-Submitted by David Drumm (Nal), Guest Blogger
Recently, Rep. Spencer Bachus (R-AL), the next chairman of the House Financial Services Committee, told the Birmingham News, “my view is that Washington and the regulators are there to serve the banks.” As part of that service, Republican members of the bipartisan Financial Crisis Inquiry Commission, that was established to examine the causes of the current financial and economic crisis, are rewriting the history of the crisis.
They want to blame Fannie and Freddie.
Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs), meaning they are privately held, but receive Federal government support. Or they were until the U.S. Treasury put them into conservatorship in Sept. 2008, run by the Federal Housing Finance Agency (FHFA).
Fannie and Freddie purchase mortgages from banks and other primary lenders. This function benefits the banks. No bank wants to have a lot of debt, especially in the form of mortgages. These long maturity loans reduce the bank’s liquidity, their ability to meet their financial obligations. One of those obligations is payment to depositors who want their money. Liquidity problems account for 35% to 57% of bank failures.
Fannie and Freddie then bundle the mortgages into mortgage-backed securities (MBSs), a process known as mortgage securitization, that are sold to investors worldwide, with a guarantee of payment, even if there’s a default.
Before Fannie or Freddie will purchase a loan it must conform to their underwriting guidelines, it must be a “conforming loan.” Two of the guidelines are the credit score and debt-to-income ratio of the borrower. In Dec. 2009, the guidelines got tougher, the credit score minimum went from 580 to 620, and your monthly debts can account for no more than 45% of your gross (after taxes) monthly income. The mortgage lobby complained.
But Fannie and Freddie had competition from private-label securitization entities with less stringent underwriting guidelines. The private-labels would buy and bundle subprime mortgages with adjustable interest rates, get AAA ratings from pay-to-play agencies such as Moody’s and S&P, and sell the securities to investors. Without those AAA ratings, investors would not have bought the MBSs. Columbia University Nobel laureate Joseph Stiglitz observed:
I view the ratings agencies as one of the key culprits. They were the party that performed that alchemy that converted the securities from F-rated to A-rated. The banks could not have done what they did without the complicity of the ratings agencies.
Fannie and Freddie got into financial trouble when, as housing prices and the economy continue to decline, foreclosures spread beyond subprime loans into the higher-quality, conforming, loans.
Republicans are walking a tightrope. The first question they have to answer is: “how will you prevent this from happening in the future?” The obvious reply is regulation of the financial industry. Regulation is not a word that the banking overlords want to hear.