Tuesday, August 17, 2010

Fannie and Freddie and Congress

This is just a guess, but a good guess I think. The mortgage companies run by Congress will cost taxpayers 10 times more than all of the "bailouts" of other financial firms when a final audit is done five years from now. That's if there is ultimately any aggregate cost at all to taxpayers from other financial bailouts in which case the F's losses would need to be called "infinitely higher". Heck, throw in GM and Chrysler as well and Fannie and Freddie may dwarf all of it. Nonetheless Congress keeps a tight hold on the rope that would open the curtain on the F couple's black hole.

The two F's were run by Congress with multiple goals that superceded running a sound and economically viable business. It was always viewed by the market and by huge financial and foreign investors in its debt as goverment sponsored aka government guaranteed if ever a crisis led to that need.

The F's main function was as a processor, packager, short term domicile, and servicer for mortgages. Average employee expenses should have been restrained given its business model as a processing plant and its implicit guaranteed access to low cost funds. To the contrary Congress let the company be run as a stand alone entity with the goal of ramping up its share price. The F's CEO's, especially at Fannie beginning with the 1990's hiring of the superficial image man Larry Small, were given salary, bonus, and options packages that exceeded those of any commercial banker and rivaled all but the most elite investment bankers. The derivatives trading areas were paid with Wall Street style profit sharing schemes to a department whose role was, or should have been, to hedge the pipeline from acquisition to securitization, a six to 12 month window at most. It's obvious that the CEO's and the trading department were incentivised to do much more than hedge. As an example, in the most recent quarter the smaller Freddie had $5 billion in credit losses(choke on that taxpayer) and $3.8 billion of derivatives trading losses(uhgg, what's this, why this icing on the cake).

These second tier CEO's, generally coming to D.C. after being passed over for bigger jobs elsewhere, and these traders who set themselves up outside of the derivatives power nexus of New York and London, were like grifters coming in for the big haul. They got it, and still are in some cases, and they are now acting put upon as in the recent comments by Franklin Raines whose tenure was a disaster. This comment may be too strong. They were backed by their Congressional oversight panel, Democrats and Republicans, every step of the way.

Why was that? The generally given answer to this question points at the significant contributions that the F's made to the politicians, year end year out, to fund their re-election campaigns. That's part of it but maybe a small part. Speaking in generalities that don't apply uniformly, to the Democrats the F's were seen to be a pain free way to fund housing goals and expand home ownership to those who otherwise would not be able to afford it(essentially disguised transfer payments) and to the Republicans the F's were boons to corporations engaged in construction, real estate development, and every aspect of building or refurbishing and furnishing new and used buildings. Social goals and business stimulus goals were achieved with no cost to anyone, so it must have seemed in the 90's and the first seven years of this century. Everyone was happy until...

As major players from House power Barney Frank to Pimco man Bill Gross make clear, we now need Fannie and Freddie more than ever as they are the mortgage market. We're stuck with 'em. They need to be seriously managed by Congress and it's far from clear that that's happening. Until Congress gives a thorough accounting and honest explanation of the F's disaster, hiding the truth prevents any effective management process overhaul.

The double standard by Congress is galling and transparently dishonest. After spending much of the last year and a half self-righteously castigating major investment banks, AIG, and others for their actions, Congress can cast no light on itself and the most costly fiasco of all to the taxpayers. The searing personal attacks on so many individuals by many members of Congress makes their refusal to take their own inventory that much more reprehensible.

Everyone knows Congress is somehow both dysfunctional and arrogant. This is just one more example, and it will without question turn out to be one of the most costly events of our Great Recession.


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