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The FCIC's Pointless Report and the Future of Fannie and Freddie


Have we learned anything new from the Commission's report? Are there clear recommendations that will help prevent another financial crisis?

In my New York Times Best Selling book, A Colossal Failure of Common Sense - The Inside Story of the Collapse of Lehman Brothers, I make a strong case. Our government allowed Fannie Mae and Freddie Mac to become a giant mortgage-backed security hedge fund, complete with 70-1 taxpayer-funded leverage.

They had sub Libor financing, meaning the luxury of borrowing money at one of the lowest interest rates in the world, all risks backed by the US taxpayer. To understand this kind of leverage, imaging walking into the most profitable casino in Las Vegas, all you have is $100 in your pocket. Yet, because of your good credit, the casino allows you to play blackjack with $7,000 at risk on the table. The slightest loss and your equity is wiped out. That's exactly what happened to Fannie and Freddie and today the US taxpayers have lost well over $360 billion in this reckless risk-taking bonanza. That's over half the cost of the entire war in Iraq.

It wasn't always this way but as Samuel Johnson once said, the road to hell is paved with good intentions. In the '90s Fannie and Freddie only used 30-1 leverage, but the great enabler, the US Congress, was there all they way, clueless as to the real risks lurking below the surface. I know a thing or two about risk and leverage. My former employer was levered 40-1, that was before we filed Chapter 11 bankruptcy. Uncle Sam chose not to save Lehman yet letting it fail cost the taxpayer dearly. When that $660 billion domino fell, it obliterated the value of Fannie and Freddie's $5 trillion mortgage portfolio, crushing the US taxpayer in the process. Thank you, Hank Paulson.

Where We Stand Today

The recent conferences in Washington debating reform of Fannie Mae and Freddie Mac are filled with political mudslinging, it's the ultimate blame game. Last week's release of the Financial Crisis Inquiry Commission's (FCIC) Report and Dissents are making big headlines. Yet, the story within the story is how political infighting tore this dysfunctional commission apart, $10 million spent and we have very little to show for it. I am outraged that President Obama has not stepped in here. I think he blew a golden opportunity to lead and protect billions of US taxpayer dollars at stake. The FCIC report is a joke; it's the rehash of all rehashes. It looks like my book, Andrew Ross Sorkin's Too Big to Fail, and Michael Lewis' The Big Short all thrown into one 700-page document.

I was interviewed for hours by the FCIC and I still don't have answers to these questions. Is there anything new we have learned in the Commission's report? Are there clear recommendations that will help prevent another financial crisis? The commission was divided by politics and their conclusions are as messed up as a Brett Farve retirement party -- his seventh one, no less. Ironically the most hapless part of the report is probably the most important. What really went wrong with Fannie and Freddie and how do we fix them?

The real battles are being fought within the Obama Administration, among regulators over smaller related housing issues, and between Republicans in the new Congress. The next few weeks will show significant developments in some of these areas, but the process for reforming Fannie and Freddie, the housing finance system more broadly, lags far behind the deficit and job creation in the minds of Congress and the Obama Administration. It's a shame but look for this battle to take years, not months, dragging out the uncertainty and sclerosis which has plagued the housing markets for the past several years.

The Obama Administration has recently leaked reports to the press that their report outlining suggested reforms to Fannie Mae and Freddie Mac will be delayed till mid-February, from the statutory due date of January 31.

The Deadly Divide?

My friends at DCTripwire tell me the likely causes of this delay are twofold:

1. A lack of senior staff at Treasury and the Federal Housing Finance Agency (FHFA) -- the same overloaded team responsible for implementing many of the rules and regulations of the Dodd-Frank Act. Guess what? They're also in charge of Fannie and Freddie reform.

2. The fact that there is a divide within the Obama Administration, both substantively and politically on any reform efforts. One side is determined to maintain some sort of government (and hence taxpayer) guarantee of mortgage securities, providing support of middle-class homeowners. The other side seeks to remove the government from having either an explicit or even implied guarantee. Instead they hope to trade this removal of the government from the market for the creation of a fund to assist low-income citizens in attaining affordable rental housing.

We all know President Lincoln once said, "A house divided against itself cannot stand." Well, this one can't even roll over.

Why? Because Treasury Secretary Geithner (and former National Economic Council Director Larry Summers) are in the former group, while Housing and Urban Development (HUD) Secretary Shaun Donovan and other progressive members of the Administration are in the latter. This might explain President Obama's silence over the politically handicapped Financial Crisis Inquiry Commission.

Even with the Administration's move back toward the political center, I think the President's chum Tim Geithner wins, and their report, whenever it is issued, will maintain some government role in the mortgage market.

I'm told the report will also spell out several options for housing finance reform, in very broad terms, and will not be in legislative language. The Obama Administration wants this report to add to the discussions on Fannie and Freddie, but for political reasons, they want to allow Republicans in the House of Representatives to launch the first salvo in this legislative battle.

Inside the Reform Process

Despite the lack of concrete action by the administration, there are several regulatory actions that are being discussed or implemented at present. The first actions have been taken internally by Fannie and Freddie. They each have improved their balance sheets since conservatorship began. Credit standards have been raised, and both they are refusing to purchase mortgages from borrowers with poor credit scores. Fees that each entity charges to banks to guarantee their loans have also been increased and this income has helped to rebuild their balance sheets.

Fannie and Freddie still owe a substantial quarterly payment to the Treasury Department in the form of a 10% dividend on the Treasury's preferred stock. If this dividend was lowered, it would allow the them to begin to repay the billions in taxpayer support and simplify any future restructuring. Any change to the dividend would need to be approved by both Treasury and the Federal Housing Finance Administration (FHFA) which is the GSEs conservator. Expect that any changes will be subjected to heavy Congressional scrutiny.
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