http://www.nytimes.com/2008/10/05/business/05fannie.html?_r=...Pressured to Take More Risk, Fannie Hit a Tipping Point By CHARLES DUHIGGNew York Times, October 4, 2008 ......by the time Daniel H. Mudd became Fannie Mae’s chief executive in 2004, his company was under siege. Competitors were snatching lucrative parts of its business. Congress was demanding that Mr. Mudd help steer more loans to low-income borrowers. Lenders were threatening to sell directly to Wall Street unless Fannie bought a bigger chunk of their riskiest loans.So Mr. Mudd made a fateful choice. Disregarding warnings from his managers that lenders were making too many loans that would never be repaid, he steered Fannie into more treacherous corners of the mortgage market, according to executives. ......Between 2005 and 2008, Fannie purchased or guaranteed at least $270 billion in loans to risky borrowers — more than three times as much as in all its earlier years combined, according to company filings and industry data.“We didn’t really know what we were buying,” said Marc Gott, a former director in Fannie’s loan servicing department. “This system was designed for plain vanilla loans, and we were trying to push chocolate sundaes through the gears.”.......“Fannie Mae faced the danger that the market would pass us by,” he said. “We were afraid that lenders would be selling products we weren’t buying and Congress would feel like we weren’t fulfilling our mission. The market was changing, and it’s our job to buy loans, so we had to change as well.”......Fannie never actually made loans. It was essentially a mortgage insurance company, buying mortgages, keeping some but reselling most to investors and, for a fee, promising to pay off a loan if the borrower defaulted. The only real danger was that the company might guarantee questionable mortgages and lose out when large numbers of borrowers walked away from their obligations....With that self-assurance [confidence in their new risk-analysis programs], the company announced in 2000 that it would buy $2 trillion in loans from low-income, minority and risky borrowers by 2010....Whenever competitors asked Congress to rein in the company, lawmakers were besieged with letters and phone calls from angry constituents, some orchestrated by Fannie itself....The ripple effect of Fannie’s plunge into riskier lending was profound. Fannie’s stamp of approval made shunned borrowers and complex loans more acceptable to other lenders, particularly small and less sophisticated banks....Fannie had a longstanding and lucrative relationship with Countrywide, which sold more loans to Fannie than anyone else.Mr. Mozilo, a butcher’s son who had almost single-handedly built Countrywide into a financial powerhouse, threatened to upend their partnership unless Fannie started buying Countrywide’s riskier loans....In the previous year, Fannie had already lost 56 percent of its loan-reselling business to Wall Street [investment banks that securitized mortgages] and other competitors. ...But Fannie’s computer systems could not fully analyze many of the risky loans that customers, investors and lawmakers wanted Mr. Mudd to buy....Even so, Fannie began buying huge numbers of riskier loans. ...“Everybody understood that we were now buying loans that we would have previously rejected, and that the models were telling us that we were charging way too little,” said a former senior Fannie executive. “But our mandate was to stay relevant and to serve low-income borrowers. So that’s what we did.”......<big snip>...In the middle of last year it became clear that millions of borrowers would stop paying their mortgages. For Fannie, this raised the terrifying prospect of paying billions of dollars to honor its guarantees..... [end quote]The story goes on from there. It's worth reading in its entirety.What strikes me most strongly is the tension between FNM's mission and the responsibilities to shareholders and taxpayers.If FNM was purely responsible to its shareholders, it wouldn't have been pressured by Congress. The loss in business to competitors might have pressured it to take higher risks, but there wouldn't have been political pressure.If FNM was purely responsible to the taxpayer, and not pressured by Congress, it might have been more prudent, defending low-risk lending standards.As always, results were determined by the reward system to the decision makers. The managers were paid bonuses and stock options. They were rewarded for taking risks, never expecting the crash to happen on their own watch.That was OK, as long as the GSEs did NOT have taxpayer support. Yes, the market believed that the government would always bail out the GSEs in a pinch, but the charters explicitly said that the GSEs were not government-backed.Nobody -- NOBODY -- was defending taxpayer interests. This is still the case, even after the market was proved right, and the charter was shredded.Who takes the risk? Who gets the reward or penalty?Follow the money, and you will see how risks are pushed past a tipping point.Wendy
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