Insider's Game

John Carney’s New York Times op-ed piece is a tour de force, a paean to nonsensical thinking. In, “Fannie Mae and Freddie Mac: Too Big Not to Fail,” Carney ignores the Fannie and Freddie of the real world. Instead, he goes after the Fannie and Freddie that exist only in his imagination.

You don’t need to be a financial expert to see where the problem lies. Anyone with good reading skills should be able to catch what was wrong with this sentence:

Mortgages guaranteed by the F.H.A., however, are exempt from the 5 percent risk-retention requirement.

Stated more clearly: If the F.H.A. retains 100 percent of the mortgage risk, it is exempt from the 5 percent risk requirement. And since a guarantee from the Federal Housing Authority is supported by the full faith and credit of the U.S. government, any bank that extends a loan guaranteed by F.H.A. need not retain 5 percent U.S. government risk.

Fannie and Freddie are culpable for many things, but they never acted like Ameriquest or New Century or Goldman or Merrill Lynch or the other entities that booked and repackaged subprime loans to be sold off as securities to a bunch of greater fools. (Some of those fools happened to be Fannie and Freddie.) On Wall Street, the business model was to earn origination fees and then sell off the assets. This model enabled a lot of the culprits to walk away rich. Roland Arnall, the owner of Ameriquest, pulled out a$1 billion in profits before he shut down his pump and dump operation. Merrill CEO Stan O’Neal walked away with more than $100 million before his company slid into insolvency.

The business model of the government-sponsored enterprises is antithetical to that of the sleazy mortgage lenders and some Wall Street banks. The Fannie and Freddie business model has always been to retain the credit risk. So it was inevitable that that Fannie and Freddie would remain saddled with bad loans once the real estate bubble deflated. If a quarter of all mortgages are under water, then it makes sense that a proportionate share are held or guaranteed by Fannie and Freddie.

John Carney sets up a bogus premise to support a bogus narrative, which is that the Dodd-Frank Bill thwarts private competition to finance home mortgages. He claims the problem is the 5 percent risk retention rule for private label securitizations somehow puts Wall Street at an unfair disadvantage. Five percent is pretty paltry, a gesture really. Remember, Goldman Sachs, John Paulson, andMagnetar all went “long” on various subprime CDOs that were designed to fail.

There are a multitude of reasons why private label mortgage securitizations have not been resuscitated since the financial collapse of 2008. None of them have to do with Fannie and Freddie. The most obvious comes from Moody’s last week:

Moody’s Analytics projects that the odds of a near-term double-dip recession have increased to one in four. In a double-dip, house prices would likely fall by another 20% before stabilizing in early 2012, compared with our baseline outlook of a 5% drop to a trough in early 2011.

If the odds of a 20 percent price decline look pretty good, why would you want to extend a mortgage loan? Since time immemorial, real estate lending has been governed by two simple rules: 1. Location, location, location; and 2. Timing is everything. In other words, the post-closing rate of home price appreciation, positive or negative, is the most important driver in determining credit losses.

There are other obvious reasons why private lending hasn’t taken off. Banks and investors realized they had no idea what they were doing before and don’t want to repeat the same mistake twice. When it comes to estimating losses on mortgage loans, the rating agencies have no credibility. The market for existing securitizations remains a big black box. That is, the secrecy surrounding CDOs and credit default swaps precludes almost anyone from getting a big-picture view of the overall market.

Since there is no private demand to finance new mortgage loans, Fannie, Freddie, and the F.H.A. have stepped in to fill the breach, financing 95 percent of the total. Carney probably imagines that those loans could have been financed elsewhere, by all those investors wishing eager take on that risk, if only the government regulations hadn’t gotten in their way. Perhaps he knows bankers who say, “Gee, I have all these customers who want to buy mortgage bonds…if only I weren’t stymied by that 5 percent retention rule.”