Why Freddie Let Down Its Guard

Why Freddie Let Down Its Guard

It will take years to determine who bears the primary responsibility for the current mortgage mess. But a piece of the puzzle fell into place last week with a story by my Post colleague David Hilzenrath about Freddie Mac's decision in 2005 to begin dealing in a significant way with "piggyback" loans that effectively allowed homeowners to borrow more than 80 percent of a property's value -- the limit set by Freddie's congressional charter.

The reason for the 80 percent rule was to limit the risk of the government-chartered corporation by ensuring it would have enough collateral in the property in the event that home prices fell. But that conservative approach apparently went out the window when Freddie's private-sector competitors began selling packages of loans up to 100 percent of a property's value.

"I think that what happened over time is we found that our own caution was making us less and less relevant, and we weren't sure, quite frankly, that our competitors [on Wall Street] were being crazy," explained Anthony "Buddy" Piszel, Freddie's chief financial officer. "Could we have run for the hills and said we're not going to do any of that? What if things didn't go down? We would basically be just taking our whole future and giving it away."

Given the continuing concern of regulators and Congress about Freddie's safety and soundness, you'd think the chief financial officer could come up with a better excuse than "all the other kids were doing it." Your mother never accepted that one, nor should we. It reflects not only an appalling lack of good business judgment but a fundamental misunderstanding of Freddie's special mission as a government-sponsored, privately owned housing finance enterprise -- a mission that does not include protecting market share at any cost.

Equally disturbing is the fact that Freddie's regulator, the Office of Federal Housing Enterprise Oversight, apparently sat on its hands when competitors in the mortgage insurance business brought all this to its attention. Always the champion of transparency and accountability, OFHEO now refuses to explain its position.

Also suspiciously silent is Freddie's corporate twin, Fannie Mae, which declined to disclose anything about its own possible involvement in no-money-down lending.

Goldman et al.'s Wiser Side

There's now a dandy debate on Wall Street about whether an investment bank should continue creating and selling mortgage-backed securities after its own trading desk has begun to advise hedge funds and other big clients to stay away from them or begun placing big bets with their own money that the mortgage market is headed for a fall.

That's what happened last year and earlier this year at Goldman Sachs, Deutsche Bank and Lehman Brothers, before the mortgage meltdown began.

In its defense, the industry argues that its investment banks were merely responding to the demand of sophisticated investors for mortgage products whose risks were fully disclosed. Moreover, this divergence of strategies within the firm only goes to show that the "Chinese wall" that it is required to maintain between trading and investment banking really does exist.

It all makes sense in a weird, Wall Street sort of way. But unless I'm missing something, it also means that when you see the name Goldman Sachs or Lehman Brothers at the top of an offering, it may not be the financial Good Housekeeping seal of approval that investors and issuers have always assumed, and for which they have always been willing to pay those premium fees.