SEC accuses ex-execs at Fannie, Freddie with understating subprime exposure by tens of billions of dollars

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

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39 comments Add your comment

saywhat?

December 16th, 2011
12:33 pm

It was the teachers’ unions’ fault, or poor people.

Stephenson Billings

December 16th, 2011
12:55 pm

But Barny Frank told me they were both on sound financial footing, that they don’t need any investigating, and that they had nothing to do with the financial crisis :rolleyes:

JF McNamara

December 16th, 2011
1:12 pm

How did they know it was bad?

Part of the problem is that the banks were paying the credit agencies to give investment grade ratings to packaged debt offerings then getting them insured by Fannie and Freddie. Fannie and Freddie based their estimate of subprime on the ratings agencies.

They probably had an idea that the rating system was broken, but what were they supposed to do? Not insure paper with a AAA rating?

Ayn Rant

December 16th, 2011
1:29 pm

Whose idea was it to “privatize” those quasi-governmental agencies, anyhow? Sounds like some wildly irresponsible Republican penchant for running things like a “bidness”!

Yeh, the F’s were run just like Lehman Bros., Merrill Lynch, CitiBank, etc.!

John

December 16th, 2011
1:39 pm

Wasn’t that around the time Newt Gingrich was a consultant to Freddit Mac?

The Lack and Absence of Moral Principles by the Republicans

December 16th, 2011
1:44 pm

IT’S NEWT’S FAULT!

carlosgvv

December 16th, 2011
1:50 pm

So, all of this happened under Bush’s watch? Don’t worry cons. It’s all Clinton’s fault.

Hillbilly D

December 16th, 2011
2:01 pm

One factor in all this has been overlooked, especially as it pertains to Georgia, the rules were changed a few years back, so that when a new bank was opened, it could be sold after 2 years. Don’t remember what the term was before that but it was longer. What happened, at least in my area, was that people opened banks, right and left, with the intention of keeping the bank 2 years, then selling it to a larger bank and making a killing in the process. The old reasons for opening a bank of serving the community and/or running a sound business over a number of years, disappeared. How do you make your bank look as attractive as possible to a potential buyer in 2 years? You loan money to anybody who walks in the door to boost the numbers. At this time, there is one locally owned bank left, in my area. The rest have been merged, in most cases, after being closed down by the regulators.

Add to that, that many of the board members were often members and/or relatives of members of the development/real estate community and you’ve got a recipe for disaster. Those who were making money out of the deal lived high on the hog for a while…….and some of them still are. Even when the bank goes under, nobody has to give back their commissions.

UGA 1999

December 16th, 2011
2:08 pm

I cant wait to see Frank Dodd and Barney Frank in handcuffs!!

Michael H. Smith

December 16th, 2011
3:40 pm

I think you meant Chris Dodd?

Kyle Wingfield

December 16th, 2011
3:45 pm

JF @ 1:12: They’re not being sued because they didn’t say the mortgages were bad. They’re being sued because they didn’t report the mortgages at all.

Kyle Wingfield

December 16th, 2011
3:49 pm

Ayn @ 1:29: Fan and Fred were privatized in 1968. Which a) wasn’t a time when Republicans were running D.C., and b) was a long time before they got into trouble. The privatization wasn’t the problem. (Privatization, like public-private partnerships, can be a good thing or a bad thing, depending on the terms of the deal.)

Lil' Barry Bailout (Revised Downward)

December 16th, 2011
4:06 pm

Golly, I thought Fan and Fred were blameless in the housing meltdown and mortgage scams.

Libtard talking point debunked. Again.

ByteMe

December 16th, 2011
4:13 pm

The role of Fannie Mae and Freddie Mac in the subprime lending crisis will be fleshed out in court

It’s already well-documented their “role”, Kyle. They were late to the game and a miniscule part of the entire pie. You even had it buried in the quote:

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.

$48 billion. Would we really be worried about a $48 billion exposure? Nope. They weren’t the problem. Just caught up in the madness like everyone else during the last days of the housing bubble.

Don't Tread

December 16th, 2011
4:24 pm

It’s past time to go back to the old ways, such as lending money only to creditworthy people. Subprime paper isn’t worth as much as toilet paper.

Lil' Barry Bailout (Revised Downward)

December 16th, 2011
4:25 pm

This is just one facet of Fan and Fred’s culpability.

Another big-government failure. Thanks Dodd, Frank, and the Democrat party.

Lil' Barry Bailout (Revised Downward)

December 16th, 2011
4:27 pm

It’s past time to go back to the old ways, such as lending money only to creditworthy people.
——–

Careful, talk like that will get you branded as raaaaaaaacist.

Hillbilly D

December 16th, 2011
4:49 pm

Subprime paper isn’t worth as much as toilet paper.

That’s because toilet paper does have a legitimate function, in this world.

JF McNamara

December 16th, 2011
4:53 pm

Kyle,

I think you missed my nuance, or I don’t quite understand how the process worked.

The banks were packaging the subprime (securitizing) loans into packages with AAA loans, and had instituted a “risk” model where the sum of all of the loans was AAA. They would then take the loan package, rated at AAA by a private label credit agency, to Fannie or Freddie. Because the paper was rated investment grade, Fannie and Freddie were obliged to take on the loans.

In reality, they often times had no idea what the loans were in the securitized package. That’s why, after the crash, no one knew how to value them. No one actually knew what was in those securitized packages, so no one would buy them.

It was a complete system failure because not only were the credit agency’s giving AAA ratings based on a horrific risk system, the banks could also buy additional insurance in the form of credit default swaps. That meant that the securitized loan that no one had a clue what was actually in it was actually insured numerous times via Credit default swap.

The inability of any of the insurers or CDS holders to pay the money back, the over aggressive leverage ratios of the big banks, and everyone’s reluctance to buy the securitized package is why the stock market crashed.

It’s going to happen again. As long as the credit agencies are not held accountable for their ratings (they aren’t), the leverage ratios of the banks are regulated (they aren’t), and CDS and other derivatives are regulated (they aren’t), the same thing will happen again.

Trying Freddie and Fannie for doing a poor job is good, but its not like they even knew what was in those securitized packages. No one did.

Lil' Barry Bailout (Revised Downward)

December 16th, 2011
5:08 pm

The desperate need libtards feel to deny Fan and Fred’s role in the mortgage meltdown is driven entirely by their desire to destroy capitalism in part by attacking Wall Street.

Why do Democrats hate free markets and free people?

Because they know they can’t cut it.

1961_Xer

December 16th, 2011
5:09 pm

ByteMe says: $48 billion. Would we really be worried about a $48 billion exposure? Nope. They weren’t the problem. Just caught up in the madness like everyone else during the last days of the housing bubble.

Multiply times 100 (or more, maybe much more) with derivatives and credit default swaps. $48B turned into something more akin to 4.8 TRILLION. The bundling of these securities was just one aspect of the meltdown. It was the HUGE derivatives multiplier that bet AGAINST these securities that sealed the deal. Imagine if I knew mega bank had exposure to $7-8B of bad debt, and I bought $70B-$80B of insurance against that debt going bad (for a measly several hundred million). THEN I did everything possible to force that megabank to fail. Both the bank that bought the bad debt AND the bank that sold the insurance are now in big trouble, and the dominoes start falling. You get the picture? THAT is what happened.

Dusty

December 16th, 2011
5:14 pm

Well, I’m glad my house is paid for and has been for some time. No Fannie no Freddie just me and mine.

Now if I can get our Christmas decorations up I will have it made. Time to be thankful for many things. Anybody got a nice little tree that needs to be cut down? Tra la la deck the halls with boughs of holly tra la

Sorry, off subject but on season.

ByteMe

December 16th, 2011
5:14 pm

Multiply times 100 (or more, maybe much more) with derivatives and credit default swaps. $48B turned into something more akin to 4.8 TRILLION

Absolutely the unregulated CDS market based on a corrupt rating system were at fault. But don’t sit around claiming that Fannie and Freddie were the big dogs laying poop in our yard like Kyle and some of the crazies try to do.

Lil' Barry Bailout (Revised Downward)

December 16th, 2011
5:16 pm

The last estimate I saw of the cost to taxpayers to bail out Dodd and Frank’s playtoys (aka Fan and Fred) is between $220 billion and $316 billion.

Thanks, Democrats.

Dusty

December 16th, 2011
5:18 pm

Oh yes and by the way, Go get’em, SEC!

Lil' Barry Bailout (Revised Downward)

December 16th, 2011
5:18 pm

Meanwhile, bailing out Wall Street (TARP) only cost taxpayers $50 billion.

$50 billion versus $220 billion. Hmm.

Kyle Wingfield

December 16th, 2011
5:22 pm

ByteMe @ 4:13: “They were late to the game and a miniscule part of the entire pie.” And “Would we really be worried about a $48 billion exposure?”

Miniscule? Hardly. And worried? Maybe we would have been — if we thought theretofore that the exposure was only $4.8 billion. (You also conveniently picked the less egregious of the two understatements. Combine them, and we are talking about exposure thought to be $6.8B-$10.8B that turned out to be $292B in reality.)

In 2007, it was estimated that the subprime mortgage market totaled $1.3 trillion. Understating their exposure would have meant that investors and other financial-market participants thought Fan and Fred were connected to less than 0.7 percent of the market, when in fact the proportion was more than 22 percent. You don’t think that’s a big difference?

Either that, or the value of the market itself was understated — in which case the value was understated by about 22 percent. We’ll know more about how the understatement affected the market as the SEC makes its case.

You’re also ignoring the specialized role the GSEs played. They could borrow more cheaply than everyone else because everyone believed they were backed by the government (which turned out to be true), and their securities were considered safer because of that implicit guarantee, too. The subprime crisis may well have happened without F&F, but it very clearly was far, far worse because of them.

JKL2

December 16th, 2011
5:27 pm

Pay no attention to the man behind the curtain. It’s all Bush’s fault…

Lil' Barry Bailout (Revised Downward)

December 16th, 2011
5:39 pm

Actually, the cost of TARP is estimated to be $25 billion, my mistake.

So, bailing out Dodd-Frank’s playthings (Fan and Fred) is going to cost ten times what bailing out Wall Street cost.

Thanks, Democrats.

Lil' Barry Bailout (Revised Downward)

December 16th, 2011
5:39 pm

Jefferson

December 16th, 2011
5:47 pm

This had nothing to do with Lehman’s failure and much of the AIG (AGI?), the roots may have been fraud, but not F&F.

JDW

December 16th, 2011
5:54 pm

WOW lots of cash and lots of apparent misdirection…I thought we had regulators to watch this stuff…damn that Obama and those Dems…wait a minute…this was 2007 to 2008? Who was in charge then?

Kyle Wingfield

December 16th, 2011
5:56 pm

Right, Jefferson: fraud, not F&F. Certainly not fraud by F&F.

Lil' Barry Bailout (Revised Downward)

December 16th, 2011
6:07 pm

WOW lots of cash and lots of apparent misdirection…I thought we had regulators to watch this stuff…
——————–

We do. We also have a whole bunch of new laws, regulations, and government employees to watch for this kind of thing, thanks to the Dodd-Frank law. And yet we have over a billion dollars of consumer’s money missing in Obozo crony John Corzine’s firm, MF Global.

Nice job with that reform, Democrats. It didn’t work, and it drove companies offshore.

@@

December 16th, 2011
10:12 pm

Whooaaaa…ho…ho…now THAT’S what I call a withholding!!!!!

independent thinker

December 17th, 2011
9:03 am

Did Newt get paid to help cover up this mess and put lipstick on the pig?

Herman Cain

December 17th, 2011
9:04 am

Did Newt get paid to help cover up this mess and put lipstick on the pig?

Lil' Barry Bailout (Revised Downward)

December 17th, 2011
11:22 am

Sockpuppet alert^^^

Observer

December 22nd, 2011
8:41 am

Why does Bush take all the blame when it was the Democratic controlled Senate and Democratic controlled House under Bush that created all those incentives for banks to make risky loans to people that were not credit worthy. I’d like to know how many whites and how many minorities (that Democrats covet) with poor credit making $30,000 a year bought homes during this time? Just to be fair.