the Washington Post reports, Fannie Mae and Freddie Mac responded by orchestrating a major campaign "by traditional allies including real estate agents, home builders and mortgage lenders. Fannie Mae ran radio and television ads ahead of a key Senate committee meeting, depicting a Latino couple who fretted that if the bill passed, mortgage rates would go up." Again, GSE pressure prevailed.
October 2004
Rep. Baker again warned about the coming crisis in the Wall Street Journal: "Then there's the lesson of a company, Frankenstein-like, seemingly grown so powerful that it can intimidate and arrogantly flout all accountability to the very government that created it."
Baker adds, "Although their bonds bear the disclaimer ‘not backed by the full faith and credit of the U.S. government,' the market does not believe it and looks right past the companies' risk strategies to the taxpayers' pockets."
In a subcommittee testimony, Democrats vehemently reject regulation of Fannie Mae in the face of dire warning of a Fannie Mae oversight report. A few of them, Black Caucus members in particular, are very angry at the OFHEO Director as they attempt to defend Fannie Mae and protect their CRA extortion racket.
Chairman Baker (R-Louisiana): "It is indeed a very troubling report, but it is a report of extraordinary importance not only to those who wish to own a home, but as to the taxpayers of this country who would pay the cost of the clean up of an enterprise failure. . . . The analysis makes clear that more resources must be brought to bear to ensure the highest standards of conduct are not only required, but more importantly, they are actually met."
Rep. Maxine Waters (D-California): "Through nearly a dozen hearings where, frankly, we were trying to fix something that wasn't broke."
Rep. Maxine Waters (D-California): "Mr. Chairman, we do not have a crisis at Freddie Mac, and particularly at Fannie Mae, under the outstanding leadership of Mr. Frank Raines."
Rep. Gregory Meeks (D-New York): "And as well as the fact that I'm just pissed off at OFHEO, because if it wasn't for you I don't think that we'd be here in the first place, and now the problem that we have and that we're faced with is: maybe some individuals who wanted to do away with GSEs in the first place, you've given them an excuse to try to have this forum so that we can talk about it and maybe change the, uh, the direction and the mission of what the GSEs had, which they've done a tremendous job. There's been nothing that was indicated that's wrong, you know, with uh Fannie Mae. Freddie Mac has come up on its own. And the question that then presents is the competence that, that, that, that your agency has, uh, with reference to, uh, uh, deciding and regulating these GSEs. Uh, and so, uh, I wish I could sit here and say that I'm not upset with you, but I am very upset because, you know, what you do is give, you know, maybe giving any reason to, as Mr. Gonzales said, to give someone a heart surgery when they really don't need it."
Rep. Ed Royce (R-California): "In addition to our important oversight role in this committee, I hope that we will move swiftly to create a new regulatory structure for Fannie Mae, for Freddie Mac, and the federal home loan banks."
Rep. Lacy Clay (D-Missouri): "This hearing is about the political lynching of Franklin Raines."
Rep. Ed Royce (R-California): "There is a very simple solution. Congress must create a new regulator with powers at least equal to those of other financial regulators, such as the OCC or Federal Reserve."
Rep. Gregory Meeks (D-New York): "What would make you, why should I have confidence? Why should anyone have confidence, and uh, in, in you as a regulator at this point?"
Armando Falcon, OFHEO Director: "Sir, Congressman, OFHEO did not improperly apply accounting rules. Freddie Mac did. OFHEO did not fail to manage earnings properly. Freddie Mac did. So this isn't about the agency engaging in improper conduct. It's about Freddie Mac."
Rep. Christopher Shays (R-Connecticut): "And we passed Sarbanes-Oxley, which was a very tough response to that, and then I realized that Fannie Mae and Freddie Mac wouldn't even come under it. They weren't under the ‘34 act, they weren't under the ‘33 act, they play by their own rules, and I and I'm tempted to ask how many people in this room are on the payroll of Fannie Mae, because what they do is they basically hire every lobbyist they can possibly hire. They hire some people to lobby and they hire some people not to lobby so that the opposition can't hire them."
Rep. Artur Davis (D-Alabama): "So the concern that I have is you're making very specific, what you have correctly acknowledged, broad and categorical judgments about the management of this institution, about the willfulness of practices that may or may not be in controversy. You've imputed various motives to the people running the organization. You went to the board and put a 48-hour ultimatum on them without having any specific regulatory authority to put that kind of ultimatum on ‘em. Uh, that sounds like some kind of an invisible line has been crossed."
Rep. Christopher Shays (R-Connecticut): "Fannie Mae has manipulated, in my judgment, OFHEO for years. And for OFHEO to finally come out with a report as strong as it is, tells me that's got to be the minimum not the maximum."
Rep. Barney Frank (D-Massachusetts): "Uh, I, this, you, you, you seem to me saying, ‘Well, these are in areas which could raise safety and soundness problems.' I don't see anything in your report that raises safety and soundness problems."
Rep. Maxine Waters (D-California): "Under the outstanding leadership of Mr. Frank Raines, everything in the 1992 Act has worked just fine. In fact, the GSEs have exceeded their housing goals. What we need to do today is to focus on the regulator, and this must be done in a manner so as not to impede their affordable housing mission, a mission that has seen innovation flourish from desktop underwriting to 100% loans."
Rep. Lacy Clay (D-Missouri): "I find this to be inconsistent and a and a rush to judgment. I get the feeling that the markets are not worried about the safety and soundness of Fannie Mae as OFHEO says that it is, but of course the markets are not political."
Rep. Barney Frank (D-Massachusetts): "But I have seen nothing in here that suggests that the safety and soundness are at issue, and I think it serves us badly to raise safety and soundness as kind of a general shibboleth when it does not seem to me to be an issue."
Rep. Don Manzullo (R-Illinois): "Mr. Raines, 1.1 million bonus and a $526,000 salary. Jamie Gorelick, $779,000 bonus on a salary of 567,000. This is, what you state on page eleven is nothing less than staggering."
Rep. Don Manzullo (R-Illinois): "The 1998 earnings per share number turned out to be $3.23 and 9 mills, a result that Fannie Mae met the EPS maximum payout goal right down to the penny."
Rep. Don Manzullo (R-Illinois): "Fannie Mae understood the rules and simply chose not to follow them that if Fannie Mae had followed the practices, there wouldn't have been a bonus that year."
Rep. Christopher Shays (R-Connecticut): "And you have about 3% of your portfolio set aside. If a bank gets below 4%, they are in deep trouble. So I just want you to explain to me why I shouldn't be satisfied with 3%?"
Franklin Raines, Fannie Mae CEO: "Because banks don't, there aren't any banks who only have multifamily and single-family loans."
Franklin Raines, Fannie Mae CEO: "These assets are so riskless that their capital for holding them should be under 2%."
January 2005-July 2006
Sen. Chuck Hagel (R-Nebraska), co-sponsored by Sens. Sununu and Dole and later Sen. McCain, re-introduced legislation to address GSE regulation.
"The bill prohibited the GSEs from holding portfolios, and gave their regulator prudential authority (such as setting capital requirements) roughly equivalent to a bank regulator. In light of the current financial crisis, this bill was probably the most important piece of financial regulation before Congress in 2005 and 2006," reports the Wall Street Journal.
Greenspan testified that the size of GSE portfolios "poses a risk to the global financial system. It would be difficult, if not impossible, to bail out the lenders [GSEs] . . . should one get into financial trouble." He added, "If we fail to strengthen GSE regulation, we increase the possibility of insolvency and crisis . . . We put at risk our ability to preserve safe and sound financial markets in the United States, a key ingredient of support for homeownership."
Greenspan warned that if the GSEs "continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road . . . We are placing the total financial system of the future at a substantial risk."
Bloomberg writes, "If that bill had become law, then the world today would be different. . . . But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter. That such a reckless political stand could have been taken by the Democrats was obscene even then."
April 2005
Treasury Secretary John Snow again calls for GSE reform, "Events that have transpired since I testified before this Committee in 2003 reinforce concerns over the systemic risks posed by the GSEs and further highlight the need for real GSE reform to ensure that our housing finance system remains a strong and vibrant source of funding for expanding homeownership opportunities in America. . . . Half-measures will only exacerbate the risks to our financial system," from a White House release.
May 2005
At AEI Online, Wallison warned that "allowing Fannie and Freddie to continue on their present course is simply to create risks for the taxpayers, and to the economy generally, in order to improve the profits of their shareholders and the compensation of their managements. It is a classic case of socializing the risk while privatizing the profit."
January 2006
Chairman Greenspan, in a letter to Sens. Sununu, Hagel and Dole, warned that the GSE practice of buying their own MBS "creates substantial systemic risk while yielding negligible additional benefits for homeowners, renters, or mortgage originators." He stated, ". . . the GSEs and their government regulator need specific and unambiguous Congressional guidance about the intended purpose and functions of Fannie's and Freddie's investment portfolios."
March 2006
Sens. Sununu and Hagel introduced an amendment to a Lobbying Reform Bill directing GAO to study GSE lobbying and requiring HUD to audit the GSEs annually.
May 2006
After years of Democrats blocking the legislation, Sens. Hagel, Sununu, Dole and McCain write a letter to Majority Leader William Frist and Chairman Richard Shelby expressing demanding that GSE regulatory reform be "enacted this year" to avoid "the enormous risk that Fannie Mae and Freddie Mac pose to the Housing market, the overall financial system, and the economy as a whole."
May 2006
Sen. McCain (R-Arizona) addressed the Senate, "Mr. President, this week Fannie Mae's regulator reported that the company's quarterly reports of profit growth over the past few years were ‘illusions deliberately and systematically created' by the company's senior management. . . . Fannie Mae used its political power to lobby Congress in an effort to interfere with the regulator's examination of the company's accounting problems. . . . OFHEO's report solidifies my view that the GSEs need to be reformed without delay."
McCain stressed, "If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole. I urge my colleagues to support swift action on this GSE reform legislation."
April 2007
Sens. Sununu, Hagel, Dole, and Mel Martinez (R-Florida) re-introduced legislation to improve GSE oversight.
April 2007
In "A Nightmare Grows Darker," the New York Times writes that the "democratization of credit" is "turning the American dream of homeownership into a nightmare for many borrowers." The "newfangled mortgage loans" called "affordability loans" "represent 60 percent of foreclosures."
September 2007
President Bush: "These institutions provide liquidity in the mortgage market that benefits millions of homeowners, and it is vital they operate safely and operate soundly. So I've called on Congress to pass legislation that strengthens independent regulation of the GSEs . . . the United States Senate needs to pass this legislation soon."
2007-2008
The housing bubble began to burst, bad mortgages began to default, and finally the Fannie Mae and Freddie Mac portfolios were revealed to be what they were, in collapse. And the testimony is evident as to why. As Wallison noted, "Fannie and Freddie were, I would say, the poster children for corporate welfare."
September 2008
Rep. Arthur Davis, whose testimony is found above in October 2004, now admits Democrats were in error: "Like a lot of my Democratic colleagues I was too slow to appreciate the recklessness of Fannie and Freddie. I defended their efforts to encourage affordable homeownership when in retrospect I should have heeded the concerns raised by their regulator in 2004. Frankly, I wish my Democratic colleagues would admit when it comes to Fannie and Freddie, we were wrong."
Today 2008
The narrative is of another socialist experiment failed, this time a massive federal effort, imperiling the whole US banking industry. Facing this economic disaster, will an informed American people put their trust Obama's socialist ideology to bring remedy? To do so is to trust in an acetylene torch to put out the fire.
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