Here's an idea: Let's give hundreds of billions of dollars in government-backed guarantees to private banks so they make a fortune writing mortgages without any risk to themselves. Hey, what could go wrong?
The FCIC's recent report illustrated an important lesson from the economic meltdown: Privatization, not big government, ruined Fannie Mae and Freddie Mac. Running a government program like a private corporation leads to the worst excesses of executive self-indulgence. Fannie and Freddie didn't bring down the economy, as some have claimed, but they were destroyed by the same privatize-and-deregulate philosophy that led to the crisis.
Now we're learning that Washington may be preparing to take that destructive philosophy even further. Proposals to "reform" Fannie and Freddie by privatizing them even more aren't just bad, dangerous ideas. Worse, they suggest that we could be returning to the blind and mistaken ideologies of the past. If that's true, then it's only a matter of time until the next meltdown comes.
Mark your calendars. This may be remembered as the week our next financial crisis began, the moment when the Greenspan Republicans and Rubin Democrats who ruined the economy the last time around regained control... and the cycle began all over again. Only two short years after Wall Street's fraud and greed brought down the world's economy, a Beltway think tank is proposing to put taxpayers on the hook for mortgages written and administered by the same corporate miscreants.
And that's the Democratic proposal. The Republicans want to double down on a failed strategy of "privatizing" government mortgage financing, while at the same time cutting back on regulation and oversight. It all boils down to the same thing: bringing back the same sybaritic, taxpayer-backed greedfest that 's already shattered the economy more than once.
Fannie and Freddie are "government-sponsored enterprises," or "GSEs." But ideologues have learned exactly the wrong lesson from the Great Recession. It was the "E" part of these companies, not the "G" part, that caused the problem. The real lesson is that it's a mistake to mix government programs with private-sector-style get-rich-quick incentives. The GSEs failed because they treated their Federal mandate as if it was the key to Fort Knox.
If the Financial Crisis Inquiry Commission wants to publicize its work more, maybe it should set up a tabloid website like The Smoking Gun, or pitch a TV tell-all scandal show about badly-behaved executives ("VH1: Behind the Mortgage"). Their first episode could feature Daniel Mudd, the former Fannie Mae CEO who bragged that he wrote his own rules with regulators and boasted that "we always won, we took no prisoners." According to the FCIC report, regulators later concluded that Mudd ran a company with an "arrogant and unethical corporate culture, where Fannie Mae employees manipulated accounting and earnings to trigger bonuses for senior executives."
Mudd ran the company with so much materialistic self-absorption that he might have been starring in an 80's hair-metal video (presumably without Tawny Kitaen on the hood of a Jaguar, but who knows?) His tenure at Fannie was marked by misleading, cheating, bullying, and the reckless pursuit of a fast buck. But then, why wouldn't it be? He was compensated like a private-sector executive, but backed by government authority and coddled with taxpayer guarantees. It was all upside, baby, and Mudd liked his upside.
Regulators found that Mudd and his colleagues "manipulated accounting" so that they could keep paying themselves huge bonuses, even as they ran what one observer called "the worst-run financial institution" he had seen in thirty years as a regulator. It worked, too. Mudd made $65 million between 2000 and 2008. (Hmm ... "manipulated accounting" ... is that legal?)
Conservatives should be just as outraged as progressives. Executives like Mudd didn't build their businesses. They didn't even manage them competently. They took a free ride with government backing, yet paid themselves as if they were captains of industry. How did this perverse situation develop?
Freddie's Dead (Fannie, too)
Fannie Mae and Freddie Mac are going to die, at least in their present form, as victims of over-indulgence. But they didn't start that way. Fannie Mae was created in 1938 and functioned smoothly for thirty years, all through the postwar housing boom. It was turned into a separate government-sponsored enterprise in 1968 in order to take its large debts off the Federal balance sheet, and Freddie Mac was created shortly afterward (to create "competition"). They're creatures of privatization, and they were encouraged to bring "free market" aggression to their mission.
And man, did they. As FCIC testimony revealed, "The "Fannie and Freddie political machine resisted any meaningful regulation using highly improper tactics... OFHEO (their regulatory overseer) was constantly subjected to malicious political attacks and efforts of intimidation."
The companies faced a turning point in 2005, when the greed-addled private market was rushing into subprime mortgages and other high-risk loans. A government-sponsored corporation that was true to its mission wouldn't have followed the lemmings, but privatization fever had taken hold. As a Fannie Mae executive told his colleagues back then: "We face two stark choices: stay the course [or] meet the market where the market is." Ill-advised by architects of calamity like Citibank, they jumped in with both feet despite dire warnings from people inside the organization.
Risk and Reward
Alan Greenspan and Robert Rubin both told the FCIC that better corporate risk management will help prevent the next financial crisis. The Fannie Mae story proves how naive that belief is. Like many financial executives, Mudd's short-term wealth depended on writing more business, whatever the risk. So he humiliated, abused, and ignored Chief Risk Officer Enrico Dallevecchia when Dallevechia warned him of the dangers of writing substandard business. The frustrated Risk Officer finally wrote a memo to Mudd which said that Fannie had "one of the weakest control processes" he had "ever witnessed in his career," and that he was "upset" that he hadn't even known told the company was taking on more risk until he saw the announcement. A bellicose Mudd told Dellavecchia to "address it (to him) man to man" and "face to face," rather than by email.
CFO Robert Levin bullied the company's chief analyst in a similar way when he was told that the company wasn't charging enough for its Alt-A mortgages. That's called "buying business," and it should never happen at a government-sponsored enterprise. It means that an enterprise created to complement the private sector is competing with it instead. Mudd and Levin did what many executives would do in a similar situation: They lowered their underwriting standards, wrote a lot of bad mortgages, and walked away as rich men. Mudd now lives comfortably in Connecticut with $80 million in earnings, thanks to the American taxpayer, and is a director for an investment fund (Fortress Investment Group -- a name we're providing as a public service to unwary investors).
Meltdown II: The Sequel
Arguments over Fannie and Freddie are usually a proxy for ideological differences about the role of government. Conservatives who blame Fannie and Freddie for the meltdown (which they didn't cause but certainly made worse) want to prove that government intervention in the economy is a bad idea. But this isn't a battle between right and left as much as it is between what works and what doesn't. We've now seen what happens when American-style bankers are given government-backed guarantees and Goldman Sachs-style bonuses. Privatizing to Wall Street is like giving your car keys to a pickpocket.
Nevertheless, Capital Markets Subcommittee Chairman Scott Garrett is holding a hearing today on "reforming" Fannie and Freddie, and his witness list contains four names: someone from an anti-government, anti-regulation think tank that's funded by Citibank, the Koch Brothers, Chase, and American Express, along with a variety of oil refiners and pharmaceutical companies; someone from another anti-government group which has received funding from Bank of America, Lehman Brothers, PriceWaterHouseCoopers, and the California Realtors Association; someone from a conservative think tank funded by Prudential and American Express, among others; and a Democrat ...
... from the Center for American Progress, the group that wrote the Democratic "privatize Fannie and Freddie" proposal." In other words, the hearings have been stacked in the banks' favor. Meanwhile the administration's plan for reforming Fannie and Freddie is overdue, but the Center for American Progress is close to the White House. If that means that its proposal is a preview of administration thinking, we've got a big problem.
We're told that the White House plan will be released Friday and will include three options. One option would have the government withdraw entirely from the mortgage market, but that's likely to be politically infeasible. Neither party wants to explain to voters why they can't get home loans and the price of their house has plummeted. And while specifics weren't provided for the other two, the Wall Street Journal reports that the others would "create a way for the government to backstop part of the secondary mortgage market" like Fannie and Freddie, but gave no specifics.
The Journal also reports that "top administration officials have publicly discussed the merits of a limited but explicit federal guarantee of securities backed by certain types of mortgages," adding: "The housing and banking industries have advanced proposals arguing that such a guarantee is needed to maintain a healthy market, particularly for long-term, fixed-rate loans that remain a keystone of U.S. housing."
The short version: There will be one proposal that's politically impossible, and two others that give banking and real estate lobbyists what they want. Care to bet which one won't make it through Congress?
Yves Smith gave the CAP proposal the once-over, under the heading "Wall Street Co-Opting Nominally Liberal Think Tanks," but our one-sentence summary of their proposal is this: They want to dismantle Fannie and Freddie and let private banks administer their programs backed by by government guarantees. And don't worry, says CAP. Our "chartered mortgage institutions," though "fully private," will have to be "fully transparent" and follow government rules. (They would never, never "manipulate accounting," would they?)
Proposals like CAP's would make Fannie and Freddie's private-sector successors a microcosm for the entire economy under the failed policies of Democrats like Clinton, Rubin, and Summers, as well as Republicans like Greenspan and... well, all of them. Executives at these financial institutions would be likely motivated to cook the books and sell bad mortgages, while taking advantage of taxpayer guarantees to consolidate their already too-big-to-fail institutions. And they'd be recruited from a Wall Street cohort with a documented record of deception and criminality. All of CAP's lofty and well-stated goals are undermined by the identify of the folks doing the lending. As for the Republicans, they don't even bother stating lofty goals.
The government has to work out a way to unwind itself from the mortgage market. The administration has a proposal to lower the size of mortgages it will guarantee, and that's a good first step. But the previews of their overall proposals are disturbing and weak, while the Republicans appear to be planning for anarchy and fiscal looting.
The problem is much bigger than Fannie and Freddie. This real danger is that this could be a turning point, a return to the failed ways of the past. If we don't see stronger proposals than these in the coming months, this will be remembered as the week that the destructive policies of the Greenspan/Rubin crowd came back from the dead. It will be recalled as the beginning of the end, the moment when the next wave of privatization began and the way was paved for a collapse that may be even greater than the one we're in today.
Richard (RJ) Eskow, a consultant and writer (and former insurance/finance executive), is a Senior Fellow with the Campaign for America's Future. This post was produced as part of the Curbing Wall Street project. Richard also blogs at A Night Light.
He can be reached at "firstname.lastname@example.org."
Website: Eskow and Associates