To us, that week, it looked very much like a run on the entire financial system

TO BE NOTED:

Sunday, May 17, 2009

How TARP Began: An Exclusive Inside View

May 14, 2009 04:01 PM ET | Rick Newman | Permanent Link | Print

When it first came into existence last September, TARP—the troubled assets relief program—sounded like just another ungainly government acronym. But since then, it has become an integral—and controversial—part of America's recession economy.

TARP's chief architect was Henry "Hank" Paulson, President Bush's treasury secretary, who led the financial rescue along with Federal Reserve Chairman Ben Bernanke and New York Fed Chairman Tim Geithner, who's now Paulson's replacement at treasury. Their initial plan was to use the $700 billion in TARP funding approved by Congress last October to purge financial firms of their so-called toxic assets.

[See why the banks still aren't fixed.]

But TARP morphed into an über-bailout that included direct cash injections into banks, the auto rescue, the AIG intervention, and other government efforts to revive the economy. If it sounds like a trial-and-error experiment, well, that's how it felt to the policymakers who designed it, too. "When we looked for easy solutions, we kept coming up empty," says David Nason, who was a senior Treasury Department official during the Bush administration. "Hank used to say all the time, 'We're going to have to do this with duct tape and fishing wire.' "

Nason and some of his Treasury colleagues did much of the jury-rigging, running doomsday scenarios, negotiating emergency deals with banks, wooing incredulous members of Congress, and devising ways to deal with problems once considered unthinkable. Frustrated Treasury Department officials, for instance, foresaw much of the carnage but found themselves poorly equipped to stop it. Anxious finance ministers from around the world began calling Treasury last summer to find out what the government planned to do about the developing crisis. The most tense moment may have been the September failure of Lehman Brothers, which occurred with alarming speed after British financial regulators scotched a takeover bid by the British bank Barclays.

[See 6 surprises from the recent bank stress tests.]

Nason and two other former Treasury officials, Philip Swagel and Kevin Fromer, spoke recently at a panel discussion sponsored by the Milken Institute. Their remarks form one of the most thorough accounts to date of how the government struggled to contain the worst financial crisis since the Great Depression. (See a video of the full discussion, which I moderated.) Here's a condensed version of their remarks:

David Nason, former assistant treasury secretary for financial institutions: The first inflection point was March 16, 2008, which was the acquisition date by JPMorgan Chase of Bear Stearns. The sheer time it took for this institution to go from viable to nonviable was breathtaking. Just two days before, the regulator [the Securities and Exchange Commission] had said Bear had adequate liquidity of $8 billion. This is an important inflection point because it was the first time the government had stood up and said we are going to support nonbanking institutions. We knew at that point the times had changed. We knew the policy ramifications were going to be very difficult and far reaching.

[See 5 signs the bailouts are getting better.]

We worried most significantly about the consequences of other similarly situated firms. It was a very trying and stressful time because when we looked for easy solutions, we kept coming up empty. The government did not have a ready-access pool of money to support or manage the resolution of financial institutions. The political climate was very challenging—at the time, people saw this as a bailout for fat cats on Wall Street. And there was some jurisdictional squabbling in Washington.

Philip Swagel, former assistant treasury secretary for economic policy: Right after Bear failed, the economy looked like it was actually in pretty good shape considering the problems in housing and the financial sector. Overall growth was positive, driven especially by exports. In the wake of Bear's failure, we looked at options, including many things that are now familiar: buying assets, insuring assets, buying pieces of pieces of institutions, in other words injecting capital, and a massive bailout from the bottom from refinancing every troubled homeowner. And we said those are all things you could write down, but back then, you had rebate checks that had been enacted but weren't yet going out, and we had positive growth. It would have been hard to imagine getting the authority to do those things or the approval from Congress for a contingency fund in case things got worse.

Nason: The next inflection point was July 2008. The government was worried about the big investment banks, CDS [credit-default-swap] spreads were blowing out, we were also worried about Fannie Mae and Freddie Mac. These were some of the most leveraged institutions on Earth. Together, they had over $5 trillion in exposure if you consider the guarantee obligations that they had. Match that against about $60 billion in capital. We were also concerned that the housing correction was turning out to be significantly worse than the GSEs [government-sponsored enterprises, such as Fannie and Freddie] expected. We were very concerned that the GSEs were being overly optimistic about their ability to manage risk and withstand future losses.

[See the best and worst bailed-out banks.]

The GSE equity prices were getting punished during this time. More important to us, however, was the debt market. It was very clear to us there's no way the U.S. financial system is going to allow a firm the size of Fannie Mae to collapse( NB DON ). We were very worried about the trillions in debt they had outstanding, and what it would do to confidence if we let that debt go.

At this time, the Treasury was getting calls from finance ministers' offices from different parts of the world inquiring, "What is the government's relationship with Fannie Mae and Freddie Mac?" It's odd, but this appeared to be the first time that people were focusing on the fact that these are quasi-governmental institutions.

During this time period, the home loan banks, another GSE with similar exposure to the housing market, decided to postpone an auction. Every auction was something that we focused on and were worried about.

[See the banks most likely to pay back their bailout funds.]

We made the decision based on this set of circumstances that we had to support the GSEs. How were we going to do that? What did we have in our toolbox? Essentially nothing. We had about $2 billion of backup credit support for the GSEs. For $1.4 trillion organizations. This was clearly not enough to support these institutions in any real way. And we had no ability to provide any kind of equity support at all. So we decided we had to go up to Congress, bite the bullet, and ask for authority to backstop these institutions.

On July 30, 2008, the president signed a bill into law to provide equity support to these institutions. And we had the ability to support their debt up to the federal debt limit.

We made the judgment not to request the authority to nationalize the GSEs. It would have muddied the political discussion. I'm not sure we would have gotten the authority, and at this time, there wasn't a pressing need to do so. There's a long, tortured story about how the GSEs and Washington interface. But we wanted to have broad authority to support the GSEs and prevent their collapse.

[See why the auto bailout is a good model for other struggling firms.]

The entire month of September was an inflection point under my definition. But the first inflection point associated with September is Sept. 7, 2008, when the GSEs were forced into conservatorship. That came after regulators determined that they were drastically undercapitalized.

Two days later, AIG's stock fell 19 percent. Lehman's discussions to sell itself to the Korean Development Bank failed. The next day, Lehman put itself on the market for sale, with no clear takers. After some very tense discussions about whether there would be a purchaser, like JPMorgan was for Bear Stearns, we were very distressed to know that there were no takers.

So from the 10th to the 14th, the Federal Reserve, with the Treasury's support, decided to flush the system with liquidity. The Federal Reserve expanded the level of collateral the primary dealer credit facility would take, they increased the collateral that the term securities lending facility could take, and they increased the ability of banks to support nonbanking institutions. The government was putting "foam on the runway" to try to deal with what we were afraid of, which was how the market would react to a Lehman Brothers bankruptcy.

The next day, Lehman Brothers filed for bankruptcy.

The question is: Did we let Lehman Brothers fail? That assumes it was a choice that we made. The simple truth is that the government was presented with an institution with a $600 billion balance sheet, with enormous leverage. Confidence in the institution was virtually nonexistent. The only way to stabilize a firm under these circumstances is to stop a run on the institution, stop counterparties from claiming their debts should immediately come due. That was manageable in the Bear Stearns situation because someone was willing to guarantee all or most of those liabilities.

[See how bailouts can butcher capitalism.]

The public posture was that government support would not be available. But there wasn't a single credible buyer at the table who was turned away by us.

So when people ask, "Why did you let Lehman Brothers fail?" I ask, "What is the deal that the government turned down that would have prevented Lehman's failure?" If there's not someone willing to take on a balance sheet as large as that of Lehman Brothers, what is the government to do? The government has a few options: We have a lending facility at the Fed, you could provide a loan to them secured against collateral, or you could guarantee all their liabilities. That might have been the right decision, but we had no authority to do that before TARP.( NB DON )

Looking back, if we could have plugged some of the holes in our authorities, maybe this could have been done differently. I don't think we would have gotten those authorities if we had asked for them before September.

[See why the feds rescue banks, not homeowners.]

Of course, things continued to be unpredictable. We didn't predict that the U.K. bankruptcy process would essentially destroy all confidence in that funding model and that business model. And we didn't expect that the commercial paper market would essentially shut down because Lehman Brothers' commercial paper was impaired. Those two markets were the transmission vehicles that killed confidence, which we didn't expect.

That same day as Lehman, Bank of America acquired Merrill Lynch. We didn't have a second to catch our breath. The day after the Lehman bankruptcy, AIG got a $50 billion loan from the Federal Reserve. There was no significant discussion over whether the Federal Reserve was going to provide backup facilities to AIG because of two distinguishing characteristics: One, they were huge. They were global. They were bigger than Lehman Brothers. But the more important distinction is that the Fed is in the business of providing loans when it is "secured to its satisfaction." And AIG had the benefit of having solvent, highly regulated, very valuable insurance subsidiaries to which the Federal Reserve felt comfortable extending its loan facilities.

[See more companies likely to fail this year.]

After that we get to Sept. 17 2008, which was essentially the creation of the TARP concept. It was at that point that there was a meeting of the minds between Paulson, Bernanke, and Geithner that enough is enough, we're going to break the back of this crisis, and we're tired of not having the tools to deal with this crisis. And the judgment was made that we were going to ask for broad authority from Congress.

At that point, it was essentially 24-hour duty at the Treasury Department. Some people slept there.

Kevin Fromer, former assistant treasury secretary for legislative a ffairs: For context, this was a program about the size of the entire federal operating budget on an annual basis. Congress usually works through that process for 10 or 15 months, just to keep the lights on. We were asking Congress for $700 billion in basically a week or two. In the context of a national election. An election year is typically not the year to do big things.

We had one week left in the legislative calendar. It was not possible to do it in a week. I wasn't sure it was possible to do it at all. We needed to get somewhere fast, so we sent up the infamous three-page bill, which was draft legislative text the committees needed to start the discussions.

[See why the markets hate the idea of bank nationalization.]

Swagel: It was very difficult to say, if this shock happens, you will get this economic effect. In September, the nation as a whole didn't understand that what was happening in the credit markets would matter to them. There was this sort of Wall Street-Main Street divide. It was hard to explain to people why this mattered.

The week of Lehman and AIG, there was a panicked flight from mutual funds, and that led to a lockup in commercial paper. In our view, that was really the key, the CP market breaking down. That had a direct link to investment. Businesses use that to fund their daily operations. That would lead to a direct plunge in business spending, and that's exactly what we've seen over the last two quarters. A very sharp decline in business investment.

The one-month Libor [London interbank offered rate] spread is a measure of stress in bank lending. It's really, do you trust a bank to hold your money for a month. After that week, the stresses in the bank funding markets were huge. To us, that week, it looked very much like a run on the entire financial system. ( NB DON )

Nason: We were afraid of a complete and utter collapse of the global financial system.( NB DON )

Swagel: Imagine if the Fortune 500, blue-chip companies, can't buy paper clips or meet their payroll. All the things these firms rely on money-market funds and commercial paper for. And it goes downhill from there. It starts with the big firms and then every firm in the nation.

Fromer: This was an extremely difficult communications challenge. It made it enormously difficult to sell the package to Congress and for them to sell it back home. They were angry when they came back from home after the election. They had seen the amount of money they were being asked to put into institutions, getting anecdotal information from small businesses and lending institutions, and the picture was, we've invested significantly in these institutions, and we're not seeing credit flow to consumers and small businesses.

The markets were volatile for quite some time, and people became desensitized to volatility in the markets. What people didn't understand, which was quite reasonable, was the credit markets, how credit is provided in this country. That's not a criticism; it's arcane to anybody without a certain educational background. It's an almost-impossible-to-explain set of circumstances.

Nason: People were getting used to seeing the stock market go up and down. We were trying to explain, "What's happening in the equity market is not really what we're worried about. We're worried about some other market that you've never seen and aren't familiar with," and people look at you like you're insane because you're asking for $700 billion and you can't provide anything besides a chart to show why it's important.

[Here's the chart, which shows how rapidly widening credit spreads reflect a seizure in the credit markets.]

People could appreciate the money-market mutual funds situation. There is $3.3 trillion of money invested in money-market mutual funds. A panic in these funds helped in terms of selling the importance of our message. And the commercial-paper market stress was important in communicating this as well. If that market collapses, you could have huge employers saying, I'm going to start laying people off. I'm going to start shutting plants down, I'm going to start defaulting on my bonds, and that's going to trigger bankruptcy( NB DON ). Those are the kinds of things you had to say, in the doomsday scenario, to convince people that this was critical to the system.

After [the first TARP vote] failed in the House [on September 29], then the equity markets finally responded. [The Dow Jones industrial average plunged 778 points.]

Fromer: It was clearly a response that forced a number of people to say, "OK, we get it now."

Swagel: Even after the legislation passed, stresses in bank funding still got worse. So we got what we needed; we were thinking about buying assets, but we needed to think more broadly.

Nason: There were two purposes at the time. This is a critically important point and something the current administration is suffering under. The dual purposes were financial system stability and provision of credit to the economy. People are not focused at all on the fact that the former is the primary reason we went up and asked for emergency authority. To derail a total breakdown of the financial markets and the global financial system. And we believe and hope that the confluence of programs put into place in a very short period of time actually did that.

The second part of it is, getting credit flowing into the economy. People seem to only focus on, "Why isn't this money being put into the economy?" That's important, of course, but you have to remember a significant portion of this money was there to be a buffer against future losses.

Swagel: To me, the stabilization of the financial markets is the salient accomplishment of the TARP and the actions of the Treasury in the fall. The normal playbook for dealing with a bank crisis is first, winnow out the banking sector so the zombie institutions don't clog up the credit channels and divert resources. As a society, I'm not sure we're going to do that. Next is stabilize, inject capital into the firms that are left so they're still viable. And No. 3 is do something about the balance sheets. Give certainty about the performance of the assets and the viability of the firms. I think we did No. 2, we stabilized the system. No. 3 is still the ongoing challenge.

Nason: The reason the TARP morphed from asset purchases to injecting capital is really quite practical. Asset purchases were taking longer than we had hoped, and it was more complicated with the vendors. Also, we needed to be in lockstep with our brethren around the world. The U.K., France, and Germany were prepared to guarantee the liabilities of the banking sector and were going to deploy capital into their banks.

Fromer: The folks in place right now clearly have the advantage of looking back at what we did and the conditions that existed when we did it. They're benefiting from experience. A number of them were part of the process going back to last summer.

Swagel: The job of the TARP has not been done, but the first step is done. In terms of the larger picture of what matters to families, we're still pretty far away from getting back to normal.

Nason: There are still valuation problems with a lot of the assets on bank balance sheets. Then we still have to deal with inevitable credit contraction.

Fromer: It's not conceivable to me that there's a TARP II. It's going to take time for these programs to stand up and operate and invoke full participation from all quarters. Given dynamics right now, I think it's unlikely there will be another TARP."

Though the risk is minimal, tax credit investors now insist on financial guarantees from developers

TO BE NOTED: From the NY Times:

"Shovel-Ready, but Investor-Deprived

By TERRY PRISTIN

For more than three years, Roger Brandt, a Rochester developer of housing for people with low incomes, has been planning the second phase of his Union Meadows project in suburban Chili (rhymes with mai tai).

He hopes to build 42 apartments in a town home style, with brick veneer facades and vinyl siding, and rent them to people earning as little as $25,000 a year. The first phase, with 48 units, was completed in 1998 and has a waiting list of 234 families.

In January, New York State awarded Union Meadows low-income housing tax credits, giving Mr. Brandt access to the equity he needed to make the $8.4 million project feasible. (To generate equity, developers sell the tax credits to corporations seeking to offset profits.)

But then last month, KeyCorp, the Cleveland financial institution that had agreed to buy the tax credits, backed out of Mr. Brandt’s project. The bank also disclosed that it had lost nearly $488 million in the first three months of the year.

KeyCorp’s withdrawal left Mr. Brandt, president of Rochester’s Cornerstone Group, scrambling for a replacement. “We’ve been dialing for dollars,” said Mr. Brandt, who has built 877 units of rent-restricted housing over the last two decades. In most of his projects, the monthly rent for a two-bedroom apartment is about $575 a month, compared with about $850 for a market-rate apartment, he said.

Mr. Brandt’s experience is being mirrored throughout the nation, demonstrating the shortcomings of a financing vehicle that was conceived more than two decades ago to inject market discipline into the development of income-restricted housing. The theory was that investors would support only those projects likely to be successful.

Many developers are finding themselves either unable to sell tax credits that they have been awarded or short millions of dollars because the price that investors are willing to pay for a tax credit has tumbled from $1 or more to less than 75 cents today.

Today, the total amount of tax credit equity available for low-income housing has shrunk to $4 billion to $4.5 billion, down from about $9 billion in 2007, Frederick H. Copeman, the national director of tax credit investment advisory services at Ernst & Young, said in an interview in his Boston office.

In New York State, some 16 affordable housing projects that were awarded tax credits by the Division of Housing and Community Renewal have yet to find buyers, the agency said. In Michigan, state officials say that of 59 proposed developments that were awarded this type of tax credits last year, they know of only two deals that have been completed, though the actual number may be slightly higher.

“Every deal is struggling,” said Deborah VanAmerongen, the New York State housing commissioner. Last year, developers of five projects turned in their tax credits after they could not find investors, she said. And yet, applications for the tax credits have increased 20 percent statewide (and have doubled in New York City), she said.

Two temporary remedies were included in the stimulus package passed by Congress. The United States Department of Housing and Urban Development will give the states $2.25 billion to distribute to developers to fill the gap left by falling tax credit prices. A second program will allow the states to exchange unused tax credits for cash from the federal government.

Allocated by the federal government since 1987, tax credits are awarded by the states to projects that meet strict requirements and are used by investors to reduce their federal income tax over a 10-year period.

Initially, the program drew a variety of investors, including companies like Chevron and Berkshire Hathaway. More recently, the program has mainly attracted financial institutions, which often use the credits to fulfill their obligations under the Community Reinvestment Act to invest in poorer neighborhoods where they have customers.

Until last year, Fannie Mae and Freddie Mac acquired 30 percent or more of the tax credits. But as their losses piled up, these agencies stopped buying credits, as did many other troubled financial institutions, including Citigroup, another big player.

Some of the remaining investors are reluctant to back projects outside major urban areas, fearing that these developments will face increased competition now that market-rate rents have slipped. The tax credits are forfeited if a foreclosure occurs, and cost overruns cannot be passed on to tenants.

“Basic market forces are at work here,” said William Traylor, the president of Richman Housing Resources, a syndication company affiliated with the Richman Group, that operates in New York City. “Investors are looking for strong real estate transactions in strong real estate markets.”

Developments the size of Union Meadows in Rochester have also suffered because investors find it more economical to participate in a few large projects rather than a lot of smaller ones, industry specialists said.

But despite the overbuilding that occurred during the housing boom, there remains a critical shortage of rental housing for low-income families and elderly people. Nationwide, about five million additional units are needed, Mr. Copeman said.

“This program at its peak efficiency creates 90,000 units a year, and more than that go out of service each year,” said Mr. Copeman, 58. “We’re not going to overbuild affordable housing in my lifetime.”

But he said that not long ago, the rent differential between market-rate and affordable housing in certain markets like Austin and Atlanta was as little as $25 a month, showing that sometimes projects are built when they are not needed. “People took their eye off the ball when capital was easy to come by,” he said. Still, he said, affordable housing remains one of the safest of all real estate investments, with a default rate of only 0.08 percent.

Though the risk is minimal, tax credit investors now insist on financial guarantees from developers if the project runs into trouble, developers said. “The requirements are much more onerous,” said Robert Hoskins, president of the NuRock Companies, a developer in Alpharetta, Ga.

In Framingham, Mass., outside Boston, a nonprofit organization, Jewish Community Housing for the Elderly, has been stymied in its efforts to break ground on a 150-unit mixed-income development on land it has owned since 2003. “We have one investor we have received offers from,” said Allan Isbitz, the vice president for real estate, who had hoped to begin construction last year. “The offer has changed twice in the month that we have been negotiating with them. They want a lot of different risk reducers in the partnership agreement.”

He said his project was particularly challenging because it fell under the type of program that included bond financing. These days, investors are shying away from putting more debt on their books, he said.

New York City developers are also affected. Lemle & Wolff, a developer, won the right to build a mixed-income project on city land in the East Bronx. But with the decline in price of tax credits, the project is $3 million short of what it needs. “Making the numbers work is very, very difficult,” said Frank Anelante, the chief executive.

Last month, New York became the first state in the nation to allocate some of the $253 million in stimulus money intended to close the tax-credit financing gap, choosing nine projects deemed “shovel ready.”

The state is also working with a syndicator in Lansing, Mich., Great Lakes Capital Fund, that has created a fund to attract a new group of investors to projects upstate.

“We think there is an opportunity for new investors, who haven’t been in the market recently,” said James L. Logue, Great Lakes’ chief operating officer. “We’re cautiously optimistic.”

a public-private hybrid doesn’t work

TO BE NOTED: From Bloomberg:

"Fannie, Freddie Face Pressure to Revamp as U.S. Aid Increases

Share | Email | Print | A A A

By Dawn Kopecki

April 15 (Bloomberg) -- Fannie Mae and Freddie Mac are under pressure from lawmakers to revamp their operations as the mortgage-finance companies tap more government money to survive.

Among the options under discussion are combining the companies, breaking them up or reshaping their missions.

“It’s highly unlikely that they would return to the way they used to be,” said Ira Jersey, the head of U.S. interest rate strategy at RBC Capital Markets in New York.

Regulators seized Fannie and Freddie in September amid a rise in mortgage delinquencies that led to a combined net loss of $108.8 billion last year at the companies, the largest sources of financing for new U.S. home loans. The Treasury Department has injected $59.8 billion in emergency funds into the companies, including $46 billion issued two weeks ago.

Executives at Washington-based Fannie have discussed internally the possibility of taking over McLean, Virginia-based Freddie’s operations, according to people familiar with the matter. A formal approach isn’t imminent, said the people, who asked not to be named because the discussions are private.

The Treasury has agreed to give the two government- sponsored enterprises, or GSEs, as much as $400 billion through Dec. 31. That agreement probably will need to be extended by Congress before year-end, said Karen Shaw Petrou, a managing partner of Federal Financial Analytics Inc., a Washington-based research firm.

‘New Structure’

“There will be a massive re-write of the GSEs into some new structure,” though probably not this year, Petrou said.

House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, is exploring ways to separate the companies’ private and public missions, said Steve Adamske, a Frank spokesman.

A merger would be the quickest way for regulators to cut costs by reducing Fannie and Freddie’s combined 11,000-person workforce, shedding underperforming mortgage assets and reducing the bureaucracy of running two companies with identical functions, said Christopher Whalen, co-founder of Institutional Risk Analytics in Torrance, California.

Substantial movement toward a merger may not come quickly. James Lockhart, who oversees the companies as director of the Federal Housing Finance Agency, has said they will remain under government control until the housing market recovers, and the Obama administration has ordered Fannie and Freddie to focus on helping homeowners meet their mortgage payments.

Public Mission

“It’s got to happen; we’re not going to put them back the way they were,” Whalen said of a merger. “The only way we’re going to be able to manage them is if we squeeze every last ounce of savings out of the administrative side and just focus on trying to keep the loss number under control.”

Brian Faith, a Fannie spokesman, and Michael Cosgrove, a spokesman for Freddie, declined to comment on the possibility of a merger or other restructuring.

Fannie, created by the government in 1938, and Freddie, formed in 1970 to be a competitor, ensure that banks have cash available to make loans by buying mortgages or guaranteeing securities they help create from the debt. Together they own or guarantee about 56 percent of all U.S. home loans.

Freddie has received $44.6 billion in federal aid, about three times as much as Fannie. Freddie’s tab at the Treasury will cost it at least $4.6 billion in annual interest payments, almost triple what Fannie owes.

“With both of them as wards of the state, do you need two of them?” said Joshua Rosner, an analyst with Graham Fisher & Co. in New York.

Ousted Management

Lockhart’s agency put Fannie and Freddie under its control and forced out executives after examiners said the two may be at risk of failing, threatening further damage to the housing market.

Top management of the companies remains in flux. Freddie Chief Executive Officer David Moffett unexpectedly quit last month. Fannie CEO Herb Allison emerged this week as the leading candidate to run the $700 billion U.S. bank-rescue program, according to a person familiar with the matter.

Under Frank’s plan, a government trust fund would assume the companies’ responsibilities to subsidize rental housing and a remaining company would continue to do business in the private mortgage market, according to Adamske, the lawmaker’s spokesman. He said it’s too soon to say what the final structure would look like.

To make Frank’s proposal work, regulators may need to put one company into receivership, a process similar to bankruptcy, said Armando Falcon, who was Fannie and Freddie’s government supervisor from 1999 through mid-2005. The fastest way would be for “one to buy all the assets and assume all the liabilities of the other, place the rest of it into receivership and wind it down,” he said.

Home Loan Banks

The solution is to “break them up,” said Representative Spencer Bachus of Alabama, the top Republican on the House Financial Services Committee. “One possibility that I’ve looked at is letting the Federal Home Loan Banks take over some of their obligations and operations.”

The Federal Home Loan Banks are 12 government-chartered cooperatives that lend money for mortgages at below-market rates to their membership of more than 8,100 thrifts, commercial banks, insurance companies and credit unions.

Daniel Mudd, ousted as Fannie’s CEO after the government’s Sept. 6 takeover, said too much is being demanded of the companies, and that lawmakers should rethink the idea of shareholder-owned firms with public missions.

‘Robust’ Debate

“We need to have a robust policy debate,” Mudd, 50, said in an interview. “Do you want large companies to be focused exclusively on housing finance, albeit prone to produce the result -- just like we’ve seen recently -- that when the housing market goes down, there will be blood?”

Falcon, now an industry consultant at Canonbury Advisors in Alexandria, Virginia, said a public-private hybrid doesn’t work. He has advised other nations to avoid following the Fannie and Freddie example in developing their secondary mortgage markets, he said.

“There are just too many inherent risks in following the U.S. model,” he said. “All that has been proven out.”

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net."

some of the only companies still willing to buy these bundles of mortgages were Fannie Mae and Freddie Mac

TO BE NOTED: From Calculated Risk:

"Mortgage Fraud in 2008: Part II

by CalculatedRisk on 4/13/2009 06:29:00 PM

Here is the 2nd part of the VoiceofSanDiego article: A Staggering Swindle: How It Could Happen in 2008

In 2008, when the loans were made to McConville's buyers, some of the only companies still willing to buy these bundles of mortgages were Fannie Mae and Freddie Mac, even though the mortgage mess had affected them, too.

At the tail end of McConville's deals, last September, the federal government took over Fannie and Freddie, assuming more direct control of the companies' day-to-day operation and pumped in funding to absorb their losses. Now the taxpayers own 79.9 percent of Fannie Mae and Freddie Mac.

"You and I are getting stuck with these inflated loans, via Fannie and Freddie," [Real estate appraiser Todd Lackner] said.

There is a way out, as long as the smaller lenders who made the loans to McConville's buyers still exist. On any loans Fannie and Freddie bought, if they discover fraud or faults in underwriting in the loans, they'll send them down the chain, requiring the investor that sold the loans to the giants to buy them back. Ultimately, the original lenders might face those buybacks, said Michael Lea, a former chief economist for Freddie Mac.

But the small lenders who made these mortgages might not be in business anymore -- like Nazari's All American Finance.

Ask Wall Street what happens when they push back loans to the small lenders - they just close up shop.

Here was Part I: Rented Identities, Extravagant Prices and Foreclosure: A Post-Boom Real Estate Scam

And a related article: Mafia-Esque Charges Brought Against Alleged Mortgage Fraud Ring

Posted by CalculatedRisk "

Mortgage Fraud: RICO Charges Filed Against Straw Buyers

by CalculatedRisk on 4/13/2009 01:49:00 PM

Here is another story from VoiceofSanDiego: Mafia-Esque Charges Brought Against Alleged Mortgage Fraud Ring

Federal prosecutors on Tuesday announced unprecedented charges against individuals involved in an alleged mortgage fraud ring involving 220 properties in San Diego County, with total purchase prices topping $100 million.

The 24 defendants were all charged with participating in a "corrupt enterprise" under a federal law created by the Racketeer Influenced and Corrupt Organizations (RICO) Act...

... defendants include several real estate professionals ... a public notary ... a licensed real estate agent ... a licensed real estate appraiser ... a CPA; and ... registered tax preparers.
...
Prosecutors also name several straw buyers as participants in the corrupt enterprise ...

This is a different case than the previous story, but notice that the straw buyers are facing charges too. "Lend" out your good credit, sign false documents - and face prosecution and jail time.

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"Mortgage Fraud in 2008

by CalculatedRisk on 4/13/2009 11:24:00 AM

Kelly Bennett and Will Carless at the VoiceofSanDiego investigate: Rented Identities, Extravagant Prices and Foreclosure: A Post-Boom Real Estate Scam

Over the course of several months last year, [James D. McConville] picked up at least 81 condo conversions from distressed developers and orchestrated their sale to more than 20 buyers who'd rented him their identities ...

By arranging purchase prices well above market value, McConville was able to pay off the developers and capture what the developers' records state as more than $12.5 million. Now, 74 of the 81 homes involved in the deals in Sommerset Villas and Sommerset Woods in Escondido and Westlake Ranch in San Marcos are in the first stage of foreclosure.

McConville bought distressed condos from developers in bulk, and then sold them to straw buyers (individuals with solid credit records who agreed to sign for the loans for a fee). McConville pocketed the difference between the straw buyer price and the bulk price - approximately $12.5 million.

McConville promised to rent the properties, and pay the mortgages from the rental income.

The individuals had pristine credit, and one mortgage lender said:

"Everything was just absolutely perfect -- some of the cleanest loans we'd seen."

Of course the relationship with McConville was apparently never disclosed.

This was happening in 2008. Lenders were supposed to be back to the three C's: creditworthiness, capacity, and collateral. These straw buyers - who apparently were willing to falsely sign that they were the actual buyers - satisfied the creditworthiness and capacity criteria. But this raises serious questions about the appraisals.

Also McConville timed the multiple applications perfectly so the lender wouldn't see the other loans apps when they performed a credit check - that is pretty amazing.

Part II will be out today tonight ...

Posted by CalculatedRisk "

Bank of America Corp. and Wells Fargo & Co., which don't need warehouse funding, are increasing their dominance of the mortgage market

TO BE NOTED: From the WSJ:

"By JAMES R. HAGERTY

The regulator of Fannie Mae and Freddie Mac is considering giving the government-backed mortgage companies another role: helping to finance small mortgage banks.

A spokeswoman for the regulator, the Federal Housing Finance Agency, said it is looking at ways that the two companies might help revive the market for so-called warehouse loans, which are loans made to mortgage banks. This possible role for Fannie and Freddie is the latest sign of how they are being used increasingly as instruments of government policy rather than corporations focused on shareholder returns.

Reuters

John Courson, head of the Mortgage Bankers Association,wants Fannie and Freddie to help small lenders.

Demand for mortgages is surging as low interest rates prompt millions of Americans to refinance. New U.S. first-lien home-mortgage loans granted this year will surge to $2.78 trillion, up 72% from 2008's depressed level, the Mortgage Bankers Association predicts. But mortgage banks have been hobbled in recent months by a dearth of credit, making it hard for them to respond to that demand.

Partly as a result of this credit crunch, giant full-service banks like Bank of America Corp. and Wells Fargo & Co., which don't need warehouse funding, are increasing their dominance of the mortgage market. Consumers will face higher interest rates and slower service if mortgage banks can't get enough credit to compete with the giants, mortgage bankers argue.

The regulator has asked representatives of mortgage banks, including the Mortgage Bankers Association, to come up with a detailed plan for Fannie and Freddie to help mortgage banks get credit. John Courson, chief executive officer of the association, said in an interview that the plan should be ready to be presented to the regulator within about a week. One possibility is that Fannie and Freddie will guarantee debt issued by warehouse lenders, making it easier for them to provide financing to mortgage banks.

When mortgage bankers complained about the lack of warehouse funding, officials in the Treasury and Federal Reserve urged them to seek help from the regulator of Fannie and Freddie.

Last September, the regulator took over management control of the two shareholder-owned companies as surging defaults depleted their thin layers of capital. They are now being propped up by funds from the Treasury. Under regulatory control, they have shifted their focus to the prevention of foreclosures, even though that may delay their return to profitability. The Treasury also has said that Fannie and Freddie may play a role in supporting state housing-finance agencies.

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Bloomberg News

Mortgage banks typically are small, family-owned companies. Unlike commercial banks or thrifts, they aren't licensed to take deposits and so don't have that source of money for their loans. Instead, they borrow money from warehouse lenders, which often are units of larger banking companies. The mortgage banks use the short-term credit to provide loans to their customers and then pay back the warehouse lenders after selling the loans to bigger banks or to investors such as Fannie or Freddie.

Until credit markets froze up in 2007, Wall Street investment banks and many large mortgage lenders were eager to provide these warehouse lines of credit. Now, many of those big institutions have stopped making warehouse loans or have cut back on that business. Warehouse Lending Project, a group of mortgage bankers seeking to revive the market, estimates overall money available for warehouse loans has dropped nearly 90% since 2006, to about $25 billion

Mr. Courson said he believes the regulator can give Fannie and Freddie temporary authority to help fund warehouse loans and that it won't be necessary to seek congressional approval for this expansion of the two companies' role. "We just don't have the luxury of time for going through the legislative meat grinder," he said."

Federal Reserve Bank of New York said late Thursday it had purchased another $47.3 billion in agency mortgage-backed securities this week

TO BE NOTED: From HousingWire:

"The Federal Reserve Bank of New York said late Thursday it had purchased another $47.3 billion in agency mortgage-backed securities this week from government-sponsored entities Freddie Mac ([1] FRE: 0.80 -4.76%), Fannie Mae ([2] FNM: 0.72 -2.70%) and Ginnie Mae. For the week ending March 25, the Fed purchased, net of $14.1 billion in coupon sales, $33.2 in agency MBS.

The Fed bought $13.45 billion from Freddie’s books, $32.55 billion from Fannie and $1.25 billion off Ginnie’s books this week. Thirty-year 4 percent coupons were the most popular item purchased at $19.7 billion from all agencies, followed by 30-year 4.5s at $12.5 billion. Meanwhile, the Fed also sold $14.1 billion in Fannie’s coupons. Thirty-year 5.5s sold the most, at $7.25 billion, while 6s sold $4.7 billion and 5s sold $2.15 billion. It was the fourth consecutive week of listed sales. All told, the Fed’s purchases have grossed $355.15 billion so far, but net of sales that figure drops to $341.55 billion.

[3] See a detailed table of the current week’s purchases and sales.

The Fed’s assets gained $9.56 billion the same week ending March 25, according to a balance sheet summary released Thursday. The data show the Fed’s consolidated balance sheet grew to a value of $2.05 trillion, and is up $1.18 trillion from the year-ago week ended March 26, 2008. Last week, the Federal Open Market Committee released a statement announcing it had decided to [4] increase the Fed’s balance sheet in an attempt to “provide greater support to mortgage lending and housing markets….” The FOMC said it would increase the Fed’s purchases of agency MBS by $750 billion, to $1.25 trillion this year. It also announced it would increase the Fed’s commitment to purchase agency debt by $100 billion, to a total of up to $200 billion.

Write to Diana Golobay at [5] diana.golobay@housingwire.com."

Purchases in agency MBS by investment managers acting as agents for the System Open Market Account (SOMA). Purchases summarize all trades executed during the indicated period including purchases associated with dollar rolls. Purchases executed during this period and prior periods, which have settled, will be reported on H.4.1: Factors Affecting Reserve Balances
E-mail alert

Gross purchases from March 19 through March 25: $47,250 million Net purchases from March 19 through March 25: $33,150 million All amounts reflect current face.

Purchases Sales

	Purchases ($ million)
Maturity 30 Year	Coupon FHLMC FNMA GNMA 4 10,100 9,300 250 4.5 3,250 8,250 1,000 5 2,150 5.5 7,250 6 4,700
15 Year1	4 100 900
Other2
Total	13,450 32,550 1,250

1 Inclusive of 10 year product. 2 20 year, 40 year and other agency programs.

"a host of measures that would dramatically expand government control over banking and investment in the United States."

From the Washington Post:

"Obama Adviser Presents Plan to Alter Global Financial System

By Anthony Faiola
Washington Post Staff Writer
Thursday, January 15, 2009; 12:27 PM

NEW YORK -- A top economic adviser to the incoming Obama administration unveiled a plan today to radically rethink the global financial system, including a host of measures that would dramatically expand government control over banking and investment in the United States.( HERE WE GO )

The plan -- which recommends limiting the size of banks( IF THEY ARE GUARANTEED, I AGREE ), setting guidelines for executive pay( SHOULD BE DONE BY SHAREHOLDERS. BUT I'M OK WITH IT IF THE BANK IS GUARANTEED ) and regulating hedge funds( SUPERVISING I APPROVE OF ) -- offers the first hint of the kind of changes to the financial system President-elect Barack Obama might push for in the coming weeks and months. Obama has pledged to present a comprehensive series of changes to prevent a repeat of the current financial crisis before world leaders gather in London for a major economic summit in April.

The report today was issued by the Group of 30, an organization of international economists and policy makers. But the recommendations were immediately seen by observers as a building block to an Obama plan because the lead author is Paul Volcker, the former chairman of the Federal Reserve during the Carter and Reagan administrations who will serve as a special Obama White House adviser. Part of Volcker's role is to help mastermind what could ultimately be the biggest overhaul of the U.S. financial system in decades.

Volcker said he would press the new administration to consider the measures, "but it's up to the administration to decide what they want to do."

The proposal offers 18 major recommendations that would insert government regulators into the board rooms of financial institutions as never before. The plan recommends vastly increased oversight of major banks, going as far as to recommend the end of an era of mega banks whose size makes their failure potentially catastrophic to the global financial system. To limit their size and scope, banks, the document states, should be prohibited from managing hedge funds or private equity funds.( AGAIN, IF GUARANTEED, FINE )

In addition, major mutual funds should be required to operate as commercial banks, subjecting them to stricter government oversight. Those that choose not to comply should be forced to sell only relatively safe financial instruments offering investors low risk, and, most probably, limited room for outsized profits.( IF GUARANTEED, YES )

The document suggests that venture capital groups and rating agencies should also face a battery of government regulators.( WON'T WORK. SUPERVISION MIGHT. )

"The issue posed by the present crisis is crystal clear: How can we restore strong, competitive, innovative financial markets to support global economic growth without once again risking a breakdown in market functioning so severe as to put the world economies at risk?" Volcker said in a statement. "We hope that our proposals, which explicitly relate to the weaknesses that have become evident in the financial system over the last year, will be a useful contribution to the debate about needed reforms both by private financial institutions and by public authorities."

The proposal suggests that the U.S. government should clarify the status of mortgage giants Fannie Mae and Freddie Mac, either making them into government agencies or regulating them as independent mortgage brokers.( I AGREE COMPLETELY )

The plan's recommendations for greater international cooperation on regulation and the creation of new laws to oversee( SUPERVISION IS FINE ) exotic financial derivatives echo similar calls from major world leaders made during an emergency economic summit in Washington on Nov. 15. With cautious support by President Bush, plans are moving forward, for instance, to enhance international cooperation in overseeing major banks( A GOOD IDEA ). But European leaders have eagerly awaited a signal from Obama about what his plan for creating a new set of rules for the global financial system might look like.

It remains unclear how many of the recommendations will ultimately make their way into Obama's final plan, but the proposal released today could lift the spirits of Europeans who have called for stricter government oversight on executives' pay and risk management in financial institutions -- an area where the Bush administration has offered only tepid support. The report today calls for government to enforce systematic board-level reviews for executive pay and the creation of new parameters for a firm's risk tolerance."

As I've said, I differentiate between Guaranteed Financial Concerns and Non-Guaranteed Financial Concerns. The guaranteed businesses should have stricter rules and supervision in order to protect the taxpayer. I would prefer that we have a separate category for non-guaranteed concerns that will allow more leeway and innovation. In order to have such a category at all, I would be willing to accept size and asset limitations.

“Government support [of mortgages[ needs to be either explicit or non-existent, and structured to resolve the conflict between public and private

From my perspective, this is big news. Via HousingWire:

"U.S. Treasury secretary Henry Paulson managed to shake more than a few feathers in the mortgage industry Wednesday, with a speech that suggested in part that the government consider turning Fannie Mae ([1] FNM: 0.7884 +5.12%) and Freddie Mac ([2] FRE: 0.7975 +6.33%) into public utilities, akin to power and telephone companies.

“Government support [of mortgages[ needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes," he told the Economic Club of Washington. "Any middle ground is a recipe for another crisis."( MY GOD. THAT'S MY WHOLE POINT ABOUT WHY WE SHOULD AVOID GOVERNMENT/PRIVATE SECTOR HYBRIDS AND MAKE GUARANTEES EXPLICIT. AND I AGREE 100% THAT IF THESE POLICIES AREN'T CARRIED OUT, WE WILL HAVE ANOTHER SUCH CRISIS, ALTHOUGH HOPEFULLY NOT OF THIS MAGNITUDE, VERY SOON. FROM PAULSON, NO LESS. AMAZING. )

Prior to the government's take-over, the "inherent conflict" in the structure of Fannie and Freddie was obvious, Paulson contended. "[T]he GSEs served both a public mission and private shareholders — they received public support but operated for private shareholder gain … returning the GSEs to their pre-conservatorship form is not an option.”( TRUE )

That sort of policy decision won’t be Paulson’s to make, of course, since the outgoing Treasury secretary will be replaced on Jan. 20 by current New York Fed chief Tim Geithner. But Paulson outlined a utility-model for the GSEs that hasn’t been suggested in the past, likely in the hopes of influencing at least some debate over the future of Fannie and Freddie — and the government’s ultimate role in mortgage banking.

“A public utility-like mortgage credit guarantor could be the best way to resolve the inherent conflict between public purpose and private gain,” Paulson said. Under this approach, Fannie and Freddie would be replaced by a private entity or entities, regulated heavily by a rate commission, that would purchase and securitize mortgages guaranteed by the government. The private organizations would not have investment portfolios, he said.( THE ONLY WAY TO KEEP GOVERNMENT INVOLVED. YES. )

The suggestions drew sharp responses from industry participants.

“We have public utilities because of economies of scale in power and utility production and distribution and because everyone needs it,” Jim Vogel, head of fixed-income research at First Financial Capital Markets Corp., [3] told American Banker. “So you need a common capital pool to produce utilities. I’m not sure how mortgages fit into any of those economic categories unless we’ve just changed the whole nation’s housing system( IT CHANGED ITSELF FRIEND, BY TURNING A BLIND EYE TO OR ACTUALLY COMMITTING FRAUD. ).”

Vogel’s remarks underscore what may be the core agenda difference between more than a few consumer groups and those in the industry: is housing a right for everyone? Or is it a privilege for those who have the means to afford it? Much of the lobbying sure to follow over the GSEs in months to come will center squarely on whatever vision for the nation’s housing system a particular group subscribes to.( LET'S CHOOSE ONE ALTERNATIVE. )

Other options for the GSEs Paulson discussed included nationalization( FINE ), privatization( MY PREFERENCE. ONLY NOT IF IT'S GUARANTEED. ) and one hybrid approach( NO ); all are options that have been discussed before, and Paulson made it clear there are problems with each, at least in his view.

Soon-to-be Treasury secretary Timothy Geithner and the new administration will need to decide if the government will explicitly( CHOOSE. NO MORE IMPLICIT GUARANTEES. THEY'VE WORSENED THE CRISIS SIGNIFICANTLY. ) back Fannie and Freddie debt and mortgage-backed securities, said Paulson. Doing so, however, would come with some hurdles; the Congressional Budget Office has already said in Sept. 2008 that it believes the GSEs [4] should be incorporated directly into the federal budget. An explicit guarantee would likely force that to take place.( IT SHOULD. YES. THE WHOLE ARRANGEMENT SHOULD BE DISCUSSED AND VOTED ON. )

Paulson also suggested that the Obama administration could use the GSEs to push mortgage rates down to 4 percent, but warned — as we have at HousingWire in the past — that doing so would require a huge issuance of new Treasury notes( A VERY BAD IDEA. ); he also hinted that the government could use such a program temporarily, as well. Of course, such efforts would require that the GSEs remain under government control, something Paulson doesn’t believe is feasible long-term.( I AGREE )

“Fannie Mae and Freddie Mac are in a temporary form that, while stable, cannot efficiently serve their Congressionally-chartered mission and protect the taxpayers’ investment over the long-term,” he said. “We took the right actions to meet a specific need at a specific time.”

In other words: what happens next is a problem for the next guy.

[5] Read Paulson’s full remarks.

- Paul Jackson contributed to this report.

Write to Kelly Curran at [6] kelly.curran@housingwire.com.

Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade."

Here's Paulson:

"Washington – Good afternoon. Thank you, David and thanks to the Washington Economic Club for this opportunity to provide my thoughts on long-term reform of the housing Government Sponsored Enterprises, the GSEs, Fannie Mae and Freddie Mac.

Debate over the role and function of these entities has raged for years. Congress established Fannie and Freddie decades ago to meet a public policy goal – to increase the funding available for home mortgage financing. The GSEs achieve this through providing liquidity to the secondary market for a limited range of home mortgages, either through credit guarantees on mortgage-backed securities (MBS) or by directly investing in mortgages and mortgage-related securities through their retained mortgage portfolios. To further this mission, their congressional charters grant the GSEs several benefits which together created a perception that the GSEs were backed by the U.S. government, even though this was not the case. This "implicit" government guarantee provided the GSEs with a funding advantage over other mortgage market participants.( AND IS A CAUSE OF THIS CRISIS. )

The inherent conflict( AS IN ALL HYBRIDS ) in this structure is obvious – the GSEs served both a public mission and private shareholders – they received public support but operated for private shareholder gain. While policymakers of every ideological stripe have acknowledged the risks created by this conflict( SEVERE ), entrenched debate, often with little recognition of market realities, prevented reform. Over time, the GSEs' advantages enabled them to grow at a phenomenal pace, so that today they have $5.4 trillion in obligations outstanding, held by investors in the U.S. and around the world. As a comparison, that is almost 40 percent the size of the entire $14 trillion U.S. economy. The systemic risk posed by such size was heightened by the fact that investors assumed that GSE securities were backed by the U.S. government and therefore virtually risk-free, despite repeated statements by consecutive U.S. administrations to the contrary( A TERRIBLE MISTAKE ). These debt-holders would be the largest, but not the only, conduits of systemic impact should either GSE fail. Derivative counterparties, for example, would also be overwhelmed by a default of either GSE.

For some time market participants had questioned whether the GSEs were adequately capitalized for the risk they were taking, and therefore able to withstand losses without triggering a systemic event. Policymakers acknowledged that the GSE regulator did not have the authorities to address these risks, yet they could not reach consensus to improve it, and instead left a clearly inadequate regulatory structure in place. When I came to Washington, I saw an opportunity to improve the regulatory structure, even if it wouldn't be perfect. I set to work in the fall of 2006 to broker progress in the House, and we did begin to solve some of the seemingly intractable differences.

Even as Washington debated GSE oversight, there was little debate over the extent to which government should subsidize homeownership( I WOULD RATHER IT SUBSIDIZE HOUSING WITH CASH FOR INDIVIDUALS TO USE FOR ANY HOUSING. ) , and whether such government support was contributing to a housing bubble( IT DID. ). The U.S. government has many policies that subsidize homeownership – it would be oversimplifying and wrong to blame Fannie and Freddie for the bubble, but they clearly are part of the public policy bias that contributed to it. ( IT'S TRUE. A SMALL PART. )

In sum, the GSE reform debate was largely frozen in place, or moving at glacial speed. Then suddenly, the unprecedented housing correction shifted the ground under that debate and forced action.

Today I will review the actions we have taken and their effect, and address two issues before us. First, in the short-term, how do we use the GSEs to mitigate the current credit crisis and housing downturn? Second, given the temporary nature of their current status, how might we address the appropriate long-term structure?

Prelude to Recent Actions Regarding Fannie Mae and Freddie Mac

As we progressed through the current housing market downturn, investors fled mortgages that carried any credit risk( A CALLING RUN, CAUSING A FLIGHT TO SAFETY. ). But because the GSEs take the credit risk on the mortgages they guarantee and because investors believed there was implicit government backing, the conforming loan market continued to function relatively well( THAT'S CORRECT. BECAUSE OF THE IMPLICIT GOVERNMENT GUARANTEES. ). As a result, the GSE share of new mortgage business rose from 46 percent in the second quarter of 2007 to 84 percent in the second quarter of 2008( TRUE. EVIDENCE THAT PEOPLE SUSPECTED A BUBBLE AND WANTED GOVERNMENT GUARANTEES. ). Without the GSEs to finance mortgages, it was very clear that mortgage finance would essentially dry up.( TRUE. RISK WAS TOO HIGH. NOTICE: MANY PEOPLE SAW A CRISIS APPROACHING. )

However, as the extraordinary housing correction deepened, weaknesses in these entities became apparent. In July 2008, investors lost confidence as they became increasingly uncertain about Fannie and Freddie's capital position. The GSEs' already depressed stock prices plummeted further. Shareholder losses did not pose a public policy concern, but the share price drop further weakened confidence among the holders of the $5.4 trillion of GSE debt and MBS. Investors at home and abroad were reducing purchases and even selling from their holdings of GSE debt( AGENCY DEBT. THE FLIGHT TO EXPLICIT GUARANTEES. ). The consequences of either GSE failing would be catastrophic. We couldn't wait for a failure; we had to act preemptively to shore up confidence in these enterprises.( I AGREE )

In July, I requested that Congress quickly complete work on long-sought GSE regulatory reform and also provide Treasury with expanded authority to support Fannie, Freddie and the Federal Home Loan Banks. Congress did so – giving us enormous temporary authorities to inject capital if the GSEs asked for it, and to create a back up liquidity facility for GSE debt.( YOU SHOULD HAVE MADE THE GUARANTEE EXPLICIT. THAT'S THE ONLY WAY TO END A CALLING RUN. )

Immediately after passage of the legislation, in coordination with the Federal Reserve, the newly-constituted GSE regulator, FHFA, and our advisor Morgan Stanley, we began a comprehensive financial review of the GSEs. At the same time, mortgage market conditions continued to deteriorate. Negative earnings announcements by Fannie and Freddie in August reflected those worsening conditions, and further roiled markets. Neither company appeared to have any reasonable prospect of raising private capital( WON'T WORK IN A CALLING RUN. ) to allay those concerns in the foreseeable future, and our examination found capital to be inadequate – in terms of both the quality of capital and the embedded losses stemming from worsening mortgage market conditions.

Confidence in the GSE model was largely shattered. It was clear to me that simply injecting even a great deal of equity into their business model would not create the market confidence necessary to fund these enterprises going forward and to bolster confidence in the $5.4 trillion of extant GSE obligations, which posed the greatest systemic risk. Market fragility and the GSEs' deteriorating balance sheets required that we take responsibility for the GSE structural ambiguities( IMPLICIT GUARANTEES ) that U.S. policymakers had let fester for decades. If we had asked Congress for, and received, the power to explicitly guarantee the GSEs' obligations, we would have done so( THIS WAS WHAT NEEDED TO BE DONE. ). But without that authority, we had to be creative and find a way to effectively guarantee the GSEs' obligations.

We had to stabilize the situation immediately. We knew that markets were exceptionally fragile and would be further threatened in September when we expected that a number of large financial institutions, including Lehman Brothers, would post disappointing earnings. Chairman Bernanke, FHFA Director Lockhart and I met almost daily, over a 10 day period, to work toward a comprehensive action plan. As I made clear at the time, we sought a temporary solution that would achieve three goals: (1) stabilize markets, (2) promote mortgage availability, and (3) protect the taxpayer( ONLY TAKING OVER A COMPANY DOES THIS. ).

In comprehensive action taken on September 7th, FHFA placed Fannie and Freddie into conservatorship, enabling Treasury to take creative steps to support their obligations. We moved quickly to do what was necessary. Our actions would have been impossible to implement were it not for the GSE reform legislation that gave FHFA the expanded power to make qualitative and quantitative judgments about capital and also gave Treasury the financial authorities necessary to make conservatorship a stabilizing, as opposed to a destabilizing, event. We devised Preferred Stock Purchase Agreements to effectively guarantee the GSEs' obligations by ensuring Fannie and Freddie would maintain a positive net worth. This commitment ensures that they can fulfill their financial obligations, even after the temporary authorities expire in December 2009. Additionally, Treasury established a new secured lending credit facility intended to serve as an ultimate liquidity backstop. To further support the availability of mortgage financing, Treasury initiated a program to purchase GSE MBS and has purchased over $50 billion thus far.

We took these actions first, to avert the financial market meltdown that would ensue from the collapse of these institutions and, second, to allow the GSEs to continue, in the midst of overall market stress, to perform their essential role of providing mortgage finance. This conservatorship, with the explicit backing of the federal government( WASN'T ENOUGH ), is temporary and must be resolved for the long-term. In the meantime, the GSEs must serve the taxpayers' interest by assisting in turning the corner on the housing correction, which is critical to return normalcy to the capital markets and resume U.S. economic growth. The GSEs can facilitate progress through the housing correction by keeping mortgage rates low and by mitigating foreclosures.( A TOUGH JOB )

Keeping Mortgage Rates Low

Lower mortgage rates enable more potential homebuyers to return to the market and help put a floor under home prices. Initially, following our September actions, mortgage rates did fall. Market turmoil subsequently increased and mortgage rates rose, but not nearly as much as the cost of other forms of credit. Still, neither the taxpayers nor the economy were getting the full benefit of the agreements put in place to effectively guarantee GSE debt. We could have gone back to Congress to ask for authority to directly guarantee GSE debt, however this would have been difficult to achieve. While a simple, direct government guarantee of GSE MBS might have reduced rates further ( WE SHOULD HAVE DONE THIS ) – given the extraordinary strains in today's markets it probably would still have failed to produce all of the desired mortgage rate reductions. Therefore, we examined other means of deploying our authorities that could reduce mortgage rates.

We immediately noted that, given the effective government guarantee and the spread between Treasury rates and those of the GSEs, the taxpayers would profit if the government simply issued Treasuries to buy GSE securities( I DON'T LIKE IT, BUT IT MAKES SENSE. ). And in fact, we have funded the purchase of GSE securities with the issuance of Treasury bonds. But to make an impact on mortgage rates, such an initiative would have to be very large and those Treasury issuances would count against the debt limit.

On November 25, the Federal Reserve announced a new program to purchase up to $100 billion in GSE debt securities and $500 billion in GSE MBS. This Federal Reserve program had a significant impact. The 30-year fixed rate has fallen from an average of 6.04 percent the week before the policy was announced to a record low 5.10 percent last week, accomplishing a vitally important step in addressing this housing correction – lower mortgage rates( I DON'T SEE THIS DOING MUCH. ) that may bring additional credit-worthy buyers into the housing market.

Foreclosure Mitigation Efforts

While the GSEs are in this temporary form, we have also worked to increase their impact on foreclosure mitigation. In November, FHFA, the GSEs, Treasury and the HOPE NOW Alliance announced a major streamlined loan modification program (SMP) to move struggling homeowners into affordable mortgages. The new protocol relies heavily on the "IndyMac model" developed by the FDIC and creates sustainable monthly mortgage payments by targeting a benchmark ratio of housing payments to monthly gross income. Together with the IndyMac/FDIC protocol, the SMP creates a powerful new model that should help ensure that no borrower who wants to stay in their home and can make a reasonable monthly payment will fall into foreclosure.( NOT WORKING WELL ENOUGH )

The SMP will directly and immediately apply to the 50 percent of homeowners with loans serviced under the GSEs' auspices. Fannie and Freddie announced that they would suspend foreclosure sales and cease evictions of owner-occupied homes until January 9th to allow time for implementation of the modification program. The timing of this initiative is especially important as prime loans now account for almost 50 percent of new delinquencies, and delinquencies are increasingly the result of overall economic factors rather than the loan features and underwriting practices associated with Alt-A and subprime products.( TRUE. ONE BIG REASON TO STOP A CALLING RUN. )

And the impact of the SMP will go much further. The vast majority of servicing contracts for non-GSE mortgages reference the GSEs' practices, and we therefore expect the SMP to be widely adopted and quickly move hundreds of thousands of struggling borrowers into sustainable, affordable mortgages. Further, this streamlined protocol frees up servicing industry resources that can be redirected to providing case-by-case assistance to more difficult cases that fall outside the SMP protocol. ( I DOUBT THIS )

Impact of Temporary Authorities to Stabilize the GSEs

Given the authority granted by Congress last summer, we have gone about as far as we can to avert systemic risk and to use the GSEs to speed progress through the housing correction that lies at the heart of our economic downturn. Although the effective guarantee of GSE debt and MBS has brought some degree of stabilization, it is not the most efficient way to remove the ambiguity inherent in the GSE structure, even temporarily.

To the extent that the Congress and the next Administration wish to use the GSEs as a tool to further reduce mortgage rates, they could, under existing authorities, make large purchases of mortgages made at a target rate of, say, 4 percent – although very large volumes of Treasury issuances would be required for such a program to be effective. A targeted program such as one that purchases only new mortgages made for home purchases, as opposed to refinancing, for a one year period would require less but still substantial funding. Separately, the next Administration could pursue legislative authority to directly guarantee GSE debt for the remainder of the conservatorship period. ( TRUE )

Long-Term Policy Recommendations

The GSEs are playing a necessary role supporting the mortgage availability which is essential to eventually turning the corner on the housing correction, reducing the stress in our capital markets and returning to growth in our economy. This must continue to be our first priority. But we will make a grave error if we don't use this period to decide what role government in general, and these entities in particular, should play in the housing market.

The public debate over the long-term structure of the GSEs is dramatically changed today – no one any longer doubts the systemic risk these entities posed. It is clear to all conservatorship is a temporary form, and that returning the GSEs to their pre-conservatorship form is not an option.

The debate about the future of Fannie and Freddie requires answering the much larger and more important question of the federal government's role in the mortgage market and in housing policy, generally. Given the bubble we have experienced, policymakers must ask what amount of homeownership subsidies are appropriate. Numerous long-standing indirect subsidies already exist, including the mortgage interest deduction, subsidized FHA mortgages, and the variety of other HUD programs that expand homeownership opportunities.( GET RID OF THEM. )

Is that enough? Or should government also reduce mortgage rates for a larger group of homebuyers? Policymakers must decide if the GSE subsidy is a public policy priority. If the GSEs are to play a role, then, the debate is clearly framed: Government support needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes( ABSOLUTELY CORRECT ).. Any middle ground is a recipe for another crisis. ( I AGREE )Although there are strong differences of opinion over the government's role in supporting housing, under any course policymakers choose, there are structures and choices that can resolve the long-term conflict of purposes issues.

And it is clear that to protect against systemic risk in the future, the GSEs should be constituted with a portfolio no larger than what is minimally necessary for warehousing purposes. Without portfolios of significant size, the enterprises' management of interest rate risk would remain a vital function for the safety and soundness of the enterprises, but would no longer present the same potential systemic risk.( FINE )

As a public policy tool to expand homeownership, the GSEs, like FHA-Ginnie Mae, reduce mortgage rates for borrowers by taking on the credit risk that mortgage investors would otherwise bear and guaranteeing( YES ) that mortgage investors will be paid in full should the mortgage borrower default. As Congress considers the future role and structure of the GSEs, it must consider how much credit risk the Federal government should take.( I AGREE )

Addressing Credit Risk

In today's stressed mortgage market, between FHA-Ginnie Mae, Fannie Mae, and Freddie Mac, almost all new mortgage market originations have federal government credit support. This is not sustainable over the long-run( TRUE ). It will lead to inefficiency, less innovation and higher costs. It also contradicts basic U.S. market principles. We must have some degree of private sector involvement in the evaluation of credit risk if we are going to have a mortgage market that allocates resources with efficiency.( TRUE )

In the mortgage market of the future, I clearly see a role for the FHA and Ginnie Mae for first-time and low income homebuyers. Beyond the explicit guarantee provided to FHA and Ginnie Mae policymakers must decide how much to further subsidize mortgage credit risk, if at all, and must decide the role of private capital in any subsidy plan. Depending on the degree of subsidy policymakers choose, there are a variety of options for structures to replace the GSEs, including:

(1) Expanded FHA/Ginnie Mae. Some advocate that beyond the current credit crisis the U.S. government's long-term policy should make the implicit, explicit. Explicitly guaranteeing Fannie and Freddie's obligations would essentially nationalize this significant portion of the U.S. housing finance market. Under this model, the GSEs could become a government entity, or their functions could be absorbed by FHA/Ginnie Mae . In either case, the GSEs would no longer have private shareholders. The size of the eligible population of homebuyers would determine how large a share of mortgage credit exposure the government would own.( I AGREE )

I view the permanent nationalization of the GSEs, essentially expanding the role of FHA and Ginnie Mae, as a less-than optimal model( I AGREE ). While it offers the perceived advantage of explicit government support, it eliminates the necessary private sector evaluations of credit risk and the private market stimulus to innovation.

(2) Partial Guarantee.( UNDER NO CONDITIONS ) A hybrid of this would be to create a Ginnie Mae-like entity for non-FHA mortgages, structured as a partial guarantee mechanism. The new entity could operate on a similar basis as Ginnie Mae, but provide only partial guarantees for MBS. Investors would then have a floor under potential MBS losses, but would still evaluate the credit risk associated with individual issuers. While such a hybrid program would clearly define the extent of the government's guarantee, developing risk sharing parameters compatible with profit incentives would be as problematic, and potentially as inefficient, as in the current GSE structure.

(3) Privatization. A third alternative would be to remove all direct or indirect government support, completely privatizing these companies while breaking them up to minimize systemic risk. As appealing as this alternative sounds, it is difficult to envision a sound, practical, private sector mortgage insurance business of any significant size that does not require large amounts of capital, and consequently generates only a modest return on capital. The recent problems encountered by monoline insurers, which ventured into guaranteeing mortgage product as well as the experience of the GSEs, underscores this point. Moreover, a break up scenario does not look particularly promising, as reverse economies of scale would take hold. It is also worth noting that a regional mortgage insurer would lack diversity as a risk mitigant. Perhaps a consortium of banks would find it advantageous to own a national mortgage insurer to wrap their product, or some other good private sector business model may emerge. But I am skeptical that the "break it up and privatize it" option will prove to be a robust or even viable model of any substantial scale, without some sort of government support or protection( NO WAY THEN ). However, should policymakers choose to scale back public policy bias toward homeownership, we will eventually find out what business model the free market would support.

(4) Housing Utility. Finally, given traditional U.S. public policy support for marshalling private capital to expand homeownership, establishing a public utility-like mortgage credit guarantor could be the best way to resolve the inherent conflict between public purpose and private gain. Under a utility model, Congress would replace Fannie Mae and Freddie Mac with one or two private sector entities. The entities would purchase and securitize mortgages with a credit guarantee backed by the federal government, and would not have investment portfolios. These entities would be privately-owned, but governed by a rate setting commission that would establish a targeted rate of return, thereby addressing the inherent conflicts between private ownership and public purpose that are unresolved in the current GSE structure. This commission would also approve mortgage product and underwriting innovations to continually improve the availability of mortgage finance for a population to be defined by the Congress. In this model, continued safety and soundness regulation would be essential.( TRUE )

Need to Support Vibrant Private Market

If we are to maintain a private-sector secondary mortgage market – which I believe serves the taxpayer and the homebuyer equally well – then we must enhance the ability of depository institutions to fund mortgages, either as competitors to a newly-established government structure or as a substitute for government funding. One way to do this is for the government to receive some compensation for its guarantee( A POSSIBILITY ). The current GSE Preferred Stock Purchase Agreements take a small step in this direction, in that as of 2010 the GSEs must pay the government a fee for the taxpayer backstop on their guarantees. Of course, if this rate perfectly reflected the risk versus the cost of the guarantee, there would be no subsidy to mortgage availability. It is obviously inherently difficult to reach an exactly correct price, yet a long-term fee-like structure in exchange for explicit government backing would help to reduce advantages over private institutions( TRUE ). Over time, another approach might be to offer other financial institutions the opportunity to pay a fee for government backing on securitized, conforming loans, a structural transformation that would lower entry barriers, and increase competition and innovation in housing finance.( A GOOD IDEA )

Covered bonds are another private sector alternative worth exploring. The FDIC has made regulatory changes to support the emergence of covered bonds, which could provide enhanced opportunities for depository institutions to fund and manage mortgage credit risk. There is strong interest in developing a U.S. covered bond market, but we will have to work through the credit crisis before a new market is likely to take hold. Some have advocated dedicated covered bond legislation, which could be helpful to establishing this market, and should be considered in the context of broader housing finance reforms.( A GOOD IDEA )

Additionally, the President's Working Group on Financial Markets has recommended extensive reforms in the mortgage securitization process by investors, ratings agencies, underwriters and regulators, especially with respect to mortgage origination oversight. When these reforms are in place, we expect private label securitization to return with greater oversight and market discipline.( UNCOVERING AND PROSECUTING CRIMES WOULD HELP )

Conclusion

My thoughts today are intended to inform the necessary debate over the future structure of the housing GSEs. By allowing the GSE structural ambiguities to persist for too long, U.S. policymakers have created an untenable situation. Today, Fannie Mae and Freddie Mac are in a temporary form that, while stable, cannot efficiently serve their Congressionally-chartered mission and protect the taxpayers' investment over the long-term. We took the right actions to meet a specific need at a specific time.

The GSEs are critical to getting us through this current period, and this is our first priority. More may need to be done to clarify and simplify their structure and to increase their effectiveness in curbing further housing price correction. But we cannot look only at this short-term need; policymakers must resolve the question of long-term structure because the pre-conservatorship model has been disproven.

The first step must be for policymakers to decide – in light of the recent housing bubble and the severe financial and economic penalty it has imposed on our nation – the role government should play in supporting home ownership. We cannot allow a repeat of the devastation this housing correction has wreaked on families and communities across the United States. Once that decision is made, the GSEs should be restructured to meet that public policy choice and satisfy three objectives: First, there must be no ambiguity as to government backing. It must be explicit or non-existent( I AGREE ). Second, there must be a clear means of managing the conflict between public support and private profit( I AGREE ). Third, there must be strong regulatory oversight of the resulting institutions( I AGREE, ALTHOUGH I WANT SUPERVISION. )

As I have outlined, whatever role the U.S. government chooses to play in subsidizing mortgage finance, there is a structure that can meet the objectives. With the knowledge of recent experience, we have a responsibility to begin work now on a long-term GSE structure which avoids the dangerous mix of policy and market distortions created by the former flawed GSE model( I AGREE ). Thank you."

Unbelievable. A very good speech. Of course, now that he's on my team, he's already become irrelevent. In order to stop a calling run, there will have to be some explicit government guarantees. I'm fine with any alternative that does that, although a more free market approach would please me. My only worry about the paying for a guarantee method is that we also need to implement other complimenatry measures, in order that this insurance not encourage too much risk. As far as housing is concerned, I favor a general housing subsidy for the less well-off. I would not favor any particular housing sector.