Exclusive Book Excerpt: Fannie and Freddie’s Starring Role in the Housing Debacle

by Charles Gasparino

Despite the few voices of caution, risk and leverage had become a national fixation, embraced both on Wall Street and in government. The SEC and the Fed, the main regulators in charge of monitoring the buildup of risky assets on the banks’ books, together with the rating agencies, were the modern-day equivalents of Nero fiddling as Rome burned.The fire in this case was the massive and rapid buildup of mortgage debt on the balance sheets of the banks; by 2006 it was approaching $1 trillion and heading higher without so much as a peep from the traditional watchdogs.

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Still, the risk taking and leverage went beyond the brokerage houses and the banks. The GSEs, Fannie Mae and Freddie Mac, were in the game as well. By now, Fannie and Freddie had fully and completely conceded their original mandates to the whims of the Washington political class, which demanded “affordable” housing for all, even those who couldn’t afford it. The politicians were giddy with Fannie and Freddie’s conversion from staid mortgage banks to subprime lenders that would make Angelo Mozilo, the CEO of the largest subprime lender in the markets, Countrywide Financial, envious.

It was an evolution that took years in the making. As HUD secretary, Andrew Cuomo boasted in one report in the late 1990s that the new mandates he was imposing on Fannie and Freddie to ramp up subprime lending “could be of significant benefit to lower-income families, minorities, and families living in underserved areas.”

With prodding from HUD, including Cuomo’s successor, Mel Martinez, appointed by George W. Bush, the GSEs would become even larger catalysts of the mortgage market that dealt with subprime borrowers and one of the big reasons that housing prices continued to soar well into the new millennium. The combined balance sheets of the GSEs grew by an average of 15 percent a year, from $1.4 trillion in 1995 to $4.9 trillion in 2007, about $1 trillion of which was subprime.

One of the ironies of the bubble Fannie and Freddie helped create through their guarantees and purchase of subprime loans is that it made housing less affordable, not more so. To own a home, working-class and poor families were now more reliant than ever before on the various gimmicks the mortgage business offered—the adjustable-rate mortgages and “no-money-down” loans that allowed families to live in their homes at minimal initial cost, only to have their mortgage payments skyrocket later.

The strain on the system was becoming apparent in mid- to late 2006 as subprime mortgage delinquencies and defaults started to spike in a meaningful way, with the GSEs picking up the cost. At first, the top executives at Fannie and Freddie didn’t seem to notice or care; the losses and the additional risk the agencies were taking on were papered over by the theory that housing was something that almost never went down in value, even as it was showing the first signs of doing just that.

The housing boom had done many things, including papering over the accounting scandals that hit both agencies. During this time, the top executives at both agencies earned salaries that could be found only on Wall Street. Fannie Mae chief Franklin Raines earned a whopping $90 million between 1998 and 2004, when he was forced to leave amid an accounting scandal not much different from what had occurred at Enron or WorldCom.

There was just one difference: Fannie and Freddie were doling out the American dream to the poor, and consequently the outcry, particularly from the press, was muted.

There were, of course, a few skeptics. Richard Baker, a Republican congressman from Louisiana, was a longtime critic of the GSEs, but his warnings were ignored even as he discovered that the agencies weren’t just in the business of facilitating mortgage lending through guarantees or through buying mortgages with cheap money, bundling them in mortgage securities, and selling off to investors; they were now keeping the mortgage securities on their own books and earning the interest in the same carry trade that had become popular on Wall Street and led to massive losses in 1986, 1994, and 1998.

Baker had no direct authority to regulate Fannie and Freddie, other than calling hearings after the accounting irregularities first surfaced and later proposing reformist legislation, which he did, much to the dismay of the powerful congressman and housing advocate Barney Frank, who dismissed the idea of either Fannie or Freddie being out of control as “overblown.” In addition to Frank, Fannie and Freddie had other powerful allies in Congress, especially Chris Dodd, the senator from Connecticut who was not just a ranking member of the Senate Banking Committee but also a “Friend of Angelo,” meaning he was on a special list of VIPs who had received low-cost mortgages from CEO Angelo Mozilo of Countrywide, the largest purveyor of subprime lending.

Frank, it should be noted, finally agreed to rein in Fannie and Freddie in 2007, but only with the provision that agencies must provide even more low-income housing—the very practice that was leading the GSEs into insolvency. (The effort eventually failed.)

It might seem easy to blame the accelerating train wreck of the GSEs on the Democrats: Cuomo at HUD, Frank and Dodd in Congress, and of course, the Clinton administration, beginning with HUD Secretary Henry Cisneros’s desire to expand home ownership to up to 70 percent of the population.

But they weren’t alone. Free-market types such as Fed chairman Alan Greenspan both warned against Fannie and Freddie’s irrational exuberance and extolled the GSEs’ subprime lending as they expanded home ownership to the poor, as did Clinton’s successor, George W. Bush.

For the president, and for Republican leaders looking to soften their image with minorities, Fannie and Freddie’s efforts to expand home ownership seemed to be the perfect vehicle to broaden their appeal to groups often hostile to Republicans. Fannie Mae’s exposure to subprime mortgages tripled from 2005 to 2008, when Republicans ran both Congress and the White House. George W. Bush may not have been as fervent a supporter of the expansion of housing to risky borrowers as Barney Frank or Chris Dodd was, but he was hardly a bystander. During one speech at the height of the bubble, the president said:

[I’ve] issued a challenge to everyone involved in the housing industry to help increase the number of minority families to be homeowners. . . . I’m talking about your bankers and your brokers and developers, as well as members of faith-based community and community programs. And the response to the home owners challenge has been very strong and very gratifying. Twenty-two public and private partners have signed up to help meet our national goal. Partners in the mortgage finance industry are encouraging homeownership by purchasing more loans made by banks to African Americans, Hispanics, and other minorities.

Representatives of the real estate and homebuilding industries, through their nationwide networks or affiliates, are committed to broadening homeownership. They made the commitment to help meet the national goal we set. Fannie Mae and Freddie Mac . . .have committed to provide more money for lenders. They’ve committed to help meet the shortage of capital available for minority home buyers. . . . There’s all kinds of ways that we can work together to meet the goal. Corporate America has a responsibility to work to make America a compassionate place.

Angelo Mozilo couldn’t have said it better.

[The Sellout: How Three Decades of Wall Street Greed and Government Mismanagement Destroyed the Global Financial System, published by HarperCollins, will be released November 3rd. The book can be pre-ordered here.]


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Posted Oct 29th 2009 at 5:45 am in Congress, Economics, Exclusives, Featured Story, History, Politics | 46 Comments