The GSEs Under Siege

Billions Lost and Lessons Learned 

Hindsight is a wonderful thing. It helps us learn; it also can be used to point fingers.

A report recently released by the FHFA Office of Inspector General (OIG) revealed that Freddie Mac and Ginnie Mae ignored "red flags" regarding a mortgage fraud scheme perpetrated by lenders Taylor, Bean & Whitaker and Colonial Bank, resulting in billions of dollars in losses for the GSEs.

But Ginnie Mae president Ted Tozer did not take the report lying down, taking issue with the OIG. In fact, he maintained that the OIG was misinterpreting the situation. He offered that if the OIG had contacted him prior to releasing the report, "We could have explained a lot of this stuff away because everything they pointed out were positives."

The ordeal began in 2002, when Lee B. Farkas was running a relatively small mortgage company in Ocala, Florida, and was caught selling eight fraudulent mortgages to Fannie Mae. Odd thing was that his name as borrower was on all of the mortgages, each of which defaulted without a single payment being made.

According to the report, when Fannie Mae discovered the fraud, they stopped doing business with Farkas' firm, the Taylor, Bean & Whitaker Mortgage Corporation. However, Fannie Mae neglected to share the information with Freddie Mac and Ginnie Mae.

Farkas just went down the street and sold bundles of securities to Freddie Mac and Ginnie Mae, as well as other such financial institutions as Deutche Bank and GNP Paribas in Europe. In fact, his company, Taylor Bean, sold $1.75 billion of worthless asset-backed commercial paper in short-term notes to various entities until this charade ended in 2009. Farkas is currently serving a 30-year sentence for his "creative" techniques in selling the same mortgages two or three times.

As a result of this debacle, the FHFA now requires increased monitoring of counterparties that exhibit abnormal or unusual characteristics. They also require the GSEs and Ginnie Mae to share negative performance and compliance data and evidence of illegal activities of counterparties in order to prevent similar losses in the future. As another precaution, Ginnie Mae President Tozer says he thinks that Ginnie Mae auditors should audit the books of counterparties instead of contractors.

Congress Weighs In

Not content to sit on the sidelines, members of Congress are trying to change the structure or charter for the GSEs. Presently, the Senate is leading the charge to fundamentally reform housing finance. These efforts are in limbo during this lame duck session preceding the swearing in of the new congress in January 2015.

The Housing Finance Reform and Taxpayer Protection Act was first introduced by Senators Bob Corker (R-TN) and Mark Warner (D-VA). The plan was crafted with the goal of winding down and eliminating Fannie Mae and Freddie Mac over a five-year period, and establishing the Federal Mortgage Insurance Corporation (FMIC) to provide a government backstop for mortgage-backed securities (MBS) and regulate the new market. Later, Senate Banking Committee Chairman Tim Johnson (D-SD) and Ranking Member Mike Crapo (R-ID) would add on to the plan and make it their own.

Like the earlier plan, this one also includes eliminating the GSEs over a five-year period and establishing the FMIC with a few additional changes. In its definition of an eligible singlefamily loan, Johnson-Crapo requires a down payment of 3.5 percent for first-time homebuyers and 5 percent for all other homebuyers (to be phased in over time). Corker-Warner requires all loans to have a 5-percent down payment. Johnson-Crapo would also establish an Office of Multifamily Housing in the FMIC that was not recommended in Corker-Warner.

"This agreement moves us closer to ending the five-year status quo and beginning the wind down of Fannie and Freddie while protecting taxpayers with strong private capital, building the components for a stable secondary market and avoiding repeating the mistakes of the past," Mike Crapo said at the time that it passed the Senate Banking Committee. "Government control of Fannie Mae and Freddie Mac with no private capital to protect taxpayers against losses is unacceptable."

Pagliara believes that the Johnson-Crapo bill will recreate the conditions that existed in the 1930s when people got into trouble because they could not refinance their homes. "Today, we realize that long-term fixedrate mortgages are an asset," he said. "However, this might not be available with Corker-Warner, which advocates raising interest rates and making the availability of long-term financing less attractive and less available."

Still, the political gridlock in Washington D.C. has never been stronger, and as we enter into the last two years of an administration that has become increasingly unpopular, the likelihood of meaningful housing finance reform diminishes with each passing day. Forecasted Republican gains in the congress will only make the gridlock more palpable.

So what is the point? Is the conservatorship really on the brink of an existential crisis, or is it all speculative greed and political posturing? Whatever the future holds, it remains unlikely that there will be a resolution anytime soon.