Fixing Fannie and Freddie: A Litany of Lies
Courtesy of Karl Denninger at The Market Ticker
Today we will be greeted with a dog and pony show on the "reform" of Fannie and Freddie, with Congress holding hearings.
“Private gains can no longer be supported by the umbrella of public protection, capital standards must be higher and excessive risk-taking must be appropriately restrained,” Geithner said in testimony prepared for the House Financial Services Committee that was obtained today by Bloomberg News. The hearing is scheduled for tomorrow.
Really Tim? That’s the not the problem and you know it. The problem lies here:
In a recent speech, David Stevens, the FHA’s commissioner, recalled meeting a group of international bankers who "peppered me with questions — very difficult questions" about what the U.S. government was doing to bring back their trust.
They all have been burned, he noted, after buying mortgage securities with triple-A ratings that turned out to be junk.
"We are at the point right now," Stevens said, "where no one trusts the American housing finance system."
That’s the problem right there.
As FHLB Seattle and San Francisco have shown, literally everyone seems to have bought garbage that was labeled "AAA".
Where’s the culpability and responsibility?
Missing, that’s where.
"AAA" is supposed to mean something – specifically, that default is about as likely as is you being struck by lightning while retrieving the mail this afternoon. The truth turned out to be something different.
This truth didn’t occur by accident. Lenders originated loans containing fraudulent misrepresentations that they either were aware of or had the tools to detect and fix – but refused to do so.
Securitizers packaged up this trash either knowing or willfully-ignorant of the lies contained within the loans, continuing to do so all the way up until the market locked up and collapsed.
Ratings agencies either knew or should have known that these loans were fraudulent and in fact have admitted to substituting made up data where there were gaps in the data transmitted to them, instead of throwing the entire package back on the securitizer and demanding that the gaps be filled in.
The losses these people took were not "accidents", "unforeseen" or "the market being wrong."
Those losses occurred due to outright fraudulent misrepresentation up and down the line.
To restore trust there must be prosecutions for those frauds and the people responsible – all of them – must be held to account.
It is not enough to say "we won’t let that happen again", because without the offenders being held accountable through lawsuit and prosecution it will happen again, for the same reason – the "fines", if any, are simply written off as a "cost of doing business."
Witness Pfizer, which committed the same crime twice – the second time almost literally while signing the first guilty plea! These were not petty crimes either – they were felonies. Since the firm pled guilty (twice!), this isn’t an allegation either – it’s now a fact.
Why? Because the fine levied against the firm for that felonious conduct was a mere one percent of it’s market cap and nobody went to prison. Oh, and Jeff Kindler, who was Pfizer’s general counsel during the first prosecution and later became CEO? He now is a board member at The Federal Reserve Bank of New York.
I would rob banks all day long if I could simply pay 1% of my net worth every time I got caught as a fine. So would a lot of other people. We put people in prison because there is no deterrent against criminal conduct if you can simply fork over a tiny percentage of one’s wealth when caught and walk off into the sunset as if nothing ever happened.
Contrast this with the person who shows up in a 7-11 and sticks a gun up the cashier’s nose, stealing $100. He goes to jail (in Florida anyway) for a minimum of 10 years hard time, and serves every single day of that sentence. Upon release he has a permanent felony record, is ineligible (in Florida) to vote, cannot own a firearm anywhere in the nation, and will never hold a board position anywhere – especially not in the organization that implements monetary policy!
We cannot fix the private securitization marketplace for home finance (or anything else) until and unless those people who commit frauds upon investors are held to account.
These events were not accidents, they were not unforeseen, and they were not a "perfect storm."
This mess was and is the result of massive, pernicious and outrageous frauds up and down the line.
Investors have every right to take risks and bear the cost or reap the reward for having done so. But risk cannot be priced accurately, nor can the market arbitrate that risk, if individuals and corporations are able to get away with intentionally misrepresenting the quality of what they are selling, irrespective of how that occurs.
When we have companies like Lehman that intentionally cook their books and federal agencies, including The Federal Reserve, The SEC and FRBNY willfully and intentionally ignore this fact, despite being warned (as has been alleged) and being in possession of the information necessary to know that this is happening, we cannot have a free and fair market.
When we have firms like AIG selling "protection" with no money and the buyers know it – that is, this "protection" is being purchased not for legitimate hedging purposes but rather to arbitrage government capital requirements – exactly as if I bought "auto insurance" from a guy who sold me a card for $100 not to provide me insurance but rather so I had something to show a cop when I got pulled over, and both parties are not only not prosecuted but instead are bailed out on the taxpayer’s dime, we cannot have a free and fair market.
When we have borrowers who intentionally overstate their incomes and mortgage "officers" and "brokers" who repeatedly run a single borrower’s application, changing the numbers one increment at a time until they get an "automated approval", a clear act of fraudulent inducement that is both allowed by the bank’s computer systems and is not then manually underwritten and verified, fraud becomes pervasive and investors have their money stolen. There were and are myriad message boards postings describing exactly how to "game" desktop "underwriting" systems in this fashion – yet nothing was or is being done about this clearly-fraudulent practice. Without this being stopped and the people responsible – all of them – being prosecuted we cannot have a free and fair market.
When we have lenders, including Fannie, Freddie and even the FHA who are willing to underwrite loans that dramatically violate known "risk limits" in their loan underwriting, that is, a significant (10% or more) down payment, 28% front end (PITI) and 36% back end (DTI) ratios, yet represent these loans as "safe" despite decades of experience in the market saying that these loans rely entirely on the ability to refinance due to rising home prices, we cannot have a free and fair market.
Can we have a "huge stock market rally" with the government replacing literally 10% of GDP with deficit spending? Sure, so long as the government can continue to do that.
But the government’s ability to borrow the money to continue this charade is not unlimited. Private discretionary spending has disappeared due to excessive debt load, and yet to clear that load both borrowers and lenders must be bankrupted, forcing the bad debt out of the marketplace and releasing spending power. Further, many who are currently spending are doing so by not paying their mortgages, while the government refuses to enforce laws against balance sheet fraud. That is, banks and others are holding loans on their books they know are worth less (or outright worthless) while their "marks" show them as worth nearly "par" (or 100% of original value.) Again, this "binds up" credit, shutting off the essential intermediation functions of the market.
In the end cash flow always wins, and it will be no different this time than it has been in the past. Frauds and deceits will eventually be flushed into the open, and the longer we wait to do so the more catastrophic the consequences for our economy.
The private housing finance system refuses to restart due to the fact that the frauds have not been flushed from the system, the guilty parties remain free while collecting billions in bonuses, and investors simply will not accept losses that were not earned as a consequence of bad bets, but occurred due to being intentionally misled.
Expecting the private markets to "heal" and return to normal function in this environment is pure idiocy. Those places where "risk has returned" have seen that return only because government has stepped in to guarantee that losers in fact won’t lose, but this has been done by papering over the fraud and deceit.
The capacity to do so is not unlimited, as both Iceland and now Greece has shown. The United States is inexorably headed for the same cliff, and our Treasury Secretary, Tim Geithner, was one of the chief architects of the willful blindness that led us into this mess.
As such he is not only uniquely unqualified to opine on what we should do to "fix it", but he should himself be in the dock facing the American people for the destruction of value and our economy that he in fact helped perpetrate. President Obama is too spineless (or corrupt) to eject him from his post and force him to face the music for his actions (and inactions), while Congress is too well-bribed to challenge him on the above points and hold him, or anyone else for that matter, to account.
We have learned nothing over the previous three years, and as such are due to suffer another "lesson" before this market clears, almost certainly with catastrophic consequences for the American economy and markets.
