Over on the imaginary stock markets where Fannie Mae and Freddie Mac trade they’ve had a rough day, with FNMA and FMCC common stock each down almost 13% and the preferred … um … down surprisingly small amounts but, y’know, on light volume. The impetus is presumably this:
A bipartisan group of senators on Tuesday introduced a bill to abolish Fannie Mae and Freddie Mac and replace them with a government reinsurer of mortgage securities that would backstop private capital in a crisis. … Under the bill, which is being led by Tennessee Republican Bob Corker and Virginia Democrat Mark Warner, the two companies would be liquidated within five years.
There’s an alternative theory of the 2007-2008 financial crisis in which it was just a minor hiccup that would have worked out fine for all concerned if the meddling U.S. government hadn’t been so trigger-happy in bailing out basically sound but momentarily embarrassed financial institutions.1 I mean, you probably won’t actually run into anyone who believes this theory, because it is a pretty loony theory. And yet! It keeps coming up in court, which I guess means the courts are full of loonies, QED.
Obviously Hank Greenberg is the most vocal and delightful proponent of this theory, since he’s been suing the government for ever and ever for taking over AIG when AIG actually would have been just fine with a little eleven-digit low-interest loan from the government. But Fannie Mae and Freddie Mac shareholders have come on strong of late, with weird lobbying for re-privatization of their shares and, now, a lawsuit filed yesterday seeking $41 billion in damages over their bailout.
The theory here should be familiar if you’ve been following along with AIG; it goes something like this: Read more »
Articles about the Fannie & Freddie preferred trade have been burbling around for a while and I’ve never understood it. The Journal has two goodarticles on it today, with this being a particularly clear explanation, and … I still don’t get it? Basically the thing is:
the government seized Fannie and Freddie in 2008 and turned off the (non-cumulative!) preferred stock dividends,
it recently swore that it would reduce their shareholders’ equity to zero, salt the earth on which they grew, and never ever ever ever unseize them or turn back on the pref dividends, so
those prefs look like a screaming buy.
Or something? Per the Journal, “Paulson & Co. and Perry Capital LLC are among a handful of hedge-fund firms that have bought so-called preferred shares in Fannie and Freddie.” They’re selling at ~18-20 cents on the dollar, which I suppose reflects a, what, 30% implied probability that they get turned back on in the imaginable future?1 Does that sound like, um, this? Read more »
Ninety percent of what happens in the typical lawsuit is (1) a lawyer for one side sends a letter to the other side asking for some information to prepare for a trial that will never happen, (2) the lawyer for the other side sends back a passive-aggressive letter refusing to provide that information, and (3) the lawyer for the first side sends a passive-aggressive letter to the judge saying “NO FAIR.” Seriously, that’s what happens. It’s called “discovery,” and it goes on until the lawyers’ bills have gotten big enough that everyone decides to settle the case.
In that milieu, someone sending an aggressive-by-passive-aggressive letter qualifies as huge news, and so there is a lot of excitement over this rather tart mandamus motion that fifteen big banks filed to overturn some discovery rulings that Judge Denise Cote made in a mortgage-backed-securities lawsuit. I will not attempt to convince you that its tartness is all that interesting; I just want you to have context for why some people think it is.
The case is interesting though. The FHFA, the regulator that oversees Fannie and Freddie, is suing the fifteen banks1 for selling crappy subprime residential mortgage-backed securities to Fannie and Freddie. Being a securities-fraud lawsuit, the basic claim is “you lied to us in the offering documents for these RMBS, and we relied on those lies, so we bought your RMBS, and then we lost money because of your lies.” And the lies in the offering documents are not “these mortgages will never default!,” but rather lies to the effect of “we bought these loans from originators, and reviewed those originators’ underwriting practices, and we believe that the originators underwrote them carefully and didn’t just stuff them full of fraud.”
The banks make a pretty good point, though, in this motion: Fannie and Freddie, who were being deceived by the big underwriter banks into buying all these RMBSes stuffed with crappy mortgages from crappy originators, were also separately buying similar mortgages directly from the same originators. And, presumably, doing whatever due diligence they expected the underwriter banks to be doing: Read more »
There are lots of things to worry about in the world and somewhere on the list is the fact that, while yields on agency mortgage-backed securities are really really really low, the rate you’ll pay for a new mortgage is only really low, so a couple of reallys have fallen off a truck somewhere. This worry isn’t at the top of my personal list – my mortgage rate is low enough I guess? – but it seems to make many other people’s list for two intersecting reasons. First, if the primary desire of Fed policy is to get people to buy houses, be rich, etc., and if its primary mechanism for doing so is buying MBS, then the inefficiency in transforming that mechanism into that desire is rather macroeconomically important and bad. Second, if money is coming out of the Fed and not ending up in homeowners’ pockets, that leaves only so many pockets it could be ending up in, and it is easy enough to observe that big banks (1) sit between the Fed and the homeowners and (2) have lots of pockets. So you can see how it might be fun to worry about money going to big multipocketed banks, because if it does, you get to be mad at them.
Anyway the New York Fed is doing a conference on it today; here’s the background paper and it’s really interesting; I recommend it, particularly if, like me, you have a hazy understanding of agency mortgage securitization. Everything in this space is predicated on somewhat fake math but their math is less fake than the simple spread math, which basically assumes that banks make a profit of:1
Annual Profit = Mortgage Rate – MBS Yield
By that math, as William Dudley points out, the spread was 30-50bps in the ’90s and early 2000s, but rose to 150bps in September and is around 120bps now. The Fed’s paper, on the other hand, walks through the actual securitization process to get cash flows into and out of the mortgage lender, and computes its profit (technically, profit plus non-interest-y costs like underwriting and hedging) as roughly:
Up-Front Profit = Sale Price Into MBS – Origination Price + 4 x (Mortgage Rate – MBS Coupon – GSE Guarantee Fee
Why 4? I dunno it’s in the paper.2 Anyway by this measure here is what has happened in the world: Read more »
ProPublica has a new story about Freddie Mac and it’s good, go read it if you like getting angry about mortgages. The gist is that Freddie were big jerks about not letting people refinance their mortgages, which everyone kind of knew already; what this reveals is that:
They were jerks mostly to increase their own profits, which I submit to you everyone also knew. Actually I submit to you that’s pretty much a tautology. But also
They were also jerks a little bit to screw with Obama, which is news:
[Board member Robert] Glauber, director Linda Bammann and head of risk management Paige Wisdom resisted mass refis. One executive viewed their objections as colored by partisan unwillingness to help the economy recover, something that would benefit President Obama.
Everyone denies everything etc. etc.
You can have both efficiency and allocation questions about refinancing mortgages. Allocation is just “there is a pot of money; it can go to mortgage owners in the form of keeping interest rates on existing mortgages the same, or to homeowners in the form of lowering those interest payments”; this is a boring question of interest-group power but one that is weird for Freddie Mac’s conservator to answer? But I guess who else would? Anyway “these officials feared that mass refinancing would hurt the company’s bottom line and therefore its ability to repay taxpayers” so I guess they picked mortgage owners – i.e. taxpayers who owned Freddie who owned mortgages, which is a somewhat attenuated path to “taxpayers”1 – over homeowners.
Efficiency is “lowering the interest rates on existing mortgages [ will | will not ] lower default rates, revive the economy, and make the pot of money bigger for everyone”; this is an interesting economics question and the evidence suggests that the answer is, yes, HARP-y refinancing programs probably do reduce defaults. You could have a good-faith empirical disagreement with that, though your good faith might be called into question if you thought that refi programs were “designed to be a stimulus” but then assumed no stimulative effect.
Ooh so Wells Fargo screwed the government out of hundreds of millions of dollars of mortgage insurance by fraudulent underwriting, allegedly. We’ve all heard big-bank mortgage fraud stories by now and they’re usually pretty juicy and smoking-gun-tastic: “shit breathers,” etc. And the government claims that WFC submitted somewhere between 6,000 and 50,000 bad loans, while specifically describing a dozen or so in the complaint, presumably cherry-picked for maximum offensiveness. Let’s look at one:
92. FHA case number 352-4948464 relates to a property on Martin Luther King Blvd. in Newark, NJ (the “King Blvd. Property”). Wells Fargo underwrote the mortgage for the King Blvd. Property, reviewed and approved it for FHA insurance, and certified that a DE underwriter had conducted the required due diligence on the loan application and that the loan was eligible for HUD mortgage insurance. The mortgage closed on or about July 23, 2003.
93. Contrary to Wells Fargo’s certification, Wells Fargo did not comply with HUD rules in reviewing and approving this loan for FHA insurance, and did not exercise due diligence in underwriting the mortgage. Instead, Wells Fargo violated multiple HUD rules, including HUD Handbook 4155.1 ¶¶ 2-3 and 3-1, HUD Handbook 4000.4 ¶ 2-4(c)(5), and Mortgagee Letters 1992-5 and 2001-01.
94. Wells Fargo’s violation of HUD Handbook 4155.1 ¶ 2-3 is illustrative of the multiple rules that Wells Fargo violated in approving the King Blvd. Property. HUD underwriting guidelines state that lenders must analyze a mortgage applicant’s credit and determine the creditworthiness of the applicant. Specifically, lenders must verify and analyze the borrower’s payment history of housing obligations, and obtain written explanations from the borrower of past derogatory credit. HUD Handbook 4155.1 ¶ 2-3. Contrary to this clear requirement, Wells Fargo failed to verify the borrower’s history of housing obligations or obtain explanations from the borrower for past derogatory credit. In violating HUD Handbook 4155.1 ¶ 2-3, Wells Fargo endorsed the King Blvd. Property for FHA insurance without sufficiently analyzing the borrower’s creditworthiness.
Gosh! Failure to verify history of housing obligations! Unobtained explanations for past derogatory credit! INSUFFICIENT ANALYSIS!
I try to be honest when telling you that a court complaint or SEC filing or research paper is a fun read, just in case you might go read it, though of course there’s no accounting for tastes and I may enjoy many things that you don’t.* And that’s okay. In any case I doubt anyone will find the SEC’s fraud complaints against Fannie Mae and Freddie Mac filed today all that fun to read. “Very, very boring” would be more like it. The only bits that I enjoyed were the names of some of the loan programs, including Freddie’s “Touch More Loans” and the Fannie/Countrywide joint effort “Fast and Easy” which, boy, different times.
But there are some fascinating things about the case. A small one: I was kidding when I said “complaints against Fannie Mae and Freddie Mac.” They’re complaints against former Fannie CEO Daniel Mudd, former Freddie CEO Richard Syron, and a handful of their executives. The SEC signed weird neither-admit nonprosecution agreements with Fannie and Freddie themselves, in which the GSEs agree to help the SEC make its case against their former bosses.
This all seems like very good PR. You are learning, SEC. The neither-admit-nor-deny thing might be awkies, but slapping a big fine on the taxpayer-funded GSEs wouldn’t make a whole lot of sense. And the people who are upset that the SEC are not going after big names connected to the financial crisis have to be happy about the fact that the SEC here is going after the CEOs of big entities that in most people’s minds are intimately connected to the cause of the financial crisis. Suing them is not quite as good as throwing them in jail, but the SEC can’t do that, and this is a start anyway.
The bad news is that the SEC’s case sounds just absolutely terrible. Here it is: Read more »