» This Story:Read +| Comments

Report on Fannie, Freddie gives new theory for collapse

Now that President Obama has signed his financial overhaul bill into law, here's a look at who in Washington has played an important role in deciding its fate.

Network News

X Profile
View More Activity
By Zachary A. Goldfarb
Thursday, August 26, 2010; 10:12 PM

A report Thursday by the federal regulator overseeing Fannie Mae and Freddie Mac put a new wrinkle in a common explanation for why the mortgage giants collapsed and could complicate efforts to restructure them.

This Story

For instance, Treasury Secretary Timothy F. Geithner has in part blamed the fact that the companies acted like huge hedge funds - borrowing money from the financial markets and then buying up hundreds of billions of dollars of mortgage bonds. "They were allowed to expand and manage their investment portfolios without regard to the risk they posed to the system," Geithner said a few months ago.

But Thursday's report from the Federal Housing Finance Agency said that Fannie and Freddie's portfolios weren't the major driver behind the companies' losses.

Rather, it was the role the companies played as a guarantor of mortgages that led to most of their losses, the FHFA said. Geithner has also pointed to the weight of souring guaranteed loans as a source for the companies' troubles.

The regulator's pronouncement could be significant. As policymakers begin to focus on what might replace Fannie and Freddie, they talk about retaining a government role as guarantor of mortgages but reducing or eliminating any government-backed mortgage investment portfolios to protect taxpayer dollars.

In a speech last week on the future of U.S. housing policy, Geithner said said there would be a continued "wind down" of Fannie's and Freddie's portfolios. But he added, "There is a strong case to be made for a carefully designed guarantee in a reformed system, with the objective of providing a measure of stability in access to mortgages, even in future economic downturns."

Federal officials seized Fannie and Freddie in September 2008 as they veered toward collapse, and they have received about $150 billion in taxpayer aid since then.

The companies started losing money in late 2007, as the housing market's slide accelerated, and have lost nearly $230 billion in total.

Fannie and Freddie each played two roles in the market. In the guarantee business, they took loans made by banks, pooled them into a security, insured the security against losses and then sold the security to investors. In the portfolio business, they bought and held mortgage securities, some of which were guaranteed and some of which weren't.

According to the FHFA report, bad investment choices accounted for $21 billion, or 9 percent, of Fannie and Freddie's losses.

By contrast, the companies lost $166 billion in their guarantee business, or 73 percent of total losses.

One reason that the companies lost so much more in their guarantee business was that it was much bigger. Fannie and Freddie simply collected a fee for putting their stamp of approval on a mortgage security, so they could essentially guarantee an unlimited number of such securities. They ultimately guaranteed nearly $4 trillion in mortgages.

Fannie and Freddie's investment portfolios, on the other hand, are worth nearly $2 trillion.

Both sides of the companies suffered for essentially the same reason. Fannie and Freddie increasingly bought and guaranteed risky loans to compete with private banks that were offering exotic products such as loans that didn't require income or employment verification.

"Nontraditional and higher-risk mortgages concentrated in the 2006 and 2007 vintages account for a disproportionate share of credit losses," the FHFA said. "However, house price declines and prolonged economic weakness have taken a toll on the credit performance of traditional mortgages."

The FHFA says that since the government took over the firms, the companies have stopped these practices. and returned to supporting only high-quality mortgages.


» This Story:Read +| Comments
© 2010 The Washington Post Company

Network News

X My Profile