The role of Fannie Mae and Freddie Mac in the subprime lending crisis will be fleshed out in court thanks to lawsuits filed today against former executives of the quasi-governmental agencies. Bloomberg has the basic facts about the suits:
Daniel Mudd, the former chief executive officer of Fannie Mae, and Richard Syron, ex-CEO of Freddie Mac, were sued by the U.S. Securities and Exchange Commission for understating by hundreds of billions of dollars the subprime loans held by the agencies. …
In the lawsuits, the SEC said Syron, Mudd and others understated the lenders’ exposure to subprime mortgage loans. From 2007 to 2008, Freddie Mac executives said the company’s exposure was between $2 billion and $6 billion when it was actually as high as $244 billion, according to one SEC complaint. From 2006 to 2008, Washington-based Fannie Mae executives said the firm’s exposure to subprime mortgage and reduced documentation loans was about $4.8 billion when it was nearly 10 times greater, according to the regulator.
“Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was,” Robert Khuzami, director of the SEC’s enforcement division, said today in a statement. “These material misstatements occurred during a time of acute investor interest in financial institutions’ exposure to subprime loans, and misled the market about the amount of risk on the company’s books.”
The defendants and/or their attorneys are denying wrongdoing.
Peter Wallison, a member of the Financial Crisis Inquiry Commission, explains why these misleading reports were so important:
[B]y 2008, before the financial crisis, Fannie and Freddie were holding or had guaranteed 12 milllion subprime or other risky loans but had not reported that fact to the markets. This made it extremely difficult for risk managers at banks, investment banks, rating agencies, and other financial institutions to understand the risks of securities backed by subprime and other weak loans, and this was one of the major causes of the financial crisis.
The lawsuits certainly lend credence to the argument, which I and many others have made, that Fan and Fred greatly exacerbated the housing and financial crises. They don’t absolve other bad actors, including the lawmakers who created incentives for banks to make risky loans, the regulators who were asleep at the switch, the ratings agencies that rated risky financial instruments as safe, the Federal Reserve for keeping monetary policy too lax for too long, and the banks themselves that in any event were over-leveraged.
That said, understating the GSEs’ exposure to subprime loans by factors of roughly ten and sixty, respectively, undoubtedly would have had a material effect on those other actors’ ability to properly gauge what was going on in the housing market in the mid-2000s.
I hope these lawsuits are contested in court until the very end, with all the facts and evidence presented in full, because they could be crucial to our understanding what really happened in the lead-up to the financial panic and crash, and the resulting recession.
– By Kyle Wingfield