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Wednesday, December 10, 2008

Ex-Executive Faults Fannie and Freddie for Nonprime Loans -

Ex-Officer Faults Mortgage Giants for ‘Orgy’ of Nonprime Loans

The New York Times
December 10, 2008

Fannie Mae and Freddie Mac engaged in “an orgy of junk mortgage development” that turned the two mortgage-finance giants into vast repositories of subprime and similarly risky loans, a former Fannie executive testified on Tuesday.

The mortgage development, which began in 2005 and lasted until at least last year, happened as senior executives at the two government-sponsored enterprises ignored repeated warnings from internal risk officers that they were delving too deeply into dangerous territory, according to internal documents released at a Congressional hearing in Washington. The two companies have been taken over by the government.

The former executive, Edward J. Pinto, who was chief credit officer at Fannie Mae, told the House Oversight and Government Reform Committee that the mortgage giants now guarantee or hold 10.5 million nonprime loans worth $1.6 trillion — one in three of all subprime loans, and nearly two in three of all so-called Alt-A loans, often called “liar loans.”

Such loans now make up 34 percent of the total single-family mortgage portfolios at Fannie Mae and Freddie Mac, a level that will link them to eight million foreclosures, or one in six, in coming years, Mr. Pinto said. The nonprime loans “have turned the American dream of homeownership into the American nightmare of foreclosure,” he said.

The hearing was the latest by Congress on the collapse of the two companies, which guarantee half of all mortgages nationwide and are the engine of the housing market. The former chief executives of Fannie Mae and Freddie Mac, Daniel H. Mudd and Richard F. Syron, and their predecessors, Franklin D. Raines and Leland C. Brendsel, faced pointed questioning from lawmakers.

Referring to what he called “the total denial that’s going on here today and the refusal to answer simple questions,” Representative Stephen F. Lynch, Democrat of Massachusetts, told the executives that “if you have accomplished anything here today, you have made conservatorship look very, very good.”

But the testimony of Mr. Pinto, who was Fannie Mae’s chief credit officer in the late 1980s and who has studied the company’s financial statements, and other private analysts shed new light on the role of the housing giants in the subprime crisis.

That role has not been fully recognized, in part because many subprime and Alt-A loans show up in databases as prime loans.

Arnold Kling, an economist who once worked at Freddie Mac, testified that a high-risk loan could be “laundered,” as he put it, by Wall Street and return to the banking system as a triple-A-rated security for sale to investors, obscuring its true risks.

Charles W. Calomiris, a finance professor at Columbia, testified that nobody saw the crisis coming because the two mortgage giants “adopted accounting practices that masked their subprime and Alt-A lending,” but he did not elaborate.

The former executives at Fannie Mae and Freddie Mac were questioned relentlessly on why they did not see the collapse in housing prices coming and why they ignored warnings from their risk officers about stepping up purchases of nonprime loans.

Fannie Mae and Freddie Mac have long insisted that their involvement with subprime and other nonprime loans has been minimal. Asked about the increased purchases, Mr. Mudd insisted that “Alt-A loans were essentially a subset of overall A loans,” and not subprime.

But internal e-mail the committee obtained told a different story.

A June 2005 presentation by Mr. Mudd described the crossroads faced by the company, which at the time was focused on prime loans amid an expanding subprime market. “We face two stark choices: one, stay the course; two, meet the market where the market is,” he wrote. Another 2005 Fannie Mae document referred to “underground efforts to develop a subprime infrastructure and modeling for alternative markets.”

And in March 2006, Enrico Dallavecchia, Fannie Mae’s chief risk officer, wrote to Mr. Mudd to say, “Dan, I have a serious problem with the control process around subprime limits.”

Despite the concerns, Fannie Mae further increased its purchases of subprime loans, according to a January 2007 internal presentation.

Freddie Mac’s senior executives ignored similar warnings. Donald J. Bisenius, a senior vice president, wrote in April 2004 to a colleague that “we did no-doc lending before, took inordinate losses and generated significant fraud cases.”

“I’m not sure what makes us think we’re so much smarter this time around,” he wrote.

Housing analysts say that the former heads of Fannie Mae and Freddie Mac increased their nonprime business because they felt pressure from the government and advocacy groups to meet goals for affordable housing as well as pressure to compete with Wall Street. But Mr. Pinto said one in five Alt-A loans in recent years were made to investors, not to first-time home buyers.

Another lever was what Representative Christopher Shays, Republican of Connecticut, said was more than $175 million in lobbying fees the companies spent over 10 years, in part to counter attempts at stronger oversight.

Copyright 2008 The New York Times Company
Ex-Executive Faults Fannie and Freddie for Nonprime Loans -

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