Posted on 05/25/2013 4:20:42 PM PDT by whitedog57
Sheila Bair, former FDIC Commission, and Barney Frank, former Congressman, penned a misleading op-ed in Fortune/CNN Money entitled Watch out. The mortgage securities market is at it again.
Here is the misleading sentence:
Big, ugly giants with names like Countrywide Financial and New Century packaged huge pools of mortgages, sliced them up into securities, and sold them to investors, who now bore the risk if the loans defaulted.
It turns out that big, ugly giants with names like Fannie Mae and Freddie Mac did exactly the same thing. They packaged huge pools of mortgages, sliced them up into securities, and sold them to investors LEAVING FANNIE MAE AND FREDDIE MAC (NOW TAXPAYERS) bearing the risk of defaulted loans.
True, the slicing and dicing were sold by investment banks. But Fannie and Freddie designed the bonds (or tranches), sometimes at the request of the investment banks.
Here is an example of a simple Fannie Mae Trust Pass-through Certificate (through Merrill Lynch). Here is a simple Fannie Mae Stripped MBS (through First Boston). And here is Freddie Macs guide to the more complex slice and dice of Collateralized Mortgage Obligations (CMO). Finally, here is my coauthor Andy Davidsons Philadelphia Fed paper on Agency CMO Risk.
Here is a screenshot of the first group of 99 bonds from a Fannie Mae 2005-14 CMO issue.
To understand the various definitions in a CMO, see Davidson, Sanders, Wolff and Ling Structuring CMOs, IOs, and POs.
So, Fannie Mae and Freddie Mac did the same thing as the big ugly giants. The difference is in the loans that were securitized and who bore the credit risk. But both packaged huge pools of mortgages, sliced them up into securities, and sold them to investors (through investment banks).
This is not a criticism of Fannie Mae and Freddie Mac. Rather, it is to point out that Sheila Bair and Barney Frank seem to ignore the 800 lb gorillas in DC: Fannie Mae and Freddie Mac. Seemingly, it is bad for investors to bear the risk of default, but good for taxpayers to bear the same risk?
True, we dont want a repeat of last decades housing bubble and crash. But with both Fed Chairman Bernanke and Fed Governor Duke calling for easing of bank lending standards, saying the banks are at it again seems inappropriate and misguided.
If the issue is skin in the game, that is a different issue. If we are talking about leveling the playing field between the banks and the GSEs (e.g., Fannie Mae and Freddie Mac), here is my paper with Gerald Hanweck and Robert Van Order on leveling the playing field. If the banks have to have skin in the game, the shadow banks (e.g., Fannie Mae and Freddie Mac) should have sufficient capital to play as well.
P.S. Someone asked about CDOs (collateralized debt obligations). Those are a different animal. See Deng, Gabriel and Sanders (2009) for a discussion of CDOs.
FYI ping
Barney Frank and the Law of Unintended Consequences: How the Frank Amendment Helped Terrorists get Legal Visas by Chuck Morse
http://amzn.com/B006O6NORU
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