Jabberwocky: “Total nonsense. A fit of rambling which resembles a civilized language but in fact is meant only to obfuscate meaning or confuse the victim, or listener.” Directly taken from the story “Alice Through the Looking Glass” by Lewis Carroll. [Urbandictionary.com][1]
A recent article in National Mortgage News titled: “Dave Brat Fudges the ‘Blame Fannie and Freddie’ Narrative,” underscores the worst thing about politicians: They often don’t know what they are talking about. It seems Mr. Brat, who touts himself as an economics professor, doesn’t have the foggiest idea what the secondary mortgage market is, and what the twin GSEs,[2] Fannie and Freddie, do for a living.
A layperson could be excused for not knowing, or for being confused. But Mr. Brat isn’t a layperson. He recently ran, and beat, House Majority Leader Eric Cantor (R-Va.) the incumbent, with 13 years’ experience representing Virginia’s 7th District. How or why that happened is not the point of this post.
My focus is on the intellectual bona fides of the victor, Mr. Brat. According to the online New York Daily News, here:
Conservative talk host Laura Ingraham described Brat this way on Wednesday: “Sunny disposition, common sense conservative, unafraid, refuses to be cowed by the Chamber of Commerce, big money crowd.”
That’s all fine. But apparently Mr. Brat also refuses to be cowed by facts; if ignorance is bliss, it might explain his “sunny disposition.”
Here’s my beef: Apparently Mr. Brat has not once, not twice, but repeatedly accused Fannie and Freddie, of “originating” bad mortgages which resulted in the collapse of the credit and housing markets, circa 2007/2008. Herewith, are some gems of misinformation that the National Mortgage News article attributed to Mr. Brat:
Fannie and Freddie made two-thirds of all subprime mortgages. That is not a free market institution,” he said in a Fox News interview the evening of the primary election. “That entity, along with the Fed printing too much money back in ’03 and ’04, caused the housing collapse.”
Not true. Fannie and Freddie don’t make mortgage loans. Never have. They are not banks; they don’t loan money; they don’t have depositors. They buy loans from originating banks that sell them mortgages which conform to their published underwriting requirements [aka “conforming loans”]. Contrary to Mr. Brat’s insinuations, these loans were subject to much stricter underwriting criteria than those existing for the toxic sub-prime paper many lenders were trafficking in. This system of originating loans to sell to a third party is what’s called the “secondary mortgage market” and it exists solely to acquire loans already made to homeowners. That way, when lenders sell their conforming loans to the GSEs, they get their cash back to make more and more loans. These bundles of mortgages – actually their stream of payments – were purchased by Fannie and Freddie and then sold as securities to large institutional investors, like pension funds and municipalities.
Back in the heydays of rampant lending, the subprime, Alt-A, no-doc, and “liar loans” given to borrowers with sketchy on nonexistent credit, were packaged and sold by large Wall Street banks into another [i.e. non-GSE] secondary mortgage market, sometimes known as the “Private Label Market.” Because these were riskier mortgages, their interest rates were higher, and were much sought after by investors looking for yields higher than those sold by the GSEs. This is why Fannie and Freddie ended up sharing about half of the secondary market with the private label market during this time. In fact, to their detriment, Fannie and Freddie decided that the lure of higher returns was too good to ignore, and so they too got on the bandwagon, and started buying packages of these toxic loans for their own investment portfolio. But contrary to Mr. Brat’s narrative of nonsense, the GSEs did not make toxic subprime loans. In fact, Fannie and Freddie have recovered billions of dollars over the last few years from banks who sold them loans that did not meet the underwriting criteria represented.[3]
The recent financial crisis, where did it start? In the housing market. We all know basically, probably the primary cause is located in Fannie and Freddie,” (Brat) said. “American Enterprise Institute estimates 70% of all subprime loans went through Fannie and Freddie. Instead of who? Instead of through your banker. So we’re putting bankers out of business. Bankers aren’t doing banking. In the past, bankers actually had to check your credit if you wanted a mortgage. Today, they don’t and Fannie and Freddie, they just say ‘here, here’s a mortgage.’
I have no idea what Mr. Brat is alluding to when he says that subprime loans “went through Fannie and Freddie *** instead of through your banker.” He makes it sound as if Fannie and Freddie were making rampant loans, not doing any underwriting, and taking business from the banks. This is not only nonsense, but demonstrates a fundamental misunderstanding of reality: It was the banks that threw their underwriting guidelines out the window, then packaged the subprime loans into securities and sold them through the “private label secondary market.”[4]
Further, to say that the “financial crisis” started in the housing market is pure bovine excrement. The opposite is true; cracks started appearing in the private label market in 3Q 2007, when investors were realizing that these toxic bundles of loans were failing in record numbers. They stopped purchasing the loans. Then the big investment houses who had been packaging and pimping these loans found themselves with no market for them. The repercussions radiated downstream, and originating lenders soon realized that there were no end purchasers for their risky loans. When folks could no longer buy homes with little or no credit, builders found themselves with excess inventory, and sellers found fewer and fewer qualified buyers. The crunch resulted in builders and sellers reducing their prices, with the predictable result that home prices plunged, leaving millions of borrowers owing more on their homes than they were worth. Pretty soon, folks who had put 20% down to purchase their home found that they had no equity, as their home had lost 40% of its value – they were now “underwater” and unable to sell or refinance their way out of the catastrophe.
Mr. Brat is wrong to say that Fannie and Freddie caused this. They certainly were at the easy-money festivities, as mortgages were being handed out like party favors; but they were not alone. The big investment houses had found a way to create a non-GSE secondary market for subprime paper that investors were gobbling up. Thus, Mr. Brat is wrong to say that the housing market caused the credit crisis – it was the reverse; the lenders were the gatekeepers. If you could get the loan, you could get the home.
What led to the last financial crisis? Fannie and Freddie. Where are they housed? At the federal government level. Should they be? Should anyone who follows the Constitution have allowed that to happen?
Wrong again, Mr. Brat. For years and years, Fannie and Freddie were private, stock holding corporations, trading on the New York Stock Exchange. It is true that they were “government sponsored” i.e. they were created by the federal government following the Great Recession, and had the “implicit” full faith and credit of the United States – suggesting to investors that Uncle Sam would not let them fail. But they were never “housed” at the federal government level, whatever that means.
It is true that after the financial crisis was in full swing, in October 2008, the government put them into receivership on the taxpayers’ dollar, thus keeping them from collapsing. Since there was no viable private label market at that time – and there still is none today – Fannie and Freddie were the only game in town. If they collapsed, the only banks making housing loans would have been those few who were willing to retain them in their own inventory [called “portfolio loans”]. The bulk of residential mortgages being sold into the secondary market at this time would have dried up.
Today, Fannie and Freddie are making money hand over fist, and have paid the government stock dividends in excess of the moneys borrowed from Uncle Sam.[5] Riddle me this, Bratman Batman: Why do you want to kill the golden goose? Until there is a suitable private replacement, which would take years to create, it appears that the GSEs are just a convenient target to rally the ranks of the similarly uninformed.
Upon learning from the National Mortgage News article that Mr. Brat had co-authored a “research paper in August 2008 and submitted (it) to an academic conference is 2009”, I was curious to find out if one so wrong about the secondary mortgage market and the GSEs might somehow be brilliant in other areas of economics – an idiot savant, if you will. So I reviewed his research paper entitled “The Mortgage Market and Credit Crunch,” here, and concluded that….well, let’s just say there was no savant lurking around in the background. The paper, which is heavy on charts and lengthy quotes from others, did not contain an original thought.
Lest anyone think my opinions harsh, let me point out that in his “research paper,” Mr. Brat makes nary a comment about the financial crisis being “caused” by Fannie and Freddie. The “blame Fannie and Freddie” narrative did not apparently resonate with him at the time. However, Mr. Brat’s paper was not submitted to an “academic conference”[6] until 2009. By that time, it was a whole new world. The financial markets had already tanked: Investment bank Bear Stearns had nearly failed, and was picked off by JPMorgan Chase for pennies on the dollar; Lehman Brothers had gone into bankruptcy; In a shotgun marriage, Bank of America acquired Merrill Lynch[7]; Investment banks Goldman Sachs and Morgan Stanley had conveniently changed their charters to become depository banks so they could queue up in the soup line, and partake in the government’s TARP bailout largesse; Insurance behemoth AIG – which was not even a bank – got an initial $85 billion taxpayer bailout that later ballooned to $180 Billion,[8] and, of course Fannie and Freddie had been taken over by the feds.
Yet, according to Mr. Brat’s research paper “…in 2005 the housing bubble burst.” For those in attendance at this August 2009 conference, perhaps some were asking themselves, why they were just now hearing about it four years later. In truth, the “bubble” was more like a balloon with a slow quiet leak. While 2005 was the statistical apogee in terms of many housing statistics, there were no loud popping sounds, as Mr. Brat would suggest. In fact, prices, sales, and lending continued expanding for the next two-plus years until 2007/2008. So while cracks in the credit system were appearing in 3Q 2007, it was not until 3Q 2008, that the housing and credit markets truly crumbled.[9]
Conclusion. I acknowledge that my rant is just that – a rant. But as a majority of one, I’m tired of seeing politicians and regulators pointing fingers at everyone but themselves. It cannot be forgotten that during this entire time, 2005 – 2007/8, politicians of every stripe, but especially of the blue persuasion, were, in the name of ‘affordable housing,’ demanding that more be done to lower the credit bar; and it was on Bill Clinton’s watch that Glass Steagall[10] was repealed by Congress in 1999, thus permitting lending banks to engage in non-bank investments, even on their own account. Then there was Sen Chris Dodd, of the Beltway set, who, as a “Friend of Angelo”[11], received two sweetheart residential refinance loans. And we can’t forget the irascible Barney Frank, whose conflicts of interest involving the GSEs are legendary; Also, we have to give a tip of the hat to the bevy of do-nothing regulators, from Fed Chair Alan Greenspan to those heading up HUD, the SEC, the FDIC, the OCC, and assorted others, for standing by, watching with benign neglect, as loan underwriting disappeared, credit standards dissolved, and housing frothed like a steaming latte.
So when I see politicians like Mr. Brat pointing fingers at others – especially while relying upon blatantly incorrect information, I feel compelled to suggest that he first learn what he is talking about, and then redirect his attention toward those equally responsible for the Great Recession: The Beltway Club that he so ardently wants to join.
[2] “Government Sponsored Enterprises,” i.e. Fannie and Freddie.
[3] These are known as “put-back” claims, and are based on the written representations and warranties made by the banks when they sell their paper to Fannie and Freddie.
[4] This market served the same function as Fannie and Freddie, but with significant differences. While the GSEs had the implicit backstop of the federal government in the event of failure, the private label market did not. It consisted of large investment banks aggregating loans in bundles, turning them into securities and selling them to institutional investors. The mortgages it purchased were cast-offs, i.e. ones that could not qualify for purchase by the GSEs. These were the infamous “subprime,” “no-doc,” and “liar” loans. And because they were riskier, their interest rates were higher. This meant that they returned higher yields than those offered by Fannie and Freddie. However, to convince investors to buy them [remember, they did not have the implicit government guarantee available on loans purchased through the GSEs], the investment banks needed someone to say that the securities were “investment quality,” i.e. suitable to be purchased by large retirement funds and municipalities. Enter the ratings agencies, S&P, Moody’s and Fitch, who, for a healthy fee, agreed to act as shills, giving good ratings to bad loans. This ruse went on until 3Q 2007, when, in a collective pang of conscience, the agencies collectively downgraded billions of the private label securities, forcing investors to divest them with the speed of Lance Armstrong’s sponsors. So the private label secondary market went into a death spiral, and by 3Q 2008, it was moribund. To date, it has never effectively come back as a viable platform for the purchase of home mortgages.
[5] It is interesting to note, however, that their “debt,” has not been retired, since the feds regard the dividends as a return on investment, and not payment on the loan. Furthermore, apparently the federal government, seizing an opportunity to keep all of Fannie and Freddie’s profits in perpetuity, has pulled a fast one on the holders of their common stock. For more, see Forbes article, here.
[6] No word on how many “academics” were in attendance. If the presentation was to one of those ubiquitous think-tanks around the country, it must have been held at the shallow end.
[7] In what was one of the worst decisions ever made, B of A had already acquired Countrywide Financial, the poster child for profligate mortgage lending, and has been paying billions of dollars in fines and damages to the government ever since. For more, see WSJ article here.
[8] The reason is startlingly clear: AIG was foolish enough to be on the losing side of billions of dollars of bets, known as “credit default swaps,” in which the Big Banks, including Goldman Sachs, were betting that the very investments they were touting and selling to investors as “safe,” were actually going to fail. When they did fail, AIG was on the hook for billions. Without a bailout, the Big Banks would not get paid for their wagers. So rather than let AIG take out bankruptcy, which would decimate the Big Banks’ returns on their bets, the federal government, under Secretary of Treasury Hank Paulson, a Goldman Sachs alum, bailed them out, dollar for dollar. This decision gives new meaning to the term “crony capitalism.”
[9] What is most inexcusable is the fact that all of the folks who were supposed to be watching for these things, were not. Are you listening Mr. Greenspan?
[10] Following the Great Depression the Glass-Steagall Act, also known as the Banking Act of 1933, was created to build a firewall between the banks as “lenders” and banks as “investment houses.” Once that firewall was removed in 1999, the failure of a large bank, with investments and clients worldwide, could have catastrophic repercussions on the rest of the economy. The result was that in 2008 some Big Banks were truly considered “Too Big To Fail,” and the American Taxpayer was forced to rescue them with billions of taxpayer TARP funds.
[11] Angelo Mozilo, CEO of Countrywide, the largest of the subprime factories in the country, who notoriously had the letters “fund’em” on his vanity license plate. To Angelo, if you could fog a mirror, you could get a loan.
