Howard, The Mortgage Wars

Just when you thought you knew everything there was to know about the meltdown of the mortgage market, along comes The Mortgage Wars: Inside Fannie Mae, Big-Money Politics, and the Collapse of the American Dream (McGraw-Hill, 2014). Timothy Howard, former CFO of Fannie Mae, was in the trenches until the end of 2004. At that time he left Fannie Mae, “along with Fannie Mae’s chairman and CEO Frank Raines, in the wake of allegations by the company’s regulator that [they] had deliberately falsified its financial reports.” A civil case lasting over eight years ensued, with Raines and the author named as individual defendants. The defendants filed motions for summary judgment in their favor, which was granted in the fall of 2012. Thus vindicated, Howard was finally free to tell his side of the story. And a fascinating story it is. Here’s some background.

Fannie Mae was set up in 1938 as a government-owned national mortgage association. In 1954 it became a mixed-ownership corporation, with the U.S. Treasury holding nonvoting preferred stock that was meant to be gradually retired so that Fannie Mae would become a wholly privately owned company. In 1968, as the national debt was approaching $100 billion, “a threshold President Lyndon Johnson desperately did not wish to exceed,” and as “pressures were growing to include Fannie Mae’s then $2.5 billion in borrowings in the debt totals,” it was rechartered. Fannie Mae was split in two—a stockholder-owned company and a new agency, Ginnie Mae. Two years later Congress created the Federal Home Loan Mortgage Corporation (FHLMC), owned and regulated by the Federal Home Loan Banks. “The act did have one noticeable shortcoming: it did not produce a pronounceable acronym for its new offspring. The closest phonetic equivalent to FHLMC, ‘Flummox,’ was out of the question as a nickname. It became known as ‘Freddie Mac’ instead.” (pp. 21-22)

Fannie Mae may have become a shareholder-owned company, but it enjoyed benefits that both created the perception of a special relationship with the U.S. government and lowered the cost or increased the marketability of the company’s securities. As such, it “faced criticism and pressures from three main sources: free-market advocates, actual and potential competitors, and the two principal bank regulators, the Federal Reserve and the Treasury.” (p. 32) But, despite calls for Fannie Mae to sever all ties with the government and become a stand-alone entity, internal studies concluded that such a step would be suicidal. Fannie Mae remained a GSE.

Fannie Mae’s real challenge was interest rate risk. In 1985, when its credit losses were $170 million, it tightened its underwriting standards; by 1993 management “could credibly claim in Congress and elsewhere that [its] management of mortgage credit risk was second to none.” (p. 46)

Criticism, however, was unrelenting—and from a host of powerful adversaries. For instance, “Greenspan and Summers both viewed the GSEs’ federal charters as the antithesis of the free-market principles they cherished. Their shared ideology led them to advocate tighter restrictions on the government-sponsored enterprises while simultaneously seeking to relax regulations on banks—which they considered to be free market entities in spite of the fact that they benefited from federal deposit insurance and a regulator, the Fed, willing to lower their cost of funds by dropping market interest rates whenever they got into difficulty (as banks periodically did).” (p. 105)

The attacks on Fannie Mae only intensified. Howard describes in vivid detail the campaign against the GSEs, as “seemingly credible sources, including the Wall Street Journal,” argued “with … frequency and fervor that the risky GSE’s must be replaced by far safer private-market alternatives.” (p. 148) The private-label mortgage-backed securities market began to flourish. We know where that took us.

Here I’ve merely offered a glimpse into some of the early events and players (there were many) that prompted the mortgage wars and eventually the housing market meltdown and the nationalization of a Fannie Mae that had lost its way. Howard takes the story through to its end, detailing the chain of events with the passion of an aggrieved insider and the precision of a number cruncher. He adds considerably to our understanding of what went wrong and offers suggestions about how we can prevent a reoccurrence. The Mortgage Wars should be required reading for politicians, regulators, and bankers—and all of us who are tasked with keeping them in check.