History of Fraud by Mortgage Regulators
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The following is a chronological list of actions and statements. They mostly surround the work of one regulator, James B. Lockhart, formerly of OFHEO/FHFA. Lockhart was the chief regulator of Fannie Mae and Freddie Mac. Now, he works for Wilbur Ross, in the foreclosure industry.
In the interest of full disclosure, I am a shareholder of Freddie Mac.
September 10, 2007
The following is an excerpt from a New York Times article.
"James B. Lockhart, the chief regulator of Fannie and Freddie, adjusted the companies’ lending standards so they could purchase as much as $40 billion in new subprime loans. Some in Congress praised the move.”
In 2007, Congress and regulators encouraged Fannie Mae and Freddie Mac to begin buying subprime securities. These securities didn't meet their own lending standards, but rating agencies had placed AAA ratings on them, the highest grade. Looking back on this crisis, we know that most of these securities were not worthy of a AAA rating.
July 8, 2008
Around this time in July 2008, Ben Bernnanke declared Fannie and Freddie adequately capitalized and so did James Lockhart. Here is a snippet of a Bloomberg story.
“Fannie and Freddie are adequately capitalized at this point,” James Lockhart, the director of the Office of Federal Housing Enterprise Oversight, said in an interview with Bloomberg Television today. “They are fulfilling their function.”
September 9, 2008
Then, Paulson and Lockhart announced the nationalization of the two companies in early September 2008, just a few months after the FHFA and Federal Reserve gave them a clean bill of health. Bloomberg ran a story regarding the takeover of Fannie Mae and Freddie Mac. The following paragraph appeared in the story:
"Washington-based Fannie had $47 billion of regulatory capital as of June 30, about $9.5 billion above what FHFA required, according to company filings. McLean, Virginia-based Freddie's capital stood at $37.1 billion, a cushion of about $2.6 billion over FHFA's standard, filings show."
November 14, 2008
Freddie Mac reports a loss of $25.3 billion, sending total stockholders equity to negative $13.795 billion. Fannie Mae reported a loss of $29.4 billion, wiping out nearly all of the company's capital. Evidence strongly suggests that the companies were not adequately capitalized in the beginning of 2008, when the companies were raising capital in the financial markets.
April 9, 2010
James Lockhart testified in front of the Financial Crisis Inquiry Commission. Here is a portion of Lockhart’s testimony.
“It became clear by August 2007 that the turmoil was too big for the Enterprises to solve in a safe and sound manner. …They were critically supporting the conforming mortgage market. We were very concerned that if we released those constraints that it would impair their ability to serve their core market as they were already purchasing or guaranteeing over 60% of the mortgages originated.”
This establishes that Lockhart knew the companies were undercapitalized in August 2007, nine months before Fannie Mae made a preferred stock offering. This was also just one short month before Lockhart and Congress encouraged the companies to load up on subprime securities.
The Big Bad Bank
Hopefully, readers of the timeline above are able to follow the events and significance of each action, but let's add one more layer of complexity to the situation. In January 2009, the Obama Adminstration proposed a new type of "bad bank" called an “aggregator bank.” We'll call this bad bank the "Big Bad Bank." Supporters of the plan included Sheila Bair and Ben Bernanke.
Generally, with bad bank scenarios, the government would bail out each bank separately, moving toxic assets off of each bank's balance sheet, one bank at a time. Each bank would get it's own bad bank for toxic assets.
With the Big Bad Bank, you would create one large toxic asset pool and move assets off of each bank's balance sheet to the central pool. The pool of bad assets would need to be administered, efficiently, with the intention of reducing losses. What better way to create a Big Bad Bank than to use the existing backstops, Fannie and Freddie.
Fannie and Freddie rewrote over 1 million mortgages, absorbed billions in dollars of losses from subprime mortgage securities, and settled repurchase claims for pennies on the dollar. Regarding the repurchase settlement with Bank of America, Congresswoman Maxine Waters said,
“This settlement may have been both premature and a giveaway." The deal may “amount to a backdoor bailout that props up the bank at the expense of taxpayers."
Conclusion
For the past few years, Fannie Mae and Freddie Mac have been used to support the mortgage market, modifying mortgages and absorbing banking sector losses. The real tragedy here is the lack of clarity by regulators into the trouble that was brewing in the market. And even today, there is an unspoken mission to support the entire market, at the expense of taxpayers and shareholders. If these companies are ever to be released from Conservatorship, these regulatory issues must be addressed.
Related Hubs
- Fractured Committee Debates Housing Finance
- Treasury Will Make Profit on Fannie and Freddie MBS
- Fannie and Freddie, Conservatorship Agreement Transparently Violated
- The Cost of Resolution at Fannie and Freddie
- Recent Supreme Court Cases May Affect GSE Outcome
- Fannie Mae and Freddie Mac Shareholders Organize
