Fannie Mae and Freddie Mac Hide Billions In Losses - Time To End Fannie and Freddie!

The Inspector General for FHFA released a report that claims Fannie Mae and Freddie Mac are masking billions of dollars in losses.

The report, written by the inspector general for the Federal Housing Finance Agency and reviewed by Reuters, said the FHFA’s timeframe for mortgage finance companies Fannie and Freddie to have up to two years to recognize the cost of mortgages delinquent at least 180 days was “inordinately long.“

The change in the accounting treatment of these delinquent loans potentially could require Fannie and Freddie, which have rebounded to enormous profitability in the past two years as the housing market recovered, to “charge off billions of additional dollars related to loans,” the inspector general’s report stated.

The FHFA’s Inspector General says that Fannie, Freddie should recognize bad loan costs immediately.

This comes at an inopportune time for the beleaguered mortgage giants since Congress is debating the future of housing finance, particularly the future of Fannie Mae and Freddie Mac.

The question facing Congress is what to do with the FHA, Fannie Mae and Freddie Mac.

1. US Senate’s Corker-Warner bill. Here is the Corker-Warner bill in the US Senate.

Here is the American Bankers assessment of Corker-Warner. This bill was NOT endorsed by President Obama.

3. Super HUD. Another school of thought is to fold Fannie Mae and Freddie Mac into HUD. This idea makes my head explode. I am certain this is the approach that President Obama favors. Alas, I haven’t seen any bill proposing this approach.

The debate boils down to 1) a government guarantee or backstop and 2) preserving the fixed-rate mortgage.

As long as there is a government guarantee, there will be risky lending. The WSJ reported on Tuesday, June 4 that the FHA had conducted a previously undisclosed stress test which found FHA losses could hit $115 billion under the Federal Reserve bank stress test. Get the point?

Prediction? Either nothing is done (4) or the Senate and House negotiate a third way: risk-sharing with government.

Risk sharing is clearly a second best approach (with no government insurance as the best approach). This approach is dangerous because government will always want to raid the cookie jar and expand risky lending for political reasons. Just ask our two local cookie jars, Fannie Mae and Freddie Mac, that we constantly lobbied to purchase risky loans from lenders. nhsdream2

Here is the infamous letter from Barney Frank and Nancy Pelosi to President Bush claiming that safety and soundness for Fannie and Freddie should be relaxed for the affordable housing mission: ranklettr

“We have been concerned that the Administration’s legislative proposal regarding the GSEs would weaken affordable housing performance by the GSEs, by emphasizing only safety and soundness. While the GSEs’ affordable housing mission is not in any way incompatible with their safety and soundness, an exclusive focus on safety and soundness is likely to come, in practice, at the expense of affordable housing. “

In other words, roll the dice on affordable housing even if it crashes the house of cards. Charming.

You’re right, but the problem was, our position was compromised by our “free trade uber alles!” Congress.

See, the ChiCom’s used to hold about $300B in RMBS Fannie/Freddie paper as they were going down in flames. The Chinese talked with the current SecTreas (Paulson) and demanded that Uncle Sugar *explicitly* backstop the issue far enough that they could sell out of their huge position without a large loss.

So we did. We took them (Fannie/Freddie) into a quasi-receivership, owning about 80% of their common stock overnight, but instead of 100%, we kept it about 80 for reasons of not putting the liabilities onto the public books.

The first thing the GOP House should have done, if they had the brains to get into a battle of wits with a cockroach (which they don’t) would have been to fold Fannie or Freddie into the other, tighten FHA lending and eliminate a huge amount of duplication of efforts in the secondary market. But they didn’t.

The smart move now would be to take an incremental approach: Kill the weaker of the two, fold the liabilities into the stronger of the two and eliminate the staff. The only reason why Freddie exists at all was that when Fannie was “spun out” of the government in 1968, the Congress decided that Fannie “needed competition” - and so they created Freddie at the same time. Some competition.

Going forward, the government should not be setting up such enterprises - that’s fully agreed. Greenspan was warning people clear back to 2000 that the liabilities of Fannie/Freddie in the credit markets were such that RMBS buyers were bidding up that paper as tho it had government backing - which it didn’t. Greenspan predicted that the Treasury would be forced to do something, lest the residential mortgage market be locked down when the inevitable came to pass. The truth is that the RMBS paper sold by Fannie/Freddie did NOT carry the FFC of the US Treasury prior to June of 2008. It was given a rating at least two steps in excess of the real risks (ie, it was given a AAA rating when it should have had something like a A1 rating).

This is one of the few areas where Greenspan was right.

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