Updated from 10:00 a.m. EST
Since the financial crisis of 2008, scores of books have been written about its cause. Many of them, notably Reckless Endangerment by Josh Rosner and Grethchen Morgenson, placed much of the blame for the crisis on Fannie Mae and Freddie Mac. (Update: Although much of the narrative focuses on the expansion of Fannie Mae -- and its rising influence with members of Congress -- Rosner says his book names investment banks as the "main culprits" in the crisis. "No industry contributed more to the corruption...than Wall Street," he writes.)
Indeed, most observers believe Fannie and Freddie contributed to the housing bubble that burst in 2008, and only 20% of Americans view the government-sponsored enterprises (GSEs) favorably, according to a June 2013 poll by On Message Inc.
“Coming out of the financial crisis of 2008, Fannie and Freddie took on the role of central villains and have not recovered,” wrote pollster Wes Anderson. “The public image of these two entities is nearly toxic!”
Now along comes an entirely different point of view from Timothy Howard, the former vice chairman and CFO of Fannie Mae.
In his new book, The Mortgage Wars, Howard vehemently defends his former firm and, by extension, its smaller cousin Freddie Mac.
“The ‘GSE model’ for the secondary mortgage market was not flawed,” he writes. “It was sabotaged by hostile and inept regulation.”
The saboteurs included former Fed Chairman Alan Greenspan and former Treasury Secretary Larry Summers, Howard says. Blinded by faith in private-market solutions, Greenspan and Summers supported the banking industry’s efforts to undermine Fannie and Freddie, he argued.
After the Savings & Loan crisis of the late 1980s-early 1990s, “Fannie and Freddie became the dominant providers of mortgage financing,” Howard explains. “Large lenders didn’t like that, nor did the Fed and Treasury because we were determining the standards for mortgages … which took control away from lenders.”
But the real villain in Howard’s saga was Armando Falcon, former director of the Office of Federal Housing Enterprise Oversight. In 2004, Falcon charged Howard and then Fannie CEO Franklin Raines with accounting fraud, which led to their departure.
In 2012, a Federal District Court Judge dismissed the charges. For Howard, that development vindicated his view that Falcon fabricated the charges for political reasons.
“Falcon knew he would get support” – from the Bush Administration, Greenspan and Summers – “if he took the lead and knocked Fannie Mae down a peg,” he says.
(Update: While Howard understandably focuses on the Judge's decision in his (and Raines') favor, a May 2006 Special Examination of Fannie by OFHEO tells a very different story. Howard's conduct was "inconsistent with the values of responsibility, accountability & integrity," the report states. Howard "failed to provide adequate oversight" and "set everyone straight that the lack of earnings volatility trumped GAAP."
In other words, Howard put the safety of Fannie's portfolio secondary to creating the appearance of smooth earnings, which contributed greatly to his compensation -- among other senior Fannie executives.
"I think the history makes it clear he was central to perverting and undermining Fannie Mae and increasing their risks," Rosner says, noting Howard's compensation topped $30 million between 1998 and 2003.)
Saving Fannie & Freddie
Even more controversially, the former Fannie Mae executive says the free-market model championed by Greenspan, Summers et al. “proved to be an unqualified disaster.”
The fatal flaw in so-called private label mortgage-backed securities is “everybody in the chain – from the broker to the primary lender to the securitizer to the rating agency – all of whom could make money off loans that never got paid back,” Howard says. “Fannie Mae and Freddie Mac were not financing 'no-doc' loans…because we were a risk-taker. If we mis-estimated risk on loans, we lost money and the investor got paid.”
Given the recent history, Howard is convinced the current push to “wind down” Fannie and Freddie and replace them with private lenders – however difficult it may be – is a recipe for disaster. “As soon as that system became the major source of finance [in the mid-2000s] credit standards plummeted,” he says. “A system based around a specialized company that has an incentive to understand, measure and manage risk is a much better system.”
And, of course, having the implicit backing of the U.S. government helps. Howard doesn’t apologize for that, arguing that a system based purely on private lending would be “much more expensive, riskier and you wouldn’t be able to sustain the level of home ownership we have now.”
Among others, Dick Bove of Rafferty Capital Markets agrees, recently writing that the fallout on the housing market would be “colossal” if Fannie and Freddie are wound down because “no bank would be willing to assume the risk” of 20- or 30-year fixed-rate mortgages.
Of course, Fannie and Freddie did loosen lending standards in the final years of the bubble and their very existence arguably helped fuel it in the first place.
But Howard notes Fannie didn’t join the subprime party until after he and Raines were forced out. Without claiming he and Raines saw the looming disaster – “it’s very hard for any company to maintain discipline in a bubble” – Howard notes Fannie Mae “did dramatically less business” in 2004 relative to its growth in the prior 15 years.
Howard is convinced Fannie would have weathered the storm better if he and Raines were not forced out in 2004. In 2008, Fannie and Freddie were placed into conservatorship by then-Treasury Secretary Hank Paulson and ultimately received nearly $200 billion in bailout funds. Fannie and Freddie remain wards of the state to this date, with the U.S. government owning about 80% of their shares.
“I don’t think Fannie Mae would have failed because we had disciplines in place that required us to put capital up against loans we either weren’t pricing correctly or were riskier than we had been taking out in the past,” he says. “That’s what fell apart after Raines and I were tossed out.”
To be sure, this is a very complicated story and one man’s (belated) effort to reclaim his legacy -- and sell books. But it's always good to challenge conventional wisdom, especially about something as profound as the cause of -- and policy response to -- the worst financial crisis since the Great Depression.
- Fannie Mae
- Freddie Mac
- Franklin Raines