Insider's Game

As you may remember, the securities regulator caused a big stir last December when it filedlawsuits alleging securities fraud committed by former Fannie Mae and Freddie Mac executives. According to the complaints, these executives  directed the companies to understate their “true” exposure to subprime and Alt-A loans.  At the same time, Fannie and Freddie had signed Non-Prosecution Agreements, which were viewed by some as an admission of culpability.

In a nutshell, the SEC alleges that for year-end 2007, Fannie falsely represented its subprime loan total as $5 billion, when the actual number was closer to $48 billion.  And it falsely represented its Alt-A total as $311 billion, when in fact it the true number was more like $634 billion.

What went largely unnoticed at the time is that the non-prosecution agreements imposed no requirement that the companies restate or change the manner in which they present their subprime and Alt-A exposure. In other words, the SEC is pursuing several  lawsuits, which consume scarce resources and may drag on for years, but it took no steps to protect the investing public from any continued dissemination of these so-called falsehoods.

So yesterday Fannie Mae released its financial results for the year, with it’s usual press release, 10-K, and Credit Supplement.  Check out pages 5, 6, and 9 from the Credit Supplement, and you’ll see that Fannie’s methods for calculating its subprime and Alt-A exposure have not changed in the least. Investors holding trillions in Fannie Mae bonds are still being “deceived” in the same way that they were in prior quarters and prior years. (Compare the Credit Supplement issued for the prior quarter, or any other quarter, to validate this point.)

One of the fatal flaws in the SEC’s lawsuit was best described by U.S. District Court Judge Paul Crotty, in a ruling wherein he dismissed most, but not all, of the causes of action against Fannie its senior management. The private lawsuit alleged similar, but not identical, violations of securities law. Judge Crotty  wrote, “A plaintiff cannot state a claim by citing snippets of corporate disclosures and alleging it is misleading; rather, such disclosures must be ‘read as a whole.'”

Since the financial filings use definitions for subprime and Alt-A that are not precise and exact, the investor must read everything in the public disclosures. If the critical information is stated in a different way, or in a footnote, so that the investor can figure out what’s going on, he cannot allege that he has been harmed by securities fraud.

As it happens, Judge Crotty will preside over the SEC’s case against the Fannie Mae executives.

For a more complete takedown of the flaws in the SEC’s case, go here and here.

A Possible Backstory To The Lawsuit

So why is the SEC proceeding with such a flimsy case? My guess that the true motivation  was political, as a sop to the Republican members of Congress who are doing  everything they can to slow down agency’s efforts at policing the markets. Consider Darrell Issa’s “inquiries,” into the timing of the SEC lawsuit against Goldman Sachs, into the timing of the settlement with Goldman Sachs, whether S.E.C. regulations are too burdensome.

The announcement of the SEC lawsuit was touted as a vindication by professional liars who promote a standard Republican narrative about the history of the mortgage crisis.  Since late  2008, Peter Wallison of the American Enterprise Institute has been touting the ridiculous notion that Fannie and Freddie caused the mortgage crisis because they held $1.6 trillion (later upsized to $1.8 trillion) in “subprime and otherwise risky” mortgages.  This metric was repeated endlessly by right wing think tanks and academics, and in a New York Timesbestseller, Reckless Endangerment.  It has also been conclusively debunked by the FCIC and by the Center for American Progress.

As New York Times writer Joe Nocera noted in his column, “The Big Lie,” which referred to Wallison’s thesis, the SEC’s lawsuit proved that Wallison’s claim that Fannie and Freddie led the way in expanding the subprime market was, well, a lie. But promoters of The Big Lieremain impervious to facts.

A Similar Case Against Fannie: According to Judge Crotty’s reasoning, another lawsuit against Fannie and its executives should have been dismissed years ago by District Court Judge Richard Leon. The complaint alleges a litany on accounting infractions; but not every accounting infraction is material. The complaint alleges that billions of dollars of mark-to-market losses were concealed by Fannie and its management; except those mark-to market losses were disclosed at the time as an adjustment to equity. Anyone who read the entire financial statements and understood accounting rules could figure out what was going on.