Ludd·ite – noun \ˈlə-ˌdīt\:  one of a group of early 19th century English workmen destroying laborsaving machinery as a protest; broadly :  one who is opposed to especially technological change  Luddite adjective. http://www.merriam-webster.com/dictionary/luddite

If the shoe fits….  Hmmm. This sounds vaguely familiar today.  As a protest, one destroys the very thing upon which they have come to depend. I note that the dictionary says the term can be used as an adjective.  This suggests to me that in today’s parlance, it is primarily descriptive. I sense that calling someone a “Luddite” is not a ringing endorsement of their common sense.

Congressional Luddites.  I believe of late that Congress has become infested with a new breed of Luddites – those who want to summarily dismantle Fannie Mae and Freddie Mac.  Why? What did these two quasi-governmental organizations with such cute names ever do to deserve to be unceremoniously cast into the junkyard of bad decisions? The answer is that these companies, collectively referred to as “government sponsored enterprises,” or “GSEs,” have become targets of revisionist history, mostly for political purposes.

I admit that after the GSEs were taken over by the government, in a 2012 post I criticized the enterprises as sucklings on the public teat, voraciously consuming taxpayer largesse that would never be paid back.  But six years after the federal takeover, Fannie and Freddie are still here, making big money, and seemingly operating well from an accounting and fiscal standpoint. So why destroy them now? 

A brief history of Fannie and Freddie.  Fannie was created in 1938, and Freddie in 1970. Their purpose was to provide a “secondary market” for banks to sell their loans to, thus freeing them up from risk of carrying loans full term.[1]  In 1968 Fannie became a private, for profit corporation, and was listed on the New York Stock Exchange.  Together, the GSEs had access to a line of credit through the U.S. Treasury, exemption from state and federal income taxes, and freedom from governmental oversight such as the Securities Exchange Commission.  These perks were why Fannie and Freddie were said to have the “implicit” guarantee of the U.S. government.  They grew exponentially over the years.[2]

As explained on the FHFA’s[3] website:

Given ongoing concerns about regulatory oversight of Fannie Mae and Freddie Mac, Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, which created the Office of Federal Housing Enterprise Oversight (OFHEO) as an independent regulator within HUD. OFHEO had the authority to conduct routine safety and soundness examinations of Fannie Mae and Freddie Mac and to take enforcement actions.

Further, the measure amended Fannie Mae’s and Freddie Mac’s charters, requiring them to meet an “affirmative obligation to facilitate the financing of affordable housing for low-income and moderate-income families.” In 1995, HUD began to require Fannie Mae and Freddie Mac to meet certain mortgage purchase goals each year.

Accounting Scandal. Franklin Raines, Fannie’s chief executive, was accused of manipulating the company’s books through what became known as “cookie jar” accounting.  In short, Fannie under-reported profits, using them as a sort of “rainy day fund,” and declared them later when income was weak. This gave the enterprise spectacularly consistent financial results, encouraging Wall Street’s confidence in its executive leadership.  Significantly, this ruse also benefited the executives, whose bonuses and stock options were tied to meeting their targeted goals. 

It is unclear just how much Mr. Raines actually paid back to Fannie.  Although in 2008, the Seattle Times, his hometown, carried the headline “Franklin Raines to pay $24.7 million to settle Fannie Mae lawsuit”, upon reading further, one sees that part of the settlement included returning stock options:

… valued at $15.6 million at the time they were issued to Raines, allowing him to buy shares at $77.10 and higher. Fannie Mae shares have been battered by the turbulence in the housing market — making the options that Raines was returning of negligible value, people familiar with the settlement said. They spoke on condition of anonymity because they did not publicly wish to criticize the accord.  [Emphasis added.]

When it Raines it pours.  After the accounting debacle in 2004, and Mr. Raines had receded into relative obscurity, the GSEs experienced another near-death experience: Fannie began doing what virtually all the investment banks, pension funds, and other large money funds were doing – placing big bets on risky paper that had been touted as “investment grade” by the ratings agencies.[4]  And the results were catastrophic for all concerned; everyone lost their shirt.

As explained on the FHFA website:

Additionally, from about 2004 through 2007, Fannie Mae and Freddie Mac embarked on aggressive strategies to purchase mortgages and mortgage assets originated under questionable underwriting standards. For example, the Enterprises purchased large volumes of Alt-A mortgages, which typically lacked full documentation of borrowers’ incomes and had higher loan-to-value or debt-to-income ratios. They also purchased private-label MBS collateralized by subprime mortgages.

In 2007 and 2008, housing prices plummeted and loan delinquencies and defaults significantly increased. Fannie Mae and Freddie Mac lost billions of dollars on their investment portfolios and MBS guarantees,[5] including MBS collateralized by Alt-A loans.[40] As foreclosures and losses increased, investor confidence in the Enterprises deteriorated. This led to a sharp increase in the Enterprises’ borrowing costs and drastic declines in shareholder equity, triggering concerns about their potential failure and its broader implications.

The big bailouts.  According to a recent Pro Publica chart here, there were 937 bailout recipients.  They mostly included banks. However, one of the biggest losers during the collapse of the financial and real estate markets wasn’t a lender, borrower, or investor.  It was the international insurance behemoth, AIG, who, in addition to other federal funds, received approximately $68 billion in taxpayer funded TARP assistance to date.

Riddle me this, Batman: Why does a private insurance company get to stand in the federal soup-line?  Would its failure lay waste to Wall Street and Main Street?  Umm, not directly. You see, at this time, the investment houses, such as Goldman Sachs, who had packaged and sold billions of risky mortgage loans to gullible trusting investors, were simultaneously betting against their own packaged investments. They did so using derivative contracts, which acted as a form of catastrophic insurance. AIG was on the other side of the contracts, i.e. they were acting as the “counter-party”, insuring the Big Banks by betting the subprime investments would succeed.  [Why AIG took these big bets is a mystery. Unless they had been on the Moon at the time, virtually everyone knew that subprime loans were failing faster than Lance Armstrong’s reputation.]

Thus, when the financial markets for the toxic paper collapsed, AIG was on the hook for billions to the Wall Street investment houses.  If it couldn’t pay, Goldman Sachs and others would lose billions. So, in a fairly obvious gift to the Big Banks [thanks to Hank Paulson, a Goldman Sachs alum and then-current Secretary of Treasury], the federal government bailed out AIG, 100 cents on the dollar – much more than it would have received if AIG had declared bankruptcy. This is what is referred to today as “crony capitalism.”

And your point is, Mr. Querin?  It is hard to say that the GSEs’ errors of judgment in purchasing toxic paper was any different than anyone else at that time.  If Fed Chair Alan Greenspan didn’t see it coming, who are we to chastise the GSEs for being blind-sided. At least Fannie and Freddie’s conduct was mandated by the “affordable housing” charter bestowed on it by the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, an obligation that was reaffirmed again in 1995.

Similarly, bailing out Fannie and Freddie was no different than the treatment accorded to other Wall Street players queued up for handouts in 2008.  In fact, there is a very credible argument that bailing out the GSEs was even more important than most of the other recipients.  This is because in 2007/8, the secondary mortgage market consisted of two major players: (a) The GSEs in the conventional lending market; and (b) The “Private Label” market, consisting of Big Banks who purchased, packaged and pimped billions of dollars in toxic mortgage paper to investors.  In late 2007 through 2008, the Private Label secondary market virtually disappeared. It remains moribund today. This means that other than FHA and VA, the GSEs are the only game in town. To dismantle them now, mostly for selective and retributive political purposes, would leave a gaping hole in the mortgage market.  With infrastructure, programs, and experience developed over decades, replacing the GSEs with an entirely new, unknown, and untested system would be a huge mistake.

With the 2010 Dodd-Frank Act, a 900-page tome that has generated thousands of pages of regulations –  and the rulemaking frenzy isn’t even over yet.[6]  Add to this, Frankendodd’s demon seed Dodd-Frank’s progeny, the Consumer Finance Protection Bureau or “CFPB,” a regulatory Leviathan, was born, seeking to regulate almost every consumer sale or purchase – from washers to widgets.

This is because the CFPB’s world view is that our country is divided into two classes of people: Either villains or victims and, the American people are either so crooked or so stupid that they need more trickle-down regulation to protect themselves from each other.[7]

Next: “The Luddites are Coming! The Luddites are Coming!”