Saturday, January 14, 2012

What is the root cause of the financial crisis? Left leaning commentators blame greedy banks and Wall Street, while right leaning pundits point out the role of the GSEs, Fannie Mae and Freddie Mac, as well has the Federal Housing Administration (FHA) and the Department of Housing and Urban Development (HUD). Even now, many on the left accuse the right of inventing the "myth that Fannie Mae and Freddie Mac caused the financial crisis" as Joe Nocera did last month in the pages of the NYT. Much of the early data was on their side, showing that FM/FM held very small portions of the sub-prime market. However, that data is changing, and the scale of it is shocking (chart from the SEC):

One of the most significant markers, to me, of the weakness of the progressive argument is the utter dearth of criminal charges against the banks for fraud and mis-representation of they types of loans that they were repackaging. Such fraud seems to be the core of the left-leaning argument. Recently, the tide has been turning. Fraud charges have been filed not against the banks, but against executives of the GSEs over their subprime portfolio:
The S.E.C. charged the most serious violations in its arsenal: intentional fraud under Rule 10b-5 and, for Mr. Mudd and Mr. Syron, the filing of false certifications of the corporate financial statements. The crux of the cases is that the executives misled investors about Fannie and Freddie’s exposure to subprime mortgages by playing down these low-end loans even though their value on the books ballooned in the two years before the housing market collapsed in 2008...

[T]he case will focus on what constitutes a “subprime” mortgage, a term that does not have any fixed meaning. In a pie chart accompanying the complaints, the S.E.C. portrays how the disclosures about Fannie and Freddie’s exposure to subprime mortgages was minuscule compared with the total amount of such loans on the books.

Over at the AEI, Peter Wallison and Edward Pinto have some details of the scale of the misrepresentation:
Of particular interest are Fannie and Freddie’s non-prosecution agreements with the SEC, in which they agree with facts that confirm—and in many cases go beyond—our original research concerning the scope of the GSEs’ subprime and Alt-A exposure. These are facts, and Nocera and others who might wish it otherwise should become familiar with them.

For example, in its non-prosecution agreement Freddie agreed that as of June 30, 2008, it had $244 billion in subprime loans, comprising 14 percent of its credit guaranty portfolio, rather than the $6 billion it had previously disclosed. Freddie also agreed that it had $541 billion in reduced documentation loans alone, vastly more than the $190 billion in previously disclosed Alt-A loans which Freddie had said included loans with reduced documentation.

While the SEC documents about $1.03 trillion in previously undisclosed subprime and Alt-A loans in Fannie and Freddie’s credit guaranty portfolios, an estimated $812.8 billion, or about 80 percent, were already accounted for in the totals of Fannie and Freddie subprime and Alt-A exposures included in Pinto’s Forensic Study and Wallison’s Dissent from the majority report of the Financial Crisis Inquiry Commission.

The SEC findings add $219 billion and 1.43 million loans to our original Fannie and Freddie subprime and Alt-A totals, bringing the combined subprime and Alt-A total to $2.041 trillion and 13.37 million loans.

All told, after adding the SEC’s new data to our original estimates, there were approximately 28 million subprime and Alt-A loans outstanding on June 30, 2008, before the financial crisis, with a value of approximately $4.8 trillion. This was half of all mortgages in the United States. Of these loans, over 74 percent were on the books of U.S. government agencies and firms subject to government housing finance policies.
Copyright © Swing Right Rudie
A notebook to myself