Some Saw The Fannie/Freddie Crash Coming

Joe Bell

Wall Street is in a financial crisis and taxpayers will probably pull the well-heeled out of their fiscal abyss. That isn’t class warfare rhetoric – it’s a fact. The Bush administration is asking Congress to provide $700 billion so the government can purchase bad mortgage loans that have troubled large companies since they became entangled in a credit crisis. It’s the wrong prescription.

Elected officials vow the bailout will be responsible. Really? Every day Congress plays with the people’s money and one hopes at some point they will exercise frugality. However, these are the same folks who helped make the mess in the first place. Since Democrats control Congress they will have the loudest voice in the rescue, yet as Investor’s Business Daily pointed out on September 15, if the market is “dysfunctional, Democrats during the Clinton years are a prime reason for it.”

IBD pointed out that during those years, “Tough new regulations forced lenders into high-risk areas where they had no choice but to lower lending standards to make the loans that sound business practices had previously guarded against making.”

On September 18, IBD reported, “Since 1989, Fannie and Freddie have spent an estimated $140 million on lobbying Washington. They contributed millions to politicians, mostly Democrats, including Senator Chris Dodd (No. 1 recipient) and Barack Obama (No. 3 recipient, despite only three years in office).”

Fannie and Freddie’s checkbook spread across both sides of the aisle. Republican Senator Richard Shelby, of Alabama, is among the top dozen recipients of Fannie and Freddie campaign contributions. He is ranking member on the Committee on Banking, Housing and Urban Affairs.

It is amazing that Freddie and Fannie got into such trouble. They are exempt from state and local taxes and they pay an artificially low interest rate on their bonds because it’s been understood that if they have trouble the Treasury will bail them out.

Arizona Senator John McCain saw the crash coming in May 2006: “…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, which resulted in a $10.6 billion accounting scandal. The Office of Federal Housing Enterprise Oversight’s report goes on to say that Fannie Mae employees deliberately and intentionally manipulated financial reports to hit earnings targets in order to trigger bonuses for senior executives. In the case of Franklin Raines, Fannie Mae’s former chief executive officer, OFHEO’s report shows that over half of Mr. Raines’ compensation for the six years through 2003 was directly tied to meeting earnings targets. The report of financial misconduct at Fannie Mae echoes the deeply troubling $5 billion profit restatement at Freddie Mac. … For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac – known as government sponsored entities or GSEs – and the sheer magnitude of these companies and the role they play in the housing market. …OFHEO’s report solidifies my view that the GSEs need to be reformed without delay.”

There were other warnings. On June 20, 2005, in its report, “Time to Reform Fannie Mae and Freddie Mac,” The Heritage Foundation cautioned, “In late 2004, the leadership of the Federal National Mortgage Association (FNMA or Fannie Mae) was accused of having engaged in a series of questionable accounting practices that led to an overstatement of its earnings and an understatement of its risk. Although Fannie Mae’s top officers denied the accusations, a careful review by the U.S. Securities and Exchange Commission confirmed the allegations. Within a few weeks, Fannie Mae conceded the charges and its top officers were forced to resign. Any doubts about the seriousness of the company’s shaky finances were laid to rest on January 19, 2005, when Fannie Mae cut its dividend in half to bolster its cash reserves.”

Heritage warned, “Fannie Mae and Freddie Mac have abused their generous federal privileges to the point that they now control as much as half of the nation’s residential mortgage market. Their commanding presence exposes U.S. financial markets to excessive risk and instability.”

The solution was well-known. Heritage recommended Congress pull the plug on federal privileges “thereby forcing them to compete with other financial institutions on a level playing field.”

Competition is a component of the free market system. When government shields some from competition it tampers with the market. But history shows companies spend large sums of money lobbying Washington lawmakers because it works.

Fannie Mae has been around since 1936 and evidence indicates it has outlived any usefulness it may have had. Heritage reported, “…in 1965, when the GSE presence in the mortgage market was slightly above 6 percent, America’s homeownership rate was 63.3 percent. In 1990, after outstanding residential mortgage credit had expanded more than tenfold from $220.8 billion in 1965 to $2.6 trillion in 1990 and after the federal and GSE presence in the residential mortgage market had grown from 6 percent in 1965 to 48 percent in 1990, America’s homeown¬ership rate was at 63.9 percent - virtually identical to the rate 25 years earlier. …the $1.24 trillion increase in federal and GSE involvement in the mortgage market was associated with an increase of less than 0.6 percentage points in the homeownership rate.”

In its 2005 report, Heritage said, “…Fannie Mae’s management team appears to be the chief beneficiary of the federal privileges and the accounting irregularities that were recently uncovered. For example, in 2003, 749 members of Fannie Mae’s management team received a staggering $65.1 million in bonuses, a portion of which was attributable to the overstated earnings that followed from the accounting irregularities. Over the past five years, the top 20 Fannie Mae executives reportedly received combined bonuses of $245 million. This disconnect between reward and mission suggests that any reconciliation with the Securities and Exchange Commission should also require that the FNMA’s management return their bonuses to a fund administered by a bona fide not-for-profit entity, such as Habitat for Humanity, for the purpose of assisting prospective homebuyers of modest means. Although management’s unearned bonuses have generated most of the headlines, the real cost to the nation is not the tawdry looting of the company by its top management team. The real problem is the concentration of risk in the hands of two massive and privileged companies that now dominate America’s housing finance markets.”

The fiscal collapse was predicted years ago. Such disasters occur when individuals have more power than they choose to exercise responsibility. Those positioned to do something to avoid the crash refused to take action. Now the same politicians who allowed the wreck to occur are pontificating about handling the bailout conscientiously. It is unfortunate that the public must rely on these charlatans to clean up the chaos and even more regrettable that we must listen to them belch noble words as they do.

Congress ignored the warnings. Now will they take some good advice? The Cato Institute’s Alan Reynolds says, “Any serious solution must begin by requiring Freddie and Fannie to do what other troubled firms are routinely required to do – sell assets, raise capital and reduce debt. Fannie Mae and Freddie Mac need to be downsized and de-leveraged, relieved of special privileges and loan guarantees and broken into small pieces agile enough to sink or swim on their own, without taxpayer support.”

If lawmakers do not take this road it will be clear that they are not serious about solving the crisis but prefer to cover up the red ink with an old tarp.

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Joseph Bell has hosted a radio talk show and is a former editorial writer/columnist for several Connecticut newspapers. A former liberal Democrat, Bell has not been on the conservative side of the aisle for very long. He voted for Clinton/Gore in 1992. Abandoning the convictions that he had held and defended through adolescence and into adulthood was not easy. Sincere soul-searching and a commitment to distinguish fact from fiction compelled him to accept that liberal ideology was bankrupt.

jbellopedresponse@hotmail.com