Committee Grills Ex-Officers on Fannie, Freddie ‘Irresponsibility’

The Committee on Oversight and Government Reform on Tuesday conducted a hearing to probe the role of government-sponsored entities Fannie Mae (FNM) and Freddie Mac (FRE) in the financial crisis. The Committee heard testimony from former Fannie executives Daniel Mudd, Franklin Raines, and Edward Pinto, as well as Freddie executives Leland Brendsel and Richard Syron. The Committee also reviewed a variety of evidence, from internal memos from the GSEs to a copy of a Fannie Mae presentation dated back to June 2005 that suggested a way to cope with aggressive growth in the ARM business and accelerated risk in mortgage products would be for the GSE to “meet the market where the market is” by accepting high-risk debt to increase revenue and gain faster book growth. Committee chairman Henry Waxman (D-CA), in his opening statements, accused the GSEs of taking irresponsible actions that could cost billions of taxpayer dollars. “The documents make clear that Fannie Mae and Freddie Mac knew what they were doing,” he said. “Their own risk managers raised warning after warning about the dangers of investing heavily in the subprime and alternative mortgage market. But these warnings were ignored.” Fannie’s chief risk officer sent an e-mail to company CEO Daniel Mudd in October 2006, warning about a “serious problem” at the company. “There is a pattern emerging of inadequate regard for the control process,” the risk officer wrote in the email, according to Waxman’s opening testimony. The same risk officer wrote Mudd again in July 2007, saying he had been warning the company lacked the proper control process for managing more credit risk, but that the board of directors had been falsely told the company had “the will and the money to change our culture and support taking more credit risk,” according to Waxman. Despite the accusation that he had willingly endangered Fannie’s liquidity by taking on additional risk, Mudd presented his testimony to the Committee, saying that through 2008, he has “worked with government officials, regulators, our customers in the banking system, housing advocates, and others to maintain an excruciating balance between providing liquidity to keep the market functioning and protecting Fannie Mae’s regulatory capital.” But Waxman questioned the real motives of the executives in his opening statements. “Taking these risks proved tremendously lucrative for the Fannie and Freddie CEOs,” he said. “They made over $30 million between 2003 and 2007. But their irresponsible decisions are now costing the taxpayers billions of dollars.” Fannie’s decision to take on riskier debt “alerted the originator community that if they could make subprime and Alt-A loans, there was ready market for them, and this stimulated an orgy of junk mortgage development,” according to the testimony of Edward Pinto, who served as Fannie’s chief credit officer from 1987 to 1989. “Likewise, Fannie’s massive expansion of its portfolio investments in the early 1990s would pressure Freddie to follow suit,” Pinto said. “Eventually Fannie and Freddie would announce over $5 trillion in affordable housing initiatives. This unprecedented abandonment of underwriting principles coupled with the fact that the GSEs were permitted to take on $5.6 trillion in credit risk and maintain portfolios of $1.5 trillion has put America’s homeowners at risk.” The GSEs “ignored common sense” and the warnings of their own credit risk experts and  loosened lending standards, unleashing a flood of unsustainable, default-prone loans, according to Pinto’s testimony. “Compounding the problems caused by their minimal capital was the fact that they followed an origination model initially established by FHA that enabled thinly capitalized mortgage brokers and bankers to take over virtually the entire origination market,” he said. But were the GSEs solely to blame? Waxman did, however, cut the GSEs a little slack. He acknowledged the CEOs of Fannie and Freddie may have made bets that eventually led to the downfall of their companies and might end up costing taxpayers hundreds of billions of dollars. “But it is a myth to say they were the originators of the subprime crisis,” Waxman said in his opening statements. “Fundamentally, they were following the market, not leading it. It is also a myth to blame the nation’s affordable housing goals.” Former Fannie CEO Franklin Raines echoed Waxman in his own testimony, in which he argued that Fannie Mae “invested relatively little in subprime mortgages,” as they account for less than 1 percent of its guaranty book of business. The majority of Fannie’s losses, he said, were due to credit losses on Alt-A loans, not subprime loans. “I continue to believe in the mission for which Congress created Fannie Mae and Freddie Mac, to expand middle- and low-income home ownership by providing liquidity to the primary mortgage market,” he said. “I believe that, properly regulated, these entities have a more important role than ever to play in increasing the liquidity in the mortgage market and innovating solutions to today’s mortgage-financing crisis.” Write to Diana Golobay at [email protected]. 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.