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Jan. 4 2010 - 11:52 am | 28,087 views | 10 recommendations | 173 comments

Fannie, Freddie, and the New Red and Blue

It has become conventional wisdom, perhaps even cliche, to pin the origins of the credit crisis on the big banks or, AIG or even the practice of financial modeling. Certainly, these actors have received the most play in the media, and have now endured the focus of populist ire for more than a year. We now think that the analysis leading commentators to focus blame on these entities is fatally flawed.

via Origins of an American Kleptocracy | zero hedge.

Over the Christmas holiday a nasty thing happened: Tim Geithner’s Treasury Department decided to lift the cap on aid to the Government-Sponsored Entities, Fannie Mae and Freddie Mac, apparently in response to Obama administration fears that the two agencies would become insolvent. The cap was raised from $200 billion on each and government backstopping of the mortgage market will apparently now extend into infinity for at least three years, through 2012.

The move has already inspired a mini-firestorm, with several outlets delving deeply into the recent history of the GSEs and uncovering some disturbing new facts. Chief among those were an analysis of the GSEs by a former chief credit officer of Fannie named Edward Pinto, who found that Fannie and Freddie routinely mismarked subprime or Alt-A (a sort of purgatory class of nonprime risky mortgage, resting between subprime and prime) mortgages as prime. The Wall Street Journal explains:

In general, a subprime mortgage refers to the credit of the borrower. A FICO score of less than 660 is the dividing line between prime and subprime, but Fannie and Freddie were reporting these mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a third-quarter 10-Q report in 2008.

This is a damning fact and if true certainly supports the Journal claim that the GSE actions were a “principal cause of the financial crisis.” But having established this, the Journal then goes in this direction:

Market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system in late 2006 and early 2007. Of the 26 million subprime and Alt-A loans outstanding in 2008, 10 million were held or guaranteed by Fannie and Freddie, 5.2 million by other government agencies, and 1.4 million were on the books of the four largest U.S. banks.

Sometimes I’m amazed at the speed with which highly provocative information like this GSE business can be converted into distracting propaganda in this country. In the right hands Pinto’s analysis of the GSEs — just like the revelations in the past few years about practices at AIG, Moody’s, Countrywide, Goldman Sachs, the Fed, and, hell, let’s add the offices of Senator Chris Dodd — would have been a starting point for a deeper investigation into a financial system that is clearly a complex and intimate symbiosis of state and private corruption.

For what we’ve learned in the last few years as one scandal after another spilled onto the front pages is that the bubble economies of the last two decades were not merely monstrous Ponzi schemes that destroyed trillions in wealth while making a small handful of people rich. They were also a profound expression of the fundamentally criminal nature of our political system, in which state power/largess and the private pursuit of (mostly short-term) profit were brilliantly fused in a kind of ongoing theft scheme that sought to instant-cannibalize all the wealth America had stored up during its postwar glory, in the process keeping politicians in office and bankers in beach homes while continually moving the increasingly inevitable disaster to the future.

That is a terrible story and it is also sort of a taboo story, since we don’t really have a system of media now that is willing or even able to digest that dark and complicated truth. Instead, our media — which has always been at best an inadvertent accomplice to these messes — is basically set up to take every revelation about the underlying truth and split it down the middle, feeding half to one side of the political spectrum and one half to the other, where the actual point is then burned up in the useless smoke of a blame game.

The essentially complicit nature of the two ruling political parties was in this way covered up for decades, as the crimes of the Democrats were greedily consumed as entertainment by the Limbaugh crowd while the crimes of the Bushies became hot-selling t-shirts and bumper stickers for the Air America listenership. The abiding mutual hatred the red/blue groups shared consistently prevented any kind of collective realization about the structure of the overall scheme.

What worries me is that we’re now reverting to the same old pattern with the financial crisis story. We’re starting to see fault lines develop, where one side blames the government while another side blames Wall Street for the messes of the last two decades. The side blaming the government tends to belong to the free-marketeer class and divines in safety-net purveyors like the GSEs and in the Fed’s money-printing fundamental corruptions of the capitalist ideal, while the side blaming the bankers tends to belong to the left-liberal tradition that focuses on greed and seeming absence of community conscience among the CEO class as primary corruptors of the social contract.

In the former view the government is to blame for punting on its oversight responsibilities and for corrupting the financial bloodstream with market-altering guarantees, while in the latter view the bankers are at fault for lobbying the politicians to make exactly the same moves. The antigovernment folks like to focus on the irresponsible (and typically low-income or minority) home-borrower and their political allies in Washington as chief villains, while the anti-banker crowd looks at the massive personal profits and outsized influence of the executive class and waves the Cui bono? stick in that direction.

Both sides are right and both sides are wrong. I know that sounds like pox-on-both-their-houses pundit sophistry. But the point is that if you focus on one side and not the other, you miss the entire point. That’s why I get freaked out when I see an important story like this GSE thing come out, and have it be immediately accompanied by arguments that “market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system,” as though the irresponsibility of the government agency precluded similar (and, I might add, intimately related) abuses on the private side.

I mean, really — market observers were unaware of the number of subprime mortgages infecting the system? Are we to understand that nobody caught on when outstanding mortgage debt grew by $3.7 trillion between 2003 and 2005, nearly equaling the entire value of all American real estate in the year 1990? They didn’t notice when subprime mortgages went from 3% of all mortgage lending in 1997 to 20% of the market in 2003? They didn’t notice when the volume of Alt-A loans and home equity loans surged through the early part of last decade?

Now I know that that’s not what Peter Wallison of the Journal is saying here; he’s saying that even if the market saw that increase in subprime loans, even those numbers were understated thanks to Fannie and Freddie’s deceptions. But the inference that the market was hoodwinked by the GSEs is absurd. It was plain to most everyone in the financial services industry that there was a bubble going on last decade, that something deeply fucked up was going on with the mortgage markets — just as it was plain to everyone in the late nineties that something was wrong with the stock markets, when companies like Theglobe.com with annual sales under $5 million could have a $5 billion stock valuation.

Everyone was involved in the mortgage scam. At the lender level the deceptions were myriad; liar’s loans, fraudulent income documentation, negative amortization loans, HELOCs, etc. The rush to get as many loans written as possible and then get those hot potatoes moved to the next sucker in the line was furious and extended from coast to coast, sinking one lender after another in Ponzoid debt and indictments.

Then there were the countless deceptions that emerged from the securitization process, the bad math that allowed banks like Goldman to do $474 million mortgage deals where the average equity in the home was just 0.71 percent, and sell 93% of that deal as investment grade paper.

Are we really to believe that the people who did those deals didn’t know what total crap they were selling? That the people who used CDO-squareds to magically turn BBB investments into AAA investments didn’t know how nuts that was?

There were the ratings agencies, who accepted all that bad math and slapped AAA ratings on crap mortgage-backed securities in exchange for the continued largess of the banks upon whom they were financially dependent — the same ratings agencies that later sputtered and coughed up bullshit my-dog-ate-my-homework excuses for mismarking mortgages, with the Moody’s revelation that a computer error caused them to misapply AAA ratings to billions’ worth of MBS being the comic low point.

Then further along in the chain you had crooks like the folks at AIG, who took advantage of the basic nonexistence of derivatives regulation to issue billions in guarantees for these mortgage investments that they had never had any intention of paying off, to say nothing of actually having the ability to do so. And of course underwriting the entire enterprise was the implicit guarantee of Alan Greenspan’s Fed, which made it known time and time again that its modus operandi was to refuse to recognize the existence of bubbles until after they blew up, at which point it would rush in and clean up the mess, bailing out all the chief actors out with easy money.

Everyone had a hand in the bubble, from the congressmen who killed regulatory initiatives to the regulators who snoozed at the wheel to the GSEs to the Fed to the banks to the ratings agencies to the lenders. I don’t think it’s really controversial to say that, but it does seem like there’s an argument brewing about what that across-the-board complicity means.

My own personal feeling is that our recent bubbles weren’t much different than pyramid scams and lotteries; they’re the handiwork of an essentially regressive and deeply cynical political organization that systematically hoovers up taxes and investment money mainly from middle-class suckers, where it eventually gets eaten in short-term cashouts and mostly blown on sports cars and tropical vacations and eye jobs for the trophy wives of Wall Street executives. Crackonomics: take literally all the spare money from four square city blocks and turn it into one tricked-out Escalade.

For me the basic dynamic of the mortgage bubble is some Ivy League dickwad hawking a billion dollars of securitized subprime mortgages to a pension fund, and then Hobie-sailing off into the sunset with a bonus after they all blow up. Of course my seeing it that way might have a lot to do with my own personal psychological prejudices, and I get that some other person with different hangups might choose to focus on Barney Frank deciding to “roll the dice on home ownership” with the GSEs.

But what I don’t see is how anybody can say that all of this happened because Fannie and Freddie rigged the game to get Mexicans in homes, and then the banks and the ratings agencies just reacted organically to the corrupted market and helped the bubble along through no fault of their own. That’s just another (albeit more convincing) version of the early attempt to pin the disaster on the Community Reinvestment Act, which in turn is just another way of playing the red-blue blame game, which in turn is missing the point.

This GSE story is a big one, but if it gets used as a path back to a “The Market Reacted Rationally” version of history, we’re screwed. It has to be looked at as an important part of a diabolical whole, a symbiotic scheme in which the banks and the state were irreversibly intertwined in an enterprise that on both sides was never about market economics, but crime. Because otherwise… the diversionary notion that one side or the other is wholly to blame is part of what makes the whole scam possible.

p.s. Just to get this out of the way, I love Zero Hedge, and Marla Singer has been really nice to me personally. I just don’t completely agree with this particular thing. I don’t see any reason why focusing blame on the banks and the ratings agencies and AIG was “fundamentally flawed,” because, well, shit, they were to blame. The fact that Fannie and Freddie now get to jump in the pigpen with them doesn’t change that for me.

I think in the end what we’re going to find is that all the relevant actors had their own motivations for getting involved in the bubble. Two and now three presidential administrations let the Fed overheat the economy for political reasons that should be obvious. Alan Greenspan, hell, he did it because he loves seeing himself on magazine covers and wanted to keep getting invited to the right Manhattan parties. There were congressmen that converted the expansion of cheap credit into low-income votes. The bankers and lenders went along because the system of compensation on Wall Street is fucked and rewards short-term thinking while ignoring long-term consequences.

To me all of these people were equally guilty of making bad decisions to benefit themselves in the here and now at the expense of the whole in the future. When it comes to bubbles, It Takes a Village, and blaming the whole mess on the “socialist” aims of a pair of government agencies seems off base — particularly since the Randian protocapitalists running the banks benefited every bit as much from this socialism as actual homeowners, and perhaps even more, when one considers that homeowners get foreclosed upon, while bonuses are forever.


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5 T/S Member Comments Called Out, 173 Total Comments
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  1. collapse expand

    There’s a goodly field of comment that really comes right out of “The Great De…”. Like these are really a unique new form of God Squad puppets in that they have decided they are in Hell and A Great Someone is going about “dividing” them and therefore created fools on the 8th day. Maybe they should quite watching animal masturbation vids for at least a little while…

  2. collapse expand

    There is a serious misconception re the mortgage default leading to the volcanic eruption of the financial system. Here is the chronology:
    1. Congress mandated easing up crdit somewhat stimulate homeownership by allowing 30 year mortgages with less than perfect credit score at a one point highr interest rate. If the borrower was ontime with payments for three years, the rate dropped to the standard.
    2. Early 2000’s, banks flooded with new money created by the collateralized Credit Bonds atarted to offer adjustable rate mtgs with with the income level set to the first year payment which could be as low as 1%. This qualified manhy more people with lower income.
    3. Between 2006-2007, banks started to offer mortgages with a minimum initial low payment and no need to verify income. This created a flood of speculative buyers including “flippers” with no intent to occupy the houses.
    4. Wall Street which offered these collaterized bonds came upo with the Credit Default Swaps(CDS) which was an insurance product insuring the CDO’s from losing value…they were offered as ‘Swaps” and not “insurance” to avoid the regulatory requirement of “cash reserves against future claims”.
    5. the economy topped out with the housing market droppinng …a normal thing in a slowing economy.
    6. Holders of the Swaps(insuramnce) started to file claims against AIG, Bear Stearns, Lehman Bros(issuers of the Swaps)whioch forced then to start weriting down their balance sheets to reflect these ppotential losses which in turn triggered rating agensies to reduce ratings which in turn caused the issuers to raise their balance sheet values which they couldn’t and all this led to an accelerating spiral causing the disaster we got.

    The failure was far more Wall street for creating the excess cash for the banks, tghe banks for creating dangerous mortgages to lend the money and the regulators for letting them get away with it.
    Had just the regulators reqwuired the issuers of the “swaps” to maintain cash reservrs against claims, like a normal insurance company, we still would have had an economic downturn and the housing values would have gone down somewhat…but we would not have had the crisis.

    That’s how it was…taking out all the politics and spin.

  3. collapse expand

    1. Fusion of Government and civil economy elites to the detriment of the country as a whole.
    2. Brilliant call.
    WMR, JWest

  4. collapse expand


    What is the solution to this systemic rot?

    Watching the health care debate unfold in Congress has been so upsetting, that is more of this rot as Congress seems driven not by what is right but by who is giving them the most money.

    What about a movement to change the laws on legal personhood so that corporations can’t participate in elections at all. If you can’t vote, you can’t bribe political candidates with your money.

    Are there other solutions?

    How do we return to a society where we invest in our future industries and people? And that includes not binding graduates from college with huge debt so they can’t take risks inherent in forming new businesses.

    Why does Europe have it so right? Universal health care and free graduate education…and we have it so wrong? And moreover, how do we right our ship of a nation?

    We all had high hopes for Obama…but he has proven more of the same, beholden to the same moneyed interests.

  5. collapse expand

    These are all noxious symptoms of something much deeper going on. Our entire economy is now squarely based on usury. People used to be able to pay off much smaller mortgages and pass real property to ensuing generations. Now the mortgages are for housing so over-priced that one can never hope to get out from under them. If you manage to get close, they reverse the mortgages for the seniors so they can pay for over-priced medical care so the houses can’t be passed down. If you fail in your payments, even 25 years of investment in ones home is totally lost and the banks keep everything.

    We’ve raised the price of cars so high that people go into debt for them at prices far higher than a house used to be. College students begin their careers under colossal student loans. Earning power becomes smaller as prices rise so that even with two breadwinners credit card debt becomes inevitable. (In my lifetime, it used to take only one breadwinner.)

    Some may be living beyond their means, but even the frugal are being trapped under crushing debt as cars break, medical incidents happen, jobs are lost, etc. The system seems totally rigged to keep everyone in debt so they can never be free of it, and huge portions of what they do earn goes straight to banks as interest.
    I’ve always found the irony of religious peoples getting involved in politics against gays (which doesn’t affect them at all), but don’t say thing one about the Old and New Testament commandments against usury, a situation that destroys and enslaves tens of millions. Instead we have made religion in this country a trillion dollar tax-free industry. Lucifer couldn’t have diverted their message better if he reinstated the coliseums. Speaking of which, even pagan Rome considered compounded interest too evil to be legal, and specifically made it illegal to have to pay more than double for something that was purchased with interest. (Code 4, 32, 28; 4,32,27; 29; 30 et al.)

    I am 51 years of age, and in my lifetime I have seen it get worse and worse with every decade. We are thralls to the banks, who in turn buy the politicians who are supposed to be representing our interests. Everyone keeps voting for the same two evil parties that keep this unjust status quo working. We have the power as a people to have a totally bloodless revolution, a gift from our forefathers. Imagine the shock of the powerful and their media lapdogs as state after state finds 3rd parties winning elections this November. At least it would be a start.

  6. collapse expand

    Thank you. Good job, Mr. Taibbi.

    “crazy” lady in TX

  7. collapse expand

    For the more things change department:

    “Of course inflation and the rest are to blame. But it would be impoverishing
    to stop there. Litan’s fellow economists assured us that financial deregulation was supposed to release untold energies by liberating the self-adjusting mechanisms of the capital markets. Instead, it released imprudence, incompetence, and fraud throughout the entire system. As a Wall Street Journal piece on the thrift disaster noted, the list of malefactors is “so long that some observers conclude there is something profoundly wrong with the country’s political and financial systems, which appear easily undone by feckless and reckless behavior. In fact, they say, the behavior of this legion calls into question the performance of this nation’s
    professional class itself” (McCoy et al. 1990). The “calls into question” is a
    little euphemizing, and the “some observers conclude” a classic journalist’s dodge for offering the forbidden controversial opinion, but the Journal’s analysis is a fine corrective to Litan’s. Unfortunately, the paper did not go into the sorry performance of the media, the Journal included, during the
    1980s, as the thrifts and everything else were spinning out of control.”

    From Doug Henwood’s “Wall Street” p. 99, surveying the wreckage of the S&L crisis.

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    I'm a political reporter for Rolling Stone magazine, a sports columnist for Men's Journal, and I also write books for a Random House imprint called Spiegel and Grau.

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