Fannie Mae, Freddie Mac Still Too Big to Nail

Fannie Mae, Freddie Mac Still Too Big to Nail: Jonathan Weil

Commentary by Jonathan Weil

July 29 (Bloomberg) -- The White House says it’s finally ready to consider new ideas for what to do about Fannie Mae and Freddie Mac. Still absent from the government’s agenda is any serious effort to hold anyone accountable for their ruin or investigate why they collapsed.

Back in December 2003, after Freddie disclosed what in retrospect was a relatively mild accounting scandal, its regulator published an exhaustive 185-page report cataloguing the company’s financial-reporting abuses. In May 2006, the same regulator disclosed similar findings about Fannie’s books in a report covering 348 pages.

Strangely, there’s no similar examination under way today by the Federal Housing Finance Agency into the reasons why Fannie and Freddie imploded in 2008, or whether anyone at the companies did anything improper. That’s probably because the agency and its predecessor, the Office of Federal Housing Enterprise Oversight, bear responsibility for letting the companies resume their natural tendency to run amok.

Other probes seem to be going nowhere. The federal panel charged with investigating the companies’ demise, the Financial Crisis Inquiry Commission, is overloaded with other assignments and running out of money.

So here we go again. This month Congress passed the 2,323- page Dodd-Frank Act without any clear understanding of why the financial crisis happened -- and without doing a thing to address Fannie and Freddie, which were central players. Now the Obama administration says it will deliver a reform proposal to Congress by January on the nation’s housing-finance system, including Fannie and Freddie. Yet the government still hasn’t undertaken any comprehensive inquiry into why these companies blew up and who was at fault.

Phony Finances

The problem at Fannie and Freddie wasn’t merely their status as government-sponsored enterprises, which earned large profits for private shareholders in good times before sticking taxpayers with massive losses. They also grossly misrepresented their financial condition.

As recently as June 30, 2008, Fannie and Freddie showed regulatory capital of $47 billion and $37.1 billion, respectively, which the housing agency said was adequate. By September 2008, the Treasury Department had deemed them insolvent and forced them into conservatorship.

Part of the blame fell with the government’s faulty way of measuring their capital. There’s more to it than that, though. Both companies had refused to acknowledge huge losses on their mortgage bonds and other assets long after those had become obvious to outside investors. As former Treasury Secretary Hank Paulson wrote in his memoir, “On the Brink,” by September 2008 “each of the companies looked to have true, economic capital holes amounting to tens of billions of dollars.”

Taxpayer Inheritance

The legacy for taxpayers is a Gordian knot no one knows how to sever. The two companies have more than $5.6 trillion of liabilities, combined. They’ve already drawn $145 billion from their unlimited government credit line to stay afloat.

Without Fannie and Freddie, the housing market would be in freefall instead of merely dismal. They own or guarantee most of the new home loans being underwritten, driving mortgage interest rates to record lows. Ending their subsidies, such as the government’s guarantee of their debt, isn’t an immediate option. Doing so now would shock the financial system back to the brink of insolvency.

Meanwhile, there’s been so little done to get these companies under control, they haven’t even been forced to change outside auditors. Fannie still has Deloitte & Touche. Freddie still uses PricewaterhouseCoopers. It’s enough to make you wonder if anyone knows what their real numbers are.

Breeden Idea

Richard Breeden, the former Securities and Exchange Commission chairman, offered a superb idea to the Senate Banking Committee in February 2002 that, with a few simple tweaks, would have addressed a big part of this problem. Unfortunately, Congress failed to act on his advice when it passed the Sarbanes-Oxley accounting-reform legislation later that year.

Whenever a public company files for bankruptcy or announces a major earnings restatement shortly after receiving a clean audit opinion, either the SEC or some alternative body should be required to review whether the auditor complied with U.S. auditing and accounting standards, Breeden said. Moreover, the findings should be released publicly. He drew a simple analogy: When there’s an airplane crash, the National Transportation Safety Board investigates the cause. Corporate crashes need the same treatment.

Looking back, Breeden’s suggestion wasn’t quite broad enough. We also need NTSB-style crash reports every time a major U.S. financial institution requires government intervention, regardless of whether it files for bankruptcy or restates financial results.

Crash Review

We have a mechanism like this for banks seized by the Federal Deposit Insurance Corp. Whenever an FDIC-insured lender fails, the agency’s inspector general must issue a report examining why it collapsed and whether banking regulators had done their jobs appropriately. Similarly, the court-appointed Lehman Brothers bankruptcy examiner, Anton Valukas, in March released a nine-volume report on the causes and culprits behind Lehman’s downfall.

As things stand now, the public never will receive a thorough, independent account explaining why Citigroup or American International Group crumbled. Those companies continue to operate as going concerns that technically didn’t fail, thanks to taxpayer bailouts. Like Fannie and Freddie, they never filed for bankruptcy.

Truth is, we still don’t know what we don’t know about the reasons Fannie and Freddie cratered. After protecting them for decades, it may be that some members of Congress such as Democrat Barney Frank don’t want to know the whole story before they rewrite the laws. The people responsible for running these companies into the ground must be pleased.