Mittwoch, September 17, 2008

From the Guys Who Were There...

This is a great view of the inside of Fannie Mae when things started their long slow decline into perdition.

Arnold Kling worked there and was involved with what went on. To quote:

After the multifamily debacle, Freddie Mac's policy was to focus on financial health and minimize the support for low-income housing.

This was the risk management culture that Richard Syron inherited when he became Freddie Mac's CEO in 2003. Syron wanted to do more for low-income housing, and he did not trust the people that he found at Freddie Mac. As we now know, there was a blow-up between Syron and Freddie Mac's Chief Risk Officer over loans with low down payments. The Chief Risk Officer argued that such loans were bad for borrowers, bad for Freddie Mac, and bad for the country. Syron fired him.
In practice, Syron's timing was awful. He pushed Freddie Mac into high risk loans just as the real estate bubble was in its final few years. He then compounded this mistake by ignoring those at Freddie Mac who said that if the company was going to take these risks, then it had to raise more capital.

And these are the comments of the two others involved there at the same time, Chet Foster and Bob Van Order of Foster-Van Order model that was used to produce estimates of default costs and capital charges for the mortgages in question:

Chet Foster:

First, the accounting system. Freddie started as a Federal agency that did not have much to do. It was set up as a secondary market for S&Ls. At that time S&Ls were not much interested in selling loans. The accounting system was the typical government accounting system, done by folks that did not have a sound understanding of mortgage risk and related accounting practice. Freddie knew that the accounting system was not good. But fixing it was a huge problem. When Syron took over at Freddie Mac, it was estimated that it would cost something like $500 million to fix, and Wall Street analysts I talked to thought that it would take a lot more. Imagine going to the Board and asking for $500 million!

One thing that irks me is the requirement that Fannie And Freddie are required to make specified proportions of their purchases in lower income and minority areas. This more than anything else has created this mortgage market disaster. The mortgage market is one of the most competitive markets in the country. We have National Banks, commercial banks, S&Ls, finance companies, Credit Unions, mortgage bankers, and mortgage brokers (I am sure I have left some out) all competing for the last nickel on the table. I live in a small town in Texas (pop. 8,911) and we have 6 Banks, a credit union and a mortgage broker. In such a market everyone should be able to get a loan as long as the property and borrower are reasonable risks.

and this from Van Order:

On the bubble I think the feedback goes both ways, but mostly it came out of the subprime market. The really big surge in house prices was after 2003 or so, which was when the Fannie Freddie share of purchases fell sharply.

The declining share may have had something to do with the risk profile after 2005.

I think the price decline is most of the story, but not all, re defaults. They also did a lot of Alt-A in the last few years (currently about 10% of book). These have high downpayments and high credit scores, but are performing lousy. They are tough to evaluate because some are in securities with subordination ahead of them and insurance. As far I I know all of the subprime is in senior pieces of securities, but the senior pieces are at risk. The problem there is more a liquidity one--noone wants to buy even senior pieces. These will take losses, but not as much as the market discount suggests. Unfortunately neither accounting equity or mark to market equity are very accurate.

There is the smoking gun: the mortgage market disaster was due to the political decision to remove right and proper risk management from Fannie Mae and Freddie Mac, coupled with the requirement to make specified proportions of their business in lower income and minority areas.

This isn't speculation: these are the facts.

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