bank run blog

The House Oversight and Government Reform Committee held a hearing recently where the former executives of the quasi-private mortgage companies Freddie Mac and Fannie Mae were questioned about what the companies knew about the risky nature of the loans that they were guaranteeing and what, if any, steps were taken to prevent the crisis of widespread foreclosures that currently confronts American homeowners.

Leland Brendsel and Richard Syron, former executives at Freddie Mac, and Daniel Mudd and Franklin Raines, former executives of Fannie Mae, appeared before a committee armed with more than 400,000 internal documents that had been subpoenaed and animated by anger as many of the committee member’s constituents have been forced into foreclosure having agreed to the questionably designed loan products that were bought by or guaranteed by the companies.

The documents, which included internal memoranda and e-mails, are replete with evidence that the companies were well informed of the disastrous ramifications of loan products that required no down payment and no documentation of the borrower’s ability to pay and loans where the borrower paid back only interest leaving the principal to never be reduced. The documents also reveal that the companies were aware that the loan products were targeted “disproportionately” at minority communities, and were commonly perceived to represent “predatory lending” practices.

In one of the subpoenaed e-mails that was received by Syron of Freddie Mac, the writer warns that the No Income/No Asset loan product being sold in the early part of this decade “appears to target borrowers who would have trouble qualifying for a mortgage if their financial position were adequately disclosed.” The writer reports that 8 to 13 percent of such loans went into delinquency in the first year of the contract. The memo goes on to warn that these loans appear also to be “disproportionately targeted towards Hispanics.” The writer proposed that Freddie Mac discontinue to guarantee such loans, even though it would result annual losses of between 10 and 50 million dollars.

In his testimony, Syron argued that “Freddie needed to participate in order to carry out its public mission of promoting affordability” in the nation’s housing market.

The chairman of the committee, Rep Henry Waxman (D-CA) said that Fannie and Freddie’s “own risk managers raised warning after warning about the dangers of investing heavily in the subprime and alternative mortgage market. But these warnings were ignored. The company executive’s irresponsible decisions are now costing the taxpayers billions of dollars.”

cross posted at

redstateupdate.net

The FBI has leaked to the press that it is stepping up ongoing fraud investigations to include aspects of the current market collapse, in what appears to be a damage control exercise serving public relations purposes in the run-up to the elections.

The New York Times assigned this story to Eric Lichtblau, one of their top reporters, who generally covers major political stories such as the Bush administration’s domestic surveillance activities and White House attempts to expand executive authority, giving credence to the emerging view that the Paulson plan is a financial PATRIOT Act. From the NYT :

“The Federal Bureau of Investigation, under pressure to look at possible criminal activity in the financial markets, is expanding its corporate fraud inquiries in the wake of the tumult in the last 10 days, officials said Tuesday.

The F.B.I. has now opened preliminary investigations into possible fraud involving the four giant corporations at the center of the recent turmoil — Fannie Mae and Freddie Mac, Lehman Brothers and the American International Group, The Associated Press reported.

A government official, speaking on condition of anonymity because he was not authorized to discuss the issue publicly, said it was ‘logical to assume’ that those four companies would come under investigation because of the many questions surrounding their recent collapse.”

The Associated Press, which broke the story yesterday, has further details this morning :

“Officials said the new inquiries bring to 26 the number of corporate lenders under investigation over the past year.

Spokesmen for AIG, Fannie Mae and Freddie Mac did not immediately return calls for comment Tuesday evening. A Lehman spokesman did not have an immediate comment.

Just last week, FBI Director Robert Mueller put the number of large financial firms under investigation at 24. He did not name any of the companies under investigation but said the FBI also was looking at whether any of them have misrepresented their assets.”

New York Times : F.B.I. Looks Into 4 Firms at Center of the Economic Turmoil

Associated Press : FBI investigating companies at heart of meltdown

In light of recent developments, this piece by Nouriel Roubini, titled Fannie and Freddie’s Bust and Deeply Flawed Government Bailout, makes an interesting read. In it the economist revisits his two year old prediction of the Fannie/Freddie collapse :

“The main, still unexplored issue, is where the risk from mortgages is concentrated: among the sub-prime lenders …or among commercial banks or among hedge funds and other financial intermediaries that purchased mortgage backed securities (MBSs) or among the GSEs (Fannie and Freddie)?”

Still to come, according to Roubini, is a “systemic risk episode” :

“And finally, a large part of the housing risk is also in the hands of Fannie and Freddie. How much are the GSEs at risk is a complex issue…Either way, a serious housing bust followed by an economy-wide recession implies serious financial risks for the entire financial system, not just risks for the real side of the economy. A systemic risk episode triggered by a housing bust cannot be ruled out.”

full story

Cleaning house before their outright nationalization, Fannie Mae announced a shakeup in senior management this afternoon after the markets closed. The Financial Times reports :

“Fannie Mae, the US government-sponsored mortgage financier, yesterday unveiled a management restructuring that put new executives in charge of its plan to improve capital management and cut credit losses.

‘As we move through the bottom of this cycle, maintaining capital, managing credit and driving revenues are priorities and we have to organise staff accordingly,’ Daniel Mudd, Fannie Mae chief executive, said.

Fannie said Stephen Swad, its chief financial officer, had chosen to leave the company after little more than a year to pursue work in the private equity field, while Enrico Dallavecchia, chief risk officer, was leaving to pursue other finance and risk management opportunities.”

full story

The coverage by the Associated Press included a rare quote from a bearish analyst, who puts the losses at the GSEs at $1 trillion or more :

“Other analysts, however, continue to express a gloomier outlook. Peter Schiff, president of Euro Pacific Capital in Darien, Conn., a longtime bearish investor, predicts that the companies’ losses could eventually hit $1 trillion or more as housing prices fall far further than most analysts expect.

‘The end result is probably going to be that they go bankrupt and the government nationalizes the function,’ Schiff said. ‘There’s no way they can survive.’

Concern also has been growing that a government rescue of Fannie and Freddie could be costly for scores of investment, banking and insurance companies that hold billions of dollars in their preferred shares. The two companies had nearly $36 billion in preferred shares outstanding as of June 30, according to filings with the Securities and Exchange Commission.”

full story

With its government “backstop” secure, Freddie Mac this morning announced huge losses for the second quarter. Analysts believe that the magnitude of the problems at the GSEs mean that the next several quarters will look worse, not better. The Associated Press is reporting :

“Freddie Mac on Wednesday posted a second-quarter loss that was more than three-times larger than Wall Street expected as a huge number of borrowers with good credit fell behind on their exotic and risky mortgages.

The losses were concentrated in a handful of state — California, Florida, Nevada, and Arizona — where home prices shot up the most and are now falling precipitously.

The dismal financial results come just weeks after the government threw a financial lifeline to Freddie and its sister company Fannie Mae to ward off fears the pair could collapse and take down the U.S. mortgage market. Together, the two hold or guarantee nearly half of outstanding U.S. mortgage debt.

Freddie lost $821 million, or $1.63 a share, for the quarter that ended June 30, compared with a profit of $729 million, or 96 cents a share, in the year-ago period.”

Reuters reports that Freddie is cutting its dividend by more than 80 percent :

“Freddie Mac said it was setting aside twice as much money for bad loans and made plans to slash its dividend by at least 80 percent. Its shares fell 16 percent, while bigger rival Fannie Mae declined 12 percent.”

The news about the GSEs put a chill on the entire financial sector :

“Among banks, shares of Bank of America Corp fell 2.8 percent to $32.65. Freddie Mac, which also announced plans to slash its dividend, doubled its reserves for losses on delinquent loans and home foreclosures.”

Associated Press : Freddie Mac swings to 2Q loss

Reuters : Financials hit Wall Street after Freddie loss