Gary D. Halbert
In last week’s letter, I focused on recent economic reports which have been modestly more positive, overall, than most forecasters had been expecting. However, I also pointed out that things on the housing front are still flashing warning signs – specifically the continued record spike in home foreclosures. My conclusion was (and is) that until we see a bottom in the housing sector, we should not expect consumer spending to rebound strongly.
This week, we will continue on that theme with the latest distressing news on Fannie Mae and Freddie Mac, which are continuing to hemorrhage with multi-billon-dollar losses every quarter. Both of these giant mortgage entities – that were taken over by the government in September 2008 – are once again begging for more huge government bailouts, as their enormous mortgage portfolios continue to plunge in value.
Here again, this suggests slow growth in the economy for the rest of this year as consumers continue to wrestle with falling home prices, a glut of foreclosed properties on the market and high unemployment. Unfortunately, it very much looks like we are at least several months away from a possible bottom in the housing sector, if not longer.
As a part of this discussion, I will also give you the background information regarding who really got us into this housing crisis in the first place. Some of you may be well aware of this information, but I expect that many readers are not. So this may be another of my E-Letters that you will find useful for sharing with friends and/or family members. Let’s get started.
Fannie & Freddie Request More Billions From Uncle Sam
Most of you will recall that Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation) – both previously privately-held corporations – were taken over by the US government on September 7, 2008 at the height of the subprime credit crisis. The Bush administration put these giant corporations into federal “conservatorship” and simultaneously fired both of their CEO’s and their boards of directors.
For many decades, Fannie and Freddie have been the largest holders of US mortgage debt, and at the time of the government takeover in September 2008, the two entities owned or guaranteed over $5 trillion in consumer mortgages, amounting to over half of all US home mortgages in existence at the time. Since the takeover of Fannie and Freddie over 20 months ago, data has been sketchy as to just how much money the government has poured into these huge agencies to keep them afloat.
Yet in the first two weeks of May, both agencies formally requested billions more in federal bailout money, just to pay the interest on their enormous debts and stay afloat. On May 5, Freddie Mac requested an additional $10.6 billion in federal money due to losses of over $8 billion in the 1Q alone. On the following Monday, May 10, Fannie Mae formally requested an additional $8.4 billion bailout and reported that it had lost $13.1 billion in the 1Q alone.
I guess that the Obama administration decided it could no longer keep these massive bailouts under wraps and quietly let it be known that the government had already pumped over $145 billion into Fannie and Freddie since the takeover in September 2008 – not counting the latest combined requests for another $19 billion. Obviously, these two giant agencies continue to lose enormous amounts of money despite the recovery in the economy.
A Brief History on Fannie & Freddie
Fannie Mae was established as an official government agency in 1938 by FDR as a part of the New Deal to make home mortgages more available to low-income families. In 1968, Congress converted Fannie Mae into a private shareholder-owned corporation, largely to get its annual expenses out of the federal budget, even though it has continued to receive government subsidies to this day. And as noted above, Fannie was formally taken over by the government in September 2008.
Freddie Mac was created in 1970 to expand the secondary market for home mortgages in the US, in part to provide a competitor for Fannie Mae. While Freddie was another private shareholder-owned corporation, it has also received government subsidies since its creation. Thus, both Fannie and Freddie came to be known as Government Sponsored Enterprises or “GSEs.”
As we all know now, Fannie and Freddie went wild with their lending practices in the 1990s and 2000s, partly due to their own profit motivations, and partly due to government pressures to make home loans available to more middle and low income Americans. But most people have little or no idea how or why this came to be. Let me give you a quick refresher course.
Back in 1999, Fannie and Freddie came under pressure from the Clinton administration (like the Carter administration in years past) to expand mortgage loans to low and moderate income borrowers by relaxing their home loan lending standards, especially in distressed inner city areas around the country. More than happy to oblige, Fannie and Freddie lowered their credit requirements on mortgages they were willing to purchase.
A few years later, with the advent of much more sophisticated debt instruments – such as Collateralized Debt Obligations (“CDOs”) and Structured Investment Vehicles (“SIVs”) and others – Fannie and Freddie were able to purchase more and more home mortgages and sell them off to investment banks, brokerage firms, etc. that packaged them into baskets of CDOs, SIVs, etc. that were subsequently sold to private investor groups. Near the height of the housing bubble, Fannie and Freddie themselves originated and sold many of these bundles of CDOs and other highly leveraged, exotic mortgage-backed securities.
Partly as a result of congressional pressure and these increasingly complicated lending vehicles – and their continued quest for ever-rising profits – Fannie and Freddie devolved into encouraging private lenders to make loans to increasingly high risk borrowers by creating the so-called “subprime” and “Alt-A” loans, most of which were at interest rates higher than conventional mortgages because the default risk was higher.
We can all still remember how mortgage companies resorted to “low-doc” and even “no-doc” mortgages, many of which included zero down payments, and little or no proof of annual income. At the height of the bubble, in some states people could purchase or refinance homes with 120-125% mortgages. Remember that in the late 1990s and up to 2007, almost no one believed that home prices could go down.
Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.
Fannie/Freddie Scandals & Lack of Regulation
As is often the case with large government subsidized entities, there was ample room for corruption and waste in Fannie and Freddie. As early as the year 2000, Fannie (and to a lesser extent Freddie) was under investigation for its accounting practices. On June 15, 2000, the House Banking Subcommittee On Capital Markets, Securities And Government-Sponsored Enterprises held hearings on Fannie Mae’s accounting practices, but no formal action was taken. I’ll tell you why later on.
By 2004, Fannie (and to a lesser extent Freddie) was again under investigation for accounting errors and waste. On September 20, 2004, the Office of Federal Housing Enterprise Oversight released a report alleging widespread accounting errors at Fannie. Once again, no significant actions were taken.
It was not until December of 2006 that regulators took any significant actions against Fannie. On December 18, 2006, US regulators filed 101 civil charges against Fannie’s chief executive officer, Franklin Raines, chief financial officer, Timothy Howard, and the former controller, Leanne Spencer. The three were accused of manipulating Fannie Mae earnings to maximize their lavish bonuses. The lawsuit sought to recoup more than $115 million in bonus payments, collectively accrued by the trio from 1998–2004, and about $100 million in penalties for their involvement in the accounting scandal.
The question is, why were no actions taken against Fannie prior to late 2006? In September 2003, the Bush administration recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis. Under the plan, a new agency would have been created within the Treasury Department to assume supervision of Fannie and Freddie. The new agency – not Congress – would have had the authority to set capital-reserve requirements for the companies and to determine whether they were adequately managing the risks of their ballooning mortgage portfolios.
Not surprisingly, the Democrats unanimously opposed the plan to create this new oversight agency for Fannie and Freddie. Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee, said the following at the time: “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.” The Bush oversight legislation went nowhere at the time, even though Republicans controlled both houses of Congress.
In the Senate, Democrats were also unanimously opposed to the Bush regulatory plan for Fannie and Freddie. The Republicans had a majority of 55 Senators at the time, but as we all know now (in light of the healthcare bill narrowly passing), it takes 60 votes in the Senate to end a filibuster. The Republicans could not get a single Democrat to vote for reforming Fannie and Freddie back in 2003.
The Bush administration made numerous subsequent attempts at regulatory reform of Fannie and Freddie in the following years, but all such attempts fell flat. John McCain led a similar effort in 2005 and actually got a serious reform bill passed in the Senate Banking Committee. Yet it also failed, even with the endorsement of former Fed chairman Alan Greenspan, who warned Congress at the time:
[If Fannie and Freddie] “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.” [Emphasis added.]
We can only wonder if the housing/subprime crisis of 2008-2009 would have been avoided if those reforms had passed! But there is a very clear reason why the Democrats, and even some Republicans, did not have the fortitude to take on Fannie and Freddie.
Fannie & Freddie Were Huge Political Contributors
As I have hinted above, there is one huge reason why members of Congress, especially Democrats, were so reluctant to regulate and reign-in Fannie and Freddie for years before the housing crisis unfolded: MONEY! Fannie and Freddie gave millions in contributions to politicians in Washington over the years to curry support, and to thwart regulatory reforms.
Just prior to the Bush administration’s takeover of Fannie and Freddie on September 7, 2008, the Federal Election Commission (FEC) reported that between 1989 and 2008, Fannie and Freddie and their employees contributed almost $5 million to members of Congress. The FEC further reported that 57% of that money went to Democrats. And the FEC report included a breakdown by name.
Recipients of Fannie Mae and Freddie Mac Campaign Contributions, 1989-2008
|Name||Office||State||Party||Grand Total||Total from
|Dodd, Christopher J||S||CT||D||$165,400||$48,500||$116,900|
|Bennett, Robert F||S||UT||R||$107,999||$71,499||$36,500|
|Kanjorski, Paul E||H||PA||D||$96,000||$57,500||$38,500|
|Bond, Christopher S ‘Kit’||S||MO||R||$95,400||$64,000||$31,400|
|Shelby, Richard C||S||AL||R||$80,000||$23,000||$57,000|
|Hoyer, Steny H||H||MD||D||$55,500||$51,500||$4,000|
I have elected to reprint only the top 25 recipients of Fannie/Freddie campaign contributions. The complete list includes 354 members of Congress that have received Fannie/Freddie money. Most noticeable on the list above is then-Senator Barack Obama who – even in his short time in the Senate – was the #2 recipient of Fannie/Freddie money. That is simply amazing! No wonder he voted to shoot down Republican efforts to reign-in Fannie and Freddie.
Let’s carry this analysis a bit further. Notice that the time period in the chart above is the 10-year period from 1989 to 2008. Barack Obama was only in the Senate for less than four years, yet he was given more money than John Kerry (#3) who was in the Senate for all 20 years. Obviously, Fannie and Freddie rained money on Obama during his presidential campaign. Remember, as noted above, that it was John McCain, Obama’s presidential opponent, who headed the last effort to reform Fannie and Freddie in 2006.
Notice also that Senator Chris Dodd was the #1 recipient. This explains why he was a vocal supporter of Fannie and Freddie and was at the forefront of the Democrats’ opposition to reforming these institutions. Ironically, it is now Sen. Dodd who is in control of the massive financial regulatory reform legislation, which I wrote at length about in my April 20 E-Letter. Yet Dodd’s financial reform proposal makes no effort to reform Fannie or Freddie, and now you know why.
Notice other prominent names on the list: Hillary Clinton, Harry Reid, Nancy Pelosi and Rham Emanuel (Obama’s Chief of Staff). Of course there are also some prominent Republicans: John Boehner, Richard Shelby, Eric Cantor and others.
You will notice in the chart above that some of the contributions came from Fannie and Freddie by way of their multiple political action committees (PACs), and from individuals that worked for Fannie and Freddie. There were many politically-motivated high-rollers that worked at Fannie and Freddie who were making absurdly high salaries and huge bonuses. They did not want the gravy train to end! Surprise, surprise!!
How & When Does the Bleeding Stop?
As noted at the beginning, Fannie requested an additional $8.4 billion, and Freddie another $10.6 billon in funding earlier this month. Including the latest request, Fannie Mae will have received more than $84.6 billion from the government. With the latest request, Freddie will have received $79.4 billion. I don’t think anyone ever expected the cost to be remotely this enormous.
Upon making the latest bailout requests, spokesmen for both Fannie and Freddie cautioned that they have no idea how much more money they will need to survive. Fannie’s spokesman warned of “significant uncertainty as to our long-term financial sustainability” as it expects the continued weak housing market to keep default rates and credit-related costs high. Housing analyst Rajiv Setia of Barclays Capital said Fannie Mae alone is likely to draw another $40-$50 billion from the government.
We were told initially that the plan to put Fannie and Freddie into conservatorship was meant to be temporary, but more than a year-and-a-half later, Treasury Secretary Tim Geithner says they have only just begun the process of figuring out how to overhaul the US housing finance system. And get this – under the terms of the government conservatorship, both Fannie and Freddie have access to a separate, unlimited credit line from Treasury to backstop their losses.
It is very tempting to conclude that if Congress had acted to reform Fannie and Freddie back in late 2003 or early 2004, the housing/credit crisis would never have happened. Remember, the Bush administration recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis back in 2003, but it was blocked by the Democrats time after time. Some Republicans opposed it as well.
It is likewise tempting to conclude that if the reforms championed in 2006 by John McCain had been passed, the housing/credit crisis could have been averted or at least minimized. Of course, all of this comes with the benefit of 20/20 hindsight.
Even so, there were people who knew the lax lending, the extreme leverage and the exotic mortgage-backed securities would end up ugly at some point. As far back as late 1999, the left-leaning New York Times warned that with Fannie’s move towards the subprime market, “Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s.”
The New York Times warned again in 2003 that “Fannie Mae’s risk is much larger than is commonly held.” Nassim Taleb, author of the wildly popular 2007 book, The Black Swan, warned: “The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup.” There were others, such as my long-time friend, John Mauldin, who predicted the subprime crisis in advance.
Unfortunately, many high-profile forecasters and research outfits believed – mistakenly – that the subprime mortgage meltdown would be “contained” within the mortgage markets. The Bank Credit Analyst (that I used to be able to quote and summarize for you) was in this camp that believed there would likely be no subprime “contagion.” But we all know what happened.
My main point in choosing this week’s topic is the following: The mainstream media and those on the left (including our current president) are very fond of blaming the big banks and mortgage companies for the housing bust, the financial crisis and the Great Recession. And it is true that they played a significant role.
Yet it is also true that government-sponsored Fannie Mae and Freddie Mac – that held $5 trillion worth of home loans (over half of all outstanding mortgages) – played an even bigger role in creating the crisis. And what you rarely see in the media is the fact that the Democrats in Congress blocked multiple efforts to significantly reform and reign-in Fannie and Freddie in 2003-2006.
And the problem goes on to this day. If you read my April 20 E-Letter, you know that I have written on the current financial regulatory reform bill making its way through Congress. If you read that letter, you know that I am all for significant financial regulatory reforms, but I am against the reform legislation that was passed by the House and is now in the Senate. I believe this is just another government takeover of a massive financial industry.
And do you know that Fannie and Freddie – the two largest financial entities in the country – are NOT going to be regulated by the new Consumer Financial Protection Agency? No, they will continue to be run by the Obama administration. In other words, despite all of Obama’s promises of change and transparency, it’s still just “politics as usual.”
Sorry to end on what I’m sure some of you will consider a partisan political note, but the facts are what they are. The financial crisis did not have to be as severe as it has been, and might have been avoided.
Gary D. Halbert