Welcome to DU!
The truly grassroots left-of-center political community where regular people, not algorithms, drive the discussions and set the standards.
Join the community:
Create a free account
Support DU (and get rid of ads!):
Become a Star Member
Latest Breaking News
General Discussion
The DU Lounge
All Forums
Issue Forums
Culture Forums
Alliance Forums
Region Forums
Support Forums
Help & Search
Economy
In reply to the discussion: Weekend Economists Ring in the Old, Wring Out the New: Dec. 30, 2011 to Jan. 2, 2012 [View all]Demeter
(85,373 posts)41. Fannie and Freddie Fantasies By William K. Black
http://neweconomicperspectives.blogspot.com/2011/12/fannie-and-freddie-fantasies.html
An important but fundamentally flawed debate about Fannie and Freddies role in the ongoing crisis has raged since the SEC sued the former senior managers of both entities for securities fraud. The Wall Street Journal and Peter Wallison (in the WSJ) have claimed that the suit vindicates their positions and discredits the Federal Crisis Inquiry Commission (FCIC). Joe Nocera, in his New York Times column, has thundered at the SEC and then Wallison, accusing him of The Big Lie. Noceras column is also interesting because it (implicitly) argues that the thesis of Reckless Endangerment is incorrect. His colleague Gretchen Morgenson and Joshua Rosner co-authored that book. I write to provide yet another view, distinct from each of the sources.
There are two primary issues about Fannie and Freddie and the crisis discussed in the debate. First, why did Fannie and Freddie, relatively suddenly, change their business practices radically and begin purchasing large amounts of nonprime mortgages? Second, what role did declining mortgage credit quality that did not descend to the level of loans that the industry described as subprime play in the Fannie and Freddie crisis? The first issue is vastly more important and this article focuses on it. (The short answer to the second question is: The first issue, for everyone except the SEC, comes down to this question: did Fannie and Freddies controlling officers (eventually) cause them to buy large amounts of nonprime loans for the same reason their counterparts running Lehman, Bear Stearns and Merrill Lynch did (the higher nominal short-term yield maximized their current compensation) or because the government made them buy the loans?) (Lehman, Bear Stearns, and Merrill Lynch were not subject to any governmental requirements to purchase any category of nonprime loans.)
I show that Fannie and Freddies controlling officers (eventually) caused them to buy huge amounts of nonprime loans for the higher short-term nominal yield (though they knew that the actual yield would be negative as soon as the housing bubble stalled). I exploit a natural experiment provided by liars loans loans made without prudent underwriting of the borrowers capacity to repay the loan. No governmental entity ever required any lender, or any purchaser of loans (and that includes Fannie and Freddie), to make liars loans. The mortgage industrys anti-fraud experts, the FBI, and the banking regulators all warned about liars loans producing an epidemic of fraud. If Fannie and Freddie purchased large amounts of liars loans, then their controlling managers did so because liars loans higher short-term nominal yield maximized their near-term compensation not because the government made them do so.
OFHEO, which was Fannie and Freddies regulator during the relevant period, had ample regulatory authority to prevent Fannie and Freddie from purchasing liars loans and its head, James B. Lockhart, was a George Bush appointee and one of his oldest friends (from prep school). Lockhart had President Bushs full support and he was in no way intimidated by Barney Frank or Chris Dodd. Lockhart shared Bushs anti-regulatory mindset, his inability to envision elite business leaders as felons, and his strong support for even the most perverse executive compensation systems. Lockhart was not captured by Fannie and Freddie. He was not a supporter of either entity. He and his senior regulators that I met simply did not believe it was legitimate for the government to regulate compensation or, absent proof that the business practice had already produced large losses, Fannie and Freddies business strategy...
An important but fundamentally flawed debate about Fannie and Freddies role in the ongoing crisis has raged since the SEC sued the former senior managers of both entities for securities fraud. The Wall Street Journal and Peter Wallison (in the WSJ) have claimed that the suit vindicates their positions and discredits the Federal Crisis Inquiry Commission (FCIC). Joe Nocera, in his New York Times column, has thundered at the SEC and then Wallison, accusing him of The Big Lie. Noceras column is also interesting because it (implicitly) argues that the thesis of Reckless Endangerment is incorrect. His colleague Gretchen Morgenson and Joshua Rosner co-authored that book. I write to provide yet another view, distinct from each of the sources.
There are two primary issues about Fannie and Freddie and the crisis discussed in the debate. First, why did Fannie and Freddie, relatively suddenly, change their business practices radically and begin purchasing large amounts of nonprime mortgages? Second, what role did declining mortgage credit quality that did not descend to the level of loans that the industry described as subprime play in the Fannie and Freddie crisis? The first issue is vastly more important and this article focuses on it. (The short answer to the second question is: The first issue, for everyone except the SEC, comes down to this question: did Fannie and Freddies controlling officers (eventually) cause them to buy large amounts of nonprime loans for the same reason their counterparts running Lehman, Bear Stearns and Merrill Lynch did (the higher nominal short-term yield maximized their current compensation) or because the government made them buy the loans?) (Lehman, Bear Stearns, and Merrill Lynch were not subject to any governmental requirements to purchase any category of nonprime loans.)
I show that Fannie and Freddies controlling officers (eventually) caused them to buy huge amounts of nonprime loans for the higher short-term nominal yield (though they knew that the actual yield would be negative as soon as the housing bubble stalled). I exploit a natural experiment provided by liars loans loans made without prudent underwriting of the borrowers capacity to repay the loan. No governmental entity ever required any lender, or any purchaser of loans (and that includes Fannie and Freddie), to make liars loans. The mortgage industrys anti-fraud experts, the FBI, and the banking regulators all warned about liars loans producing an epidemic of fraud. If Fannie and Freddie purchased large amounts of liars loans, then their controlling managers did so because liars loans higher short-term nominal yield maximized their near-term compensation not because the government made them do so.
OFHEO, which was Fannie and Freddies regulator during the relevant period, had ample regulatory authority to prevent Fannie and Freddie from purchasing liars loans and its head, James B. Lockhart, was a George Bush appointee and one of his oldest friends (from prep school). Lockhart had President Bushs full support and he was in no way intimidated by Barney Frank or Chris Dodd. Lockhart shared Bushs anti-regulatory mindset, his inability to envision elite business leaders as felons, and his strong support for even the most perverse executive compensation systems. Lockhart was not captured by Fannie and Freddie. He was not a supporter of either entity. He and his senior regulators that I met simply did not believe it was legitimate for the government to regulate compensation or, absent proof that the business practice had already produced large losses, Fannie and Freddies business strategy...
Edit history
Please sign in to view edit histories.
150 replies
= new reply since forum marked as read
Highlight:
NoneDon't highlight anything
5 newestHighlight 5 most recent replies
RecommendedHighlight replies with 5 or more recommendations
Weekend Economists Ring in the Old, Wring Out the New: Dec. 30, 2011 to Jan. 2, 2012 [View all]
Demeter
Dec 2011
OP
Put the the bazooka to the transitory unintended consequences from black swan events
Po_d Mainiac
Dec 2011
#10
Krugman is -- and has been -- ivory towered and out of touch for a long time n/t
Tansy_Gold
Dec 2011
#70
Leasing Through the Back Door: The Private Financing of “Public” Prisons By Christopher Petrella
Demeter
Dec 2011
#73
Cities that broke up Occupy camps now face lawsuits over free speech, use of force
Demeter
Jan 2012
#84
Populism Isn't Dead, It's Marching: What 19th Century Farmers Can Teach Occupiers About How to Keep
Demeter
Jan 2012
#116
"We’ve got to change it all, and we’ve got to do it before the ice caps melt"
bread_and_roses
Jan 2012
#132
Lies, Damn Lies And The Four Whoppers Of 2011 (Jonathan Alter is a Bloomberg View columnist)
Demeter
Jan 2012
#99
How Germany Builds Twice as Many Cars as the U.S. While Paying Its Workers Twice as Much
Demeter
Jan 2012
#100
Goodbye "Shop Til You Drop" Mentality: Renegade Band of Economists Call for "Degrowth" Economy
Demeter
Jan 2012
#101
I REPEAT: The original purpose of the Postal Service was to Deliver Democracy!
Demeter
Jan 2012
#108
"The Protester" Becomes Time's Person of the Year, Wants More by: J.A. Myerson, Truthout
Demeter
Jan 2012
#120
What if the SEC investigated Banks the way it is investigating Mutual Funds? By William K. Black
Demeter
Jan 2012
#126
Firefox has completely stopped working...again, and screwed up the machine doing it
Demeter
Jan 2012
#135
GENERAL, OFF-TOPIC QUERY: What has changed so much on DU that it feels like a foreign land?
Demeter
Jan 2012
#140
The Number One Catastrophic Event That Americans Worry About: Economic Collapse
Demeter
Jan 2012
#143
Michael Olenick: Is Shadow Housing Inventory Vastly Larger Than Widely Believed?
Demeter
Jan 2012
#146