UPDATE- MAY 1, 2012-A top executive at Freddie Mac is leaving the mortgage buyer a year after he was appointed to head its single-family business.
The regulator for Freddie Mac and Fannie Mae responded to political pressure in March by slashing salaries for the chief executives of the two firms and ruling out bonuses for many top executives.
The companies, which guarantee half of all U.S. mortgages, have soaked up about $170 billion in taxpayer aid since they were taken over in the wake of the 2008 financial crisis.
Freddie Mac said in a filing with the U.S. Securities and Exchange Commission that Anthony Renzi, a member of the company’s management committee reporting directly to the Chief Executive, would leave the company on May 11.
Charles Halderman Jr, Freddie Mac’s CEO, has also expressed his desire to step down from the government-controlled mortgage firm.
Revelations that Freddie Mac and Fannie Mae, the two largest sources of U.S. mortgage finance, were paying out $12.79 million in bonuses for 10 executives caused an uproar on Capitol Hill last fall among Democrats and Republicans.
Before joining Freddie Mac, valued at $187.1 million, Renzi worked at GMAC Mortgage for 25 years.
UPDATE-February 29, 2012-Fannie Mae Reports Fourth-Quarter and Full-Year 2011 ResultsFannie Mae Maintains a Clear Focus on Building Profitable, High-Quality New Book of Business and Providing Liquidity for the Mortgage Market Company Enables Millions of Americans to Benefit from Financing Solutions that Promote Homeownership and Quality Rental Housing
WASHINGTON, DC – Fannie Mae (FNMA/OTC) today reported a net loss of $2.4 billion in the fourth quarter of 2011, compared with a net loss of $5.1 billion in the third quarter of the year. The company’s
net loss in the fourth quarter reflected $5.5 billion in credit-related expenses, the substantial majority of which were related to its legacy (pre-2009) book of business and due largely to a decline in home prices.
These charges were partially offset by a growing percentage of net revenues from the company’s highquality new book of business.
For the full year of 2011, Fannie Mae reported a net loss of $16.9 billion, compared with a loss of $14.0 billion for 2010. The increase in the net loss for the year was due primarily to a $6.1 billion increase in
net fair value losses in 2011. This resulted from losses in the company’s risk management derivatives in 2011 caused by a significant decline in interest rates during the year. These fair value losses on the
company’s derivatives were offset by fair value gains during 2011 related to its mortgage investments; however, only a portion of these investments is recorded at fair value in its financial statements.
fannie-mae-freddie-mac-execs-accused-fraud-15175308 - CLICK HERE FOR VIDEO
FANNIE MAE LAWYERS ARE MAKING A FORTUNE -
The total bill is actually even higher – and the worst part is that, by law, taxpayers shouldn’t have to pay it at all.
Taxpayers have footed the bill for $194.4 million on legal fees to defend former executives like Franklin Raines and the companies themselves over accounting frauds that boosted bonuses and predated the government takeover of the companies, as well as for their role in the housing collapse. And that’s money spent only since the government seized them in 2008.
The new figures come from the office of Rep. Randy Neugebauer (R-Tex.), whose House oversight subcommittee oversees Fannie and Freddie. The figures are based on confidential government documents FOX Business has reviewed.
Rep. Neugebauer now has a bill cosponsored by Reps. Spencer Bachus (R-Ala.), Scott Garrett (R-NJ) and three other Congressmen that will attempt to minimize the impact on taxpayers, his office says.
Fannie and Freddie have also spent another $272 million for general legal costs since their government takeover, for things like bringing actions against banks to take back bad mortgage bonds the two had bought, Rep. Neugebauer’s office says.
Veering Towards Half a Billion Dollars
That brings the total Fannie and Freddie have spent on legal costs to $466.4 million since the government took them over through July 2011, “a number that is now rising well above a half a billion dollars, because we are still awaiting a document dump for a year’s worth of data,” says a Congressional official close to the matter.
The controversy raises anew the question whether the government should have restructured them instead by placing the two into receivership, since a bankruptcy trustee would have been legally free to nix these legal fees.
And under the 2008 federal law letting the government seize Fannie and Freddie, the former executives would be prohibited from suing the companies’ bankruptcy estate—they’d have to get in line with other unsecured creditors, and possibly end up with nothing.
“Seems a Little Fishy”
Moreover, Fannie signed agreements with its former executives in 2004 stipulating it would refund their legal fees—well after the companies’ government regulator had launched an investigation into its accounting fraud engineered by these officials. ”It seems a little fishy that we had to renew the contracts in 2004,” Mr. Neugebauer has said.
Taxpayers are paying a virtually open-ended legal bill for an army of lawyers and expert witnesses to defend former Fannie and Freddie executives and their increased compensation, which they got through orchestrating accounting frauds that helped destroy their companies and drove the two into the arms of the U.S. government in September 2008.
Fannie and Freddie execs routinely donated to Congressional campaigns. Countrywide Financial was one of Fannie’s biggest clients, providing about 28% of all the mortgages Fannie guaranteed. Fannie in 1999 backed Countrywide’s “Fast and Easy” program to give buyers loans without proof of their income or assets.
Because of their unlimited pipeline into the U.S. Treasury, taxpayer costs for Fannie and Freddie continue to mount, with Fannie yesterday asking another $4.57 billion, bringing their total taxpayer cost to nearly $190 billion.
The FHFA, the regulator for both, is charged with “minimizing taxpayer losses” at the two. Today, Fannie and Freddie guarantee an estimated three out of every four new mortgages.
“A Feeding Frenzy”
And because of that unlimited Treasury pipeline, the government has created a perverse incentive for outside lawyers for Fannie and Freddie to delay and not settle, and to run up colossal legal bills footed by U.S. taxpayers, says Rep. Neugebauer, with no end in sight.
“This is a feeding frenzy,” Ohio’s attorney general has testified–his state’s public pension system is suing Fannie Mae.
It’s the equivalent of betting against the house, having the house fall down not on you, but on taxpayers–and letting your lawyers charge taxpayers legal fees into infinity to defend you for the collapse you created.
The inspector general for the Federal Housing Finance Agency (FHFA) has reported that Fannie and Freddie spent $110 million to defend former executives since 2004.
That includes $37 million shelled out since the government took them over in September 2008—and all of that money was spent on just the three former Fannie execs, an official with the FHFA’s inspector general’s office confirms to FOX Business.
The actual $194.4 million number breaks down to an estimated $159.7 million for Fannie and its execs since September 2008, and an estimated $34.7 million for Freddie and its execs for that time (factor in the $73 million paid for just the executives legal fees since 2004, and the total number rises to $267.4 million).
Fannie did not return calls for comment. Freddie Mac spokesman Michael Cosgrove emailed FOX Business to say such payments are “in accordance with Virginia law and our bylaws and indemnification agreements.”
An Army of Lawyers and Experts
Tens of millions of dollars in taxpayer money has been flying out the door for an army of outside lawyers, consultants and troves of expert witness to defend the former executives, and their increased compensation, as well as for things like computer data services.
Fannie and Freddie are also reimbursing lawyers for their copying costs, long distance phone calls, and travel expenses, government documents show.
Based on info from the FHFA, and according to analysis by Rep. Neugebauer’s office, an army of lawyers has racked up an astonishing 159,000 billable hours for just the three former Fannie executives since the government took them over.
There are only 8,760 hours in a year.
That means these lawyers somehow packed in 18 years worth of round the clock work, wall to wall, 24/7 legal work in just four years’ time.
Also, the government lets the former executives’ lawyers bill for charges at every one tenth of an hour (six minutes), says the new report from the inspector general for the FHFA.
A Fannie case “ongoing since 2004 has included over 120 fact depositions, various expert depositions and millions of discovery documents. Unfortunately, no end is in sight,” Rep. Neugebauer says.
Ohio attorney general Michael Dewine notes that, even just for short routine conferences, “where nothing substantive is discussed,” Fannie Mae typically brings a crowd of 35 to 40 attorneys and paralegals, “costing taxpayers over $600 per hour for some of these lawyers.”
For example, Raines’ deposition held in April 2010 “lasted 12 hours, covering two days,” Dewine says, adding that “the Fannie Mae defendants brought 13 lawyers,” including five for Raines, two each for the former CFO and controller, and one for Daniel Mudd, a former Fannie Mae official, “who isn’t even a defendant in the case.”
What did taxpayers get for these 13 lawyers?
“None of these 13 lawyers asked a single question at this particular deposition,” Dewine testified.
Just as bad are the taxpayer-paid for “expert” witnesses hired to defend the former executives against their accounting fraud — and to defend their compensation rigged higher by the frauds.
At one point in the Ohio suit, defendant KPMG had five experts. But the Fannie Mae defendants had “25 experts, costing taxpayers an astounding $600 to $1500 an hour,” Dewine testified.
Moreover, Raines had “nine experts just for himself, including four to say essentially that he fulfilled his job as CEO by properly relying on others,” and “two to say that his $91 million in compensation over five years was justified,” the Ohio attorney general says.
Dewine noted that at a later hearing, the judge on the case said there is absolutely no way that so many experts would actually testify at trial, “admonishing Fannie Mae defendants: ‘so you don’t need to have five experts say the same damn thing…the costs are just staggering.’”
The problem is, the Ohio case has been going on now for over seven years. There are other lawsuits as well, involving even more lawyers.
Dewine has warned: “It’s really easy to hold up the resolution of a lawsuit, when you’ve got a seemingly bottomless coffer of U.S. taxpayer dollars from which to pay your legion of lawyers to engage in wasteful delay tactics.”
Ignoring Efforts to Settle
Dewine noted that, although his office is trying to settle its class action suit, their “efforts, at every turn, have been ignored, with no meaningful conclusion in sight.”
Dewine also has testified that Fannie Mae “is doing everything in its power to delay and stall, all while racking up astronomical legal costs and sticking America’s taxpayers with the bill,” because they continue to use “U.S. taxpayer dollars to pay their highly compensated cadre of lawyers to over-lawyer their indefensible actions.”
The judge on the Ohio class action suit has also commented in court that “I am not so sure the taxpayers are doing pretty well, but the lawyers are doing pretty well in this deal.”
Shangri-La for Lawyers
And the Ohio attorney general has noted: “If, what Supreme Court Justice David Brewer once said is true — that ‘America is the paradise of lawyers’ — then counsel for Fannie Mae, Raines, Howard, and Spencer have found Shangri-La!”
Dewine notes that in his experience, “98% of all securities cases reach a conclusion in far less time — and with far less cost,” adding that even a similar June 2003 securities fraud class action case against Freddie Mac “was resolved in a little under three years.”
The bottom line, as Judge Leon put it, is this: “The more this litigation is protracted and prolonged, the greater the risk that..pensioners and the shareholders will not have as much or will have markedly less and the taxpayers will be out millions and millions and tens and tens of millions of dollars for legal fees that can’t be recouped.”
Taxpayers Still Kept in the Dark
And after all these payments are shelled out by taxpayers, Fannie and Freddie still must abide by the executives “attorney client privileges.”
Meaning, the lawyers don’t have to disclose any further evidence they uncover that the executives knowingly and willingly broke the law–and thus broke the companies’ indemnification standards.
Here’s What Happened
In 2006, the federal government found that Fannie’s former head, Raines, and two other executives put their own personal interests ahead of Fannie’s when they engineered a $10.6 billion accounting fraud to manipulate earnings, and their bonuses, higher over a six-year period, from 1998 to 2006. The moves smoothed Fannie’s earnings so as to hit Wall Street earnings targets.
Freddie, too, was found to have manipulated its profit figures from 2000 to 2002; the company later revised its results by $5 billion.
Raines and the executives could not be reached for comment.
That fraud resulted in Fannie Mae overstating reported income and capital by an estimated $10.6 billion, said the Office of Federal Housing Enterprise and Oversight, Fannie and Freddie’s federal overseer at the time, in a May 2006 report. The fraud triggered a restatement and losses.
Fannie Mae admitted its wrongdoing in May 2006, when it paid a record $400 million total to the SEC and OFHEO for violating more than two dozen generally accepted accounting principles and a variety of OFHEO rules, among other things.
Former OFHEO head James Lockhart described Fannie as having an “arrogant and unethical corporate culture where Fannie Mae employees manipulated accounting and earnings” which in turn “maximized the bonuses” for Raines, which totaled over $90 million from 1998 through 2003. Of Raines’ total, “over $52 million was directly tied to achieving earnings per share targets,” OFHEO said.
Neither Admit Nor Deny = Refunded Legal Fees
However, the trio neither admitted nor denied the charges—which means taxpayers have to keep on paying. “They did not admit to offenses that would have cost them their indemnification,” Edward J. DeMarco, Acting Director Federal Housing Finance Agency, testified last year.
It is standard practice for executives to settle cases neither admitting nor denying culpability, although the SEC is now trying to curtail this practice.
In addition, the executives got their total settlement fines of $31 million covered by Fannie’s insurance policies, and paid via forfeiture of stock options, pension and bonuses, among other things.
Taxpayers Foot Fannie’s Legal Bills for Housing Collapse
And taxpayers are now footing the legal bills for class action and other law suits, legal fights between Fannie and its auditor KPMG, as well as government investigations that are nearly a decade old, including probes by the Securities and Exchange Commission, the FBI, and other Congressional probes.
Taxpayers are also footing legal bills to defend the Fannie and Freddie for their outsized role in the housing crisis—where they took on an estimated $1.7 trillion in high risk mortgages.
The two are now stuck with trillions of dollars in mortgages and securities, including fraudulent liar loans and fraudulent subprime liar’s loans, which they took on so as “to increase profits and regain market share,” guaranteeing even fatter bonuses and more fatal losses, noted Armando Falcon, Lockhart’s successor at OFHEO.
Both of their balance sheets combined now total $5.4 trillion—equal to the gross domestic product of Germany and the United Kingdom–combined.
Paying Cash Advances, Too
Moreover, both Fannie and Freddie are paying cash advances to former executives to cover their legal fees ahead of time with little oversight—which means they face “no expense in just running up the tab for the U.S. taxpayers,” says Rep. Neugebauer.
Moreover, Fannie’s board sped up the time of that payment, a deadline of just 20 days for executives like Raines to get their taxpayer funded cash advances. Freddie, too, pays after 45 days time.
This practice, too, is causing taxpayer costs to soar.
Moreover, the FHFA has not independently certified whether the internal systems that Fannie and Freddie use to pay these cash advances for legal bills protect taxpayers, government documents show.
On Feb. 29, 2008, Fannie Mae’s board adopted a policy allowing for the advancement of cash to current and former board directors and executives for these costs.
The board suddenly decided that, if an executive was in compliance with its indemnification standards, “Fannie Mae will pay to directors and officers expenses incurred in advance of the final disposition of a proceeding,” an internal company document says.
Fannie didn’t return calls asking how the board determined Raines and the execs were “in compliance” with these standards.
Also, all Raines and the executives have to do is send a letter of request to Fannie’s general counsel, which is then supposedly put to a vote by the board.
And in a confidential, internal document, Freddie’s bylaws prohibit payment of legal fees if an employee “knowingly engaged in certain conduct and knowingly or recklessly caused a substantial loss to Freddie Mac or a substantial pecuniary gain or other benefit.”
It goes on to say that any employee “who has engaged in misconduct resulting in a loss to Freddie Mac or who has improperly received benefits as a result of such misconduct” may be subject to “legal action by Freddie Mac for restitution or reimbursement.”
Frannie and Its Regulator Say “We Have to Pay”
But instead of minimizing taxpayer losses–as the FHFA is charged with doing–by fighting to void these legal fees, Fannie and Freddie now argue, along with the FHFA, that their options are limited; that court cases enforcing payment for legal bills take precedent; that the executives could sue them and win; and that they need to keep paying these fees to keep existing employees on staff and attract skilled workers.
Cosgrove adds that “if FHFA or we were to cut off these payments, the officers could sue us to enforce their rights to such payments, which could subject us to additional costs.”
However, efforts to save taxpayers money are spotty. Fannie merely questions bills if more than one lawyer attends, says the FHFA IG, while Freddie does not.
Taxpayers Should Not Have to Pay
Trouble is, the 2008 federal law sanctioning their government takeover and even the companies’ own bylaws let the two repudiate these legal fees if their executives act against the companies’ best interests, engage in intentional misconduct or breach their duty of loyalty to their companies.
The inspector general for the FHFA also noted that the FHFA could have voided these legal fees under the 2008 law authorizing their government takeover.
An outside law firm has confirmed these findings, noting that the FHFA “has express statutory authority to repudiate or disaffirm” the refunding of these legal fees, which come as part of what are called standard, corporate indemnification agreements.
Nothing to Lose By Nixing These Fees
However, an outside law firm which has reviewed the contractual agreements says the government should take a shot at this and not pay, because if it lost, taxpayers would only have to pay their legal fees anyway if Raines and the other executives turn around and sue for breach of contract.
That’s because under a worst case scenario, in the 2008 law letting the government seize Fannie and Freddie, the law says the government would only have to pay the legal fees.
The 2008 law says the costs “should not exceed what the FHFA would have paid if it had continued to pay the former employees’ legal fees under the indemnification agreements.”
The 2008 law also says the damages would only equal “actual direct compensatory damages,” not punitive damages, damages for lost profits or pain and suffering.
Meaning, “the former executives’ incurred legal fees and expenses” the government would have paid in the first place if it didn’t try to void them, the legal analysis shows.
And taxpayer costs for a lawsuit nixing these legal fees would be low, since the FHFA could use its own legal staff, and not a phalanx of outside lawyers.
Fannie’s Legal Fees Contravene SEC Order
And Fannie’s payment of these legal fees for the 2004 accounting fraud contravenes a consent order it entered into with the SEC earlier last decade when it settled its accounting charges.
According to FOX Business’s review of its SEC consent order, Fannie Mae agreed to “not take any action or to make or permit to be made any public statement denying, directly or indirectly, any allegation in the [SEC’s] complaint or creating the impression the [SEC’s] complaint is without factual basis.”
However, by continuing to pay to defend these executives, Fannie Mae is doing just that, as its lawyers are “dragging out” litigation “billable hour by billable hour — and bleeding Americans,” Ohio Attorney General Dewine has testified to Congress last year.
Why the Sudden Indemnification?
Executives can get indemnification “only if the officers and directors were acting within the scope of their authorities, the FHFA IG’s report says.
Is securities fraud and cooking the books “in the scope of their authorities?”
Plus Fannie mysteriously, and suddenly, offered its executives indemnification well after the government had started probing its accounting fraud.
Another internal Fannie Mae document that Raines signed on Nov. 12, 2004 entitled “undertaking to repay indemnification expenses” noted that he agreed to reimburse Fannie Mae “for all expenses paid” by Fannie for his defense in any civil or criminal action if it’s determined he is “not entitled” to be indemnified.
The indemnification sets for “rights” AND “obligations” of these executives in order to be “indemnified.”
The document notes they must act “in good faith and in a manner he or she reasonably believed to be in or not opposed to Fannie Mae’s best interests.”
Being involved in an accounting fraud is not acting in the best interests of any company.
Also, according to their bylaws, payment of legal bills must be “reasonable” expenses.
Are 40 lawyers and paralegals for one short courtroom conference, and a phalanx of experts defending fat cat pay rigged by accounting frauds “reasonable”?
UPDATE FEB 17, 2012-Government backed mortgage giants Fannie Mae and Freddie Mac — at the behest of their regulator, the Federal Housing Finance Agency, and its acting director, Edward DeMarco — have not been writing down loan principal for troubled homeowners, despite the view of many economists that doing so would aid the economic recovery. In an interview with the Wall Street Journal yesterday, Secretary of Housing and Urban Development Shaun Donovan called on Fannie and Freddie to begin providing such relief to homeowners. “More and more economists across the political spectrum are recognizing [principal reduction] is a critical step,” Donovan said. “Clearly it’s an important piece of the puzzle that Fannie and Freddie move forward on this.” In 2010, Fannie Mae actually had a plan in place to reduce loan principals, but “pulled the plug” on it due to opposition from its executives.
UPDATE- JAN 27, 2012-Why is no one in Congress up in arms over the possibility of a half-a-billion-dollar bailout of Bank of America (BAC) last month?
Early in August, Fannie Mae agreed to buy the mortgage servicing rights (MSRs) of a portfolio of 400,000 loans with an unpaid principal balance of $73 billion from Bank of America. In exchange for these rights to collect payments from homeowners in this portfolio, Bank of America reportedly received “more than $500 million.”
Strangely, the actual purchase price is unknown. So, too, are the contents of the mortgage portfolio, because neither Fannie Mae, its regulator the Federal Housing Finance Agency, nor the selling bank itself is talking.
Whatever the quality of the MSRs, though, Fannie Mae stands to lose a bundle if President Obama’s national refinance program, proposed officially in his jobs speech last week, is pushed forward by the White House and Treasury. Anything that causes borrowers to refinance or prepay mortgages causes the value of MSRs to decline. A revamp of the Home Affordable Refinance Program—which has so far been a total failure—to streamline reducing interest rates would significantly reduce the value of the recently purchased MSRs overtime and possibly lead to serious losses beyond just delinquencies.
Of course, discussion of a more streamlined refinance program has been on the table for months now. Fannie Mae and its regulator, the Federal Housing Finance Agency, knew about this possibility and went ahead with the deal anyway. Considering the lack of transparency and the possibility for millions in losses for Fannie (i.e., taxpayers) on this deal, the transaction is more than a little suspicious.
At least five or six private financial institutions were given access by Bank of America to analyze the mortgage portfolio and perform due diligence before potentially bidding on the MSRs. However, Bank of America didn’t wait for even a single competing bid. Perhaps Bank of America decided that Fannie Mae’s offer was far above anything it could get from the private sector. Or even worse, perhaps Bank of America knew the delinquency risks in the portfolio were so high that no private actor would want to consider acquiring such a toxic asset.
If either of these cases turned out to be true, the Fannie Mae offer amounts to nothing less than a bailout. And if the government did overpay for the MSRs, the only possible reason is that the Treasury wanted to infuse Bank of America with cash to keep it stable.
Given Bank of America’s recent struggles—its stock has fallen 55 percent from the beginning of 2011 to its lowest point last month—it has had a not-so-clandestine need for capital and confidence. Warren Buffett’s $5 billion capital injection to this end was a much-discussed event in August. The Treasury Department’s $500 million-plus capital injection via Fannie Mae two weeks before the Oracle of Omaha got back in the bank saving game was not.
The secrecy is a problem, particular given the absurdity of Fannie Mae—which itself needed a $5.1 billion bailout just two months ago—bringing more liabilities onto its balance sheet.
Mortgage servicing rights can be particularly challenging to assign a value, particularly during volatile interest rate environments. And without a liquid secondary market for MSRs, each portfolio must be valued independently. But since the characteristics of the loan pool that Fannie Mae purchased are unknown to the public, it is impossible to assign a value to the mortgage servicing rights, and to know whether $500 million is a fair price.
However, there are a few things we do know that would suggest the taxpayers are yet again getting a raw deal.
Earlier this year Bank of America was forced to buy back $2.5 billion in misrepresented toxic mortgages from Fannie Mae. Who knows how many of those might be underlying the servicing rights just sold to taxpayer supported Fannie Mae?
Even though Bank of America estimates the pool of loans has a 13 percent delinquency rate, many outside analysts believe the default rate on the mortgages that underlie the MSRs could be as much as double that. One financial institution that reviewed a portfolio of Bank of America MSRs, which looked suspiciously similar to what Fannie Mae purchased, estimated the loans had a delinquency rate of 25 percent.
Of course, it is possible that this is just bad housing policy and a lack of transparency. But even if it turns out that the portfolio’s risks are low, and the MSRs turn a nice profit for Fannie Mae, there remains a question: Why are the taxpayers outbidding the private sector for mortgage servicing rights? If this truly is a profitable asset, then a healthy bank could benefit both its shareholder and the economy by using the cash flow to increase loans to businesses and individuals. Is that not what the White House wants?
Adding to the confusion of this bizarre story, FHFA recently filed lawsuit against Bank of America and 16 other banks for mortgage-related fraud. Why bail out a bank only to turn around and sue it? Imagine the scandalous possibility of Bank of America settling for $500 million in this new legal drama.
Given all the condemnation of bailing out banks, you would think the Democrats, who blame the financial crisis on Wall Street, would be outraged over the idea that another big financial institution receiving a cash infusion. We should at least see the Republicans and Tea Party wanting to get to the bottom of this suspicious purchase. And it is especially urgent with a streamlined refinance program in the wings that might only be stopped with evidence that it will hurt the taxpayers more than help them. With Congress back from their August recess, hopefully someone will stand up to discover exactly what Fannie Mae purchased, and whether Bank of America got yet another backdoor bailout.
UPDATE DECEMBER 21, 2011- It’s been a bad month for Fannie Mae and Freddie Mac.The Securities and Exchange Commission announced last week that it was suing half a dozen former executives from the mortgage giants, including the ex-CEOs of both companies. Now, the Federal Bureau of Investigation is reportedly asking questions about Fannie and Freddie’s behavior in the months preceding the financial crisis, according to The Daily.
At issue is whether Fannie and Freddie — two of the largest mortgage companies in the country, and the recipients of a major government bailout in September 2008 — misled the public and investors about the relative risk of their loans in the lead up to the financial crisis, the Daily reports. The matter has serious implications, since many allege that mortgage lenders’ enthusiasm for making loans to homeowners with shoddy credit, and banks’ penchant for using those loans as financial instruments, are among the principal reasons for the housing crash and financial crisis.
The SEC’s lawsuit probes much the same question, hitting six former executives at the two companies with charges of security fraud, and accusing them of continuing to hold onto questionable loans even after the magnitude of the risk became clear. Neither company is directly named as a defendant in the SEC’s suit.
The SEC appears to be framing that suit as a response to critics who have accused the agency of going easy on the major banks and financial institutions who played a central role in the financial meltdown, according to The New York Times.
However, it’s unclear whether the SEC’s pursuit of Fannie and Freddie alumni will assuage taxpayer ire or merely inflame it further, since, as CNBC recently pointed out, it’s taxpayers who may end up paying the legal fees for the six defendants named in the suit, as Fannie and Freddie are now owned by the government.
One of the defendants in the SEC suit — Daniel Mudd, the former CEO of Fannie Mae — announced this week that he would be taking a leave of absence from his current position as CEO of Fortress Investment Group, citing the need to focus on “matters outside of Fortress.”
Six former top executives of housing finance giants Fannie Mae and Freddie Mac were accused of securities fraud Friday by federal regulators for allegedly misleading investors about the size of the companies’ risky subprime mortgage holdings.
Among those named in the SEC’s civil actionwere former Fannie Mae Chief Executive Daniel H. Mudd and former Freddie Mac Chief Executive and Chairman Richard F. Syron. They are two of the highest-ranking figures to face accusations in the wake of the financial crisis.
“Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was,” said Robert Khuzami, director of the SEC’s Enforcement Division. “These material misstatements occurred during a time of acute investor interest in financial institutions’ exposure to subprime loans, and misled the market about the amount of risk on the company’s books.”
The SEC’s action, filed in the U.S. District Court for the Southern District of New York, allege that the Fannie Mae executives made misleading statements, or aided and abetted others making those statements, between December 2006 and August 2008.
In addition to Mudd, who headed Fannie Mae from 2005-2008, the other Fannie Mae executives named in the SEC action were former Chief Risk Officer Enrico Dallavecchia and Thomas A. Lund, former executive vice president of the company’s single-family mortgage business.
The Freddie Mac officials are accused of making misleading statements about the company between March 2007 and August 2008. The executives include Syron, who headed Freddie Mac from 2003 to 2008, Patricia L. Cook, former executive vice president and chief business officer, and Donald J. Bisenius, former executive vice president for the single family guarantee business, the SEC said.
Khuzami said that “all individuals, regardless of their rank or position, will be held accountable for perpetuating half-truths or misrepresentations about matters materially important to the interest of our country’s investors.”
THOUGHTS BY ALLAN HENNESSEY, A CONTRACT LAW SPECIALIST
RE: HOW FANNIE MAE IS A GOVERNMENT SPONSORED CRIMINAL ENTERPRISE (JUST LIKE THE NATIONAL BANKS)
As shown in the FNMA prospectus and supplement, it is apparent that the actual transactions where some consideration was passed both ways involves the mortgage bonds(CERTIFICATES), not the loans.
The distinction between the mortgage bonds and the loans is blurred in the FNMA prospectus. They are using that blur to say that the “loan” was transferred when in fact it was some certificate or other instrument that did it (and now they are coming up with fabricated documents to relate
to that specific loan when no such documentation previously existed).
You want to show that they may have documents, but these documents lack foundation to show that the transaction referred to therein ever took place. Based upon my information and reports I have received, THAT is the crux of the matter. As long as they have the judge’s attention directed at the documents, they have a good chance of winning because of various presumptions. But if you redirect the court’s attention to the transactions that are the foundation for the writing of those documents, you will win for sure. The transactions never took place — at least not in the
form they said it did and not between the parties they are saying are involved.
Your argument is something like this:
Judge, the Banks have proven that they can come up with mountains of documents. The question is whether you are going to presume those documents actually reflect a real transaction or if you are going to stop me from inquiring and getting the evidence I need to prove my case and
disprove theirs. If those documents lack any true foundation in fact, where there was no such transaction, then I’m sure we can all agree that the documents should be ignored. If they reflect real transactions, the parties here should have no problem in providing that evidence. I can file a
mountain of documents too but my conscience prevents me from filing false documents reflecting transactions that never happened. I request the court to apply the same standard against these Banks who have been censured across the country and sued by all 50 state attorney
generals for submitting false, fraudulent, forged and fabricated documents.
My goal here is not to get out of a legitimate debt. it is to determine the amount of principal due, the amount of interest that applies and to whom it is owed after deducting all payments received from me and all other parties that were payments covering liability on the obligation. At the time
I signed the documents, I thought that I was the only one obligated and the only one from whom payment was due. It turns out that there are dozens of cross agreements that obligate other parties to pay. Without following the actual money trial, we have no way of knowing the true identity of
the true creditor or the true balance due. I am only asking for what was ordinary procedure for all foreclosures. The lender would come in
and show all payments made on the account, the original mount due and the calculation of the current amount due. Here we are not being allowed to see that. They don’t want you to see that the creditor received payments from outside the small part of a much larger chain. They don’t want to give you an accounting from the creditor because it will show that the creditor has been paid in part or in whole and that the creditor is treating it as paid. They don’t want you to see that payments were received on behalf of the creditor by its agents and not applied to the balance due to the creditor-investors. They want you to assume they did everything right and that the math was right without ever showing you the actual monetary transactions.
If we have learned anything the past few years it is that these Banks are more than willing to misstate the facts. I want to test those facts and determine the balance due, who it is due to and make sure I can establish clear title to my property. They want you to take their word for it. That
isn’t evidence. If I make a representation tot he court it is not presumed correct until I prove it with competent evidence and firm foundation laid down for the introduction of each piece of evidence. I am only asking that the same standard applied to me be applied to mo opposition.
Analysis of FNMA loan
1. let’s assume that the mortgage is defective because it was not perfected. The note described a party who was not the creditor and gave no notice as to the actual identity of the creditor.
2. Let’s assume also that the note was paid in full from a variety of sources, which you know about ad nauseum.
3. Let’s further assume that the transfer documents are either non-existent or defective in that there was no actual transaction (they are false), there was no authority of the signatories etc.
4. Now let’s see what evidence I come up with to show that one or all of these things are true.
SUPPLEMENT TO PROSPECTUS: (Quotes are from prospectus supplement)
“We will issue and guarantee the certificates. Each certificate represents an undivided ownership interest in a pool of adjustable-rate residential mortgage loans. We offer each certificate by this prospectus supplement and the prospectus referenced in the pool statistics included
What that means is that they (a) intend to do something in the future as of the date of this instrument, which appears to be some time in 2005 and (b) each certificate represents an undivided interest in the loans as a pool and do not represent direct ownership of the loans themselves (c) that FNMA issues and guarantees the certificates, not the loans.
“The certificates are issued under the terms of the ARM trust indenture dated as of July 1, 1984, as amended.”
What that means is that the agreement and intentions of the parties were set long before the first contact or application was made by the borrower. This impacts the mortgage origination. TILA and RESPA require full disclosure of the identity of the lender because the very purpose of TILA
was to make sure the borrower had enough information to make a choice between one lender or another. BY depriving you of this knowledge, you were unaware that the purpose of your “loan” product was to sell securities and that the parties had a greater incentive to sell the loan than
make sure that the loan was viable. You were also not advised that your name and credit score would be used to sell those securities. Now this doesn’t mean the loan wasn’t real, but it does point to the fact that the actual identity of the funders of the loan was being kept secret and that
the note was defective in failing to show that this was the intent of the parties sitting across the table from you.
“We have responsibility for the servicing of the mortgage loans in the pool. Every month we will pay to certificate holders scheduled installments of principal on the mortgage loans in the pool, together with one month’s accrued interest at the pool accrual rate. We guarantee to pay these amounts, whether or not the borrowers under the mortgage loans
pay us. If we foreclose on a mortgage loan, we also must pay certificate holders the full principal balance of that loan even if we recover a lesser amount.”
There are several possible interpretations here. One is that FNMA was the creditor in fact the whole time. Another is that the investors were the creditors, and still another is that the trust was the creditor. It’s really not that clear. What IS clear is that the investors were paid no matter what,
which means that from the investor point of view there could be no default — ever, unless FNMA defaulted. Hence the source of funding was paid and is being paid and is guaranteed to be paid in all events. So here is the problem: if the guarantee was of the certificate and not of the mortgage how exactly does FNMA claim direct ownership of the loan? You have a right to see those transactions and ascertain the true value of your mortgage and the true creditor. It is unlikely that there were two guarantees — one for the certificates and one for the loans. And the
interesting part of that is my understanding of the process is that FNMA was to guarantee loans not certificates.
“We guarantee that the holders of the certificates will receive timely payments of interest and principal. We alone are responsible for making payments under our guaranty.”
OK. So what we have here is a source of funding who is getting a promise not from the borrower but from FNMA. The deal is between the investor and FNMA. The money comes from the investor and FNMA agrees to pay it back. The note you signed however was to accept the funds from the undisclosed investor and pay it to a party who was neither the source of funding nor the administrator of the pool. SO you have two separate deals: one between investor and FNMA (which we know is not the whole story) and the other between you and the loan originator which discloses nothing about the actual underwriting and funding of your loan when taken in context of these documents. Yet the single transaction rule asks whether the transaction would have been completed without both ends of the stick being fully accounted for — in other words would the investor have put up the money without the borrower taking a loan and would or could the borrower have taken a loan without the investor coming up with the money. In all events it is clear that FNMA was not the lender or creditor because it was not the source of funds.
SO what does that mean? I think it means that the nexus between the loan documents executed by the borrower and the certificates, prospectus etc. issued to the creditor.investor is missing in action. The borrower is never given the information about the true nature of the transaction and
thus is deprived of an opportunity to shop for a more straightforward loan at better terms and without the risk of title defects.
“In determining whether to purchase any issue of certificates in any initial offering, you should rely ONLY on the information in this prospectus, the related prospectus supplement and any information which we have otherwise incorporated into these documents by reference. You should not rely on information that may be offered to you by a third party.
It may not be reliable.”
I think this means that if your loan documents were not part of that prospectus, the prospectus doesn’t cover it. THAT in turn would mean that the whole FNMA thing is a misdirection because (a) they never referenced your loan in particular, and (b) they were never guaranteeing the loan
or loan payments (they were giving a guarantee as to payments called for by the certificates and prospectus which was a separate contract.
“Each prospectus supplement will include information about the pooled mortgage loans backing that particular issue of certificates and about the certificates themselves.”
I think this means that when the investor gave up his money and his money went into an account on behalf of the pool he, by definition, had no idea what loans were going to be in the pool because they were going to issue a prospectus supplement later. what we need to know was whether, as I believe, money actually exchanged hands somewhere between the individual investors and the promoters of the pool (not necessarily FNMA) based on this prospectus but before your loan was consummated.
If a pool contains fixed-rate mortgage loans, we will pay to certificate holders interest at the fixed pass-through rate stated in the related prospectus supplement. If a pool contains adjustable-rate loans, other than those permitting negative amortization, we will pay to certificate- holders interest at the variable pool accrual rate.
This is contrary to the terms of the promissory note. The prospectus is saying you, as investor, will get the payment described in the prospectus, not the payments, as received from borrowers. There are references to receipt of payments from borrowers but I do not see anything that conditions payment upon receipt from borrowers. What I DO see is this
contradictory passage which relates only to principal not interest and is not the same as the promissory note terms:
“We receive collections on the mortgage loans on a monthly basis. The period we use to differentiate between collections in one month and collections in another month is called the due period. The due period is the period from and including the second day of the preceding month to and including the first day of the month in which the distribution date occurs.
On each distribution date, we will pass through to certificate holders:
the aggregate amount of the borrowers’ scheduled principal payments for the related due period, the stated principal balance of mortgage loans that were prepaid in full during the calendar month preceding the month in which the distribution date occurs‚ the stated principal balance of mortgage loans that were purchased out of the pool for any reason during the calendar month preceding the month in which the distribution date
occurs, and‚ the amount of any partial prepayments on mortgage loans received during the calendar month preceding the month in which the distribution date occurs. Prepayments in full received on the first day of a month may be treated as if received on the last day of the preceding month. If they are so treated, they will be passed through on the
distribution date in the month of actual receipt. For example, if a prepayment is received on February 1st, it may be treated as if it had been received on January 31st and, if it is so treated, the prepayment will be passed through on February 25th (or the next business day, if February 25th is not a business day).
So regardless of what the borrower pays, the money will be distributed to investors in accordance with the terms of the prospectus, NOT the NOTE.
On each distribution date, we guarantee payment to certificate holders of:
‚ the aggregate amount of the borrowers’ scheduled principal payments for the related due period, whether or not received, and‚ an amount equal to one month’s interest on the certificates.
The risk of loss is thus passed on to the investors as to unpaid interest that is over one month old. Now another question this raises is whether there were credit enhancements used even though they were not necessary and whether the investors were made whole through the payment by a
third party not mentioned even in the prospectus. The investment banks were betting against the pools they were creating and selling. There is no reason they didn’t do the same with FNMA.
Quite the reverse. By including the ability to declare a pool as failing they trigger payment of interest and principal at least in part. So the obligation gets split repeatedly with each third party payment made on behalf of either the borrower or FNMA or as a result of some other third party
contract, hedge or otherwise.
RISK FACTORS: MY OPINION IS THAT IF THEY MADE THESE DISCLOSURES TO ONE SIDE OF THE TRANSACTION THEY CREATED A DUTY TO MAKE THE EXACT SAME DISCLOSURE TO THE OTHER SIDE — I.E., YOU.
PAGE 11: “Because we guarantee the payment of principal on the certificates, a default by a borrower does not reduce the amount of principal that will be paid to certificate holders. If a mortgage loan becomes delinquent with respect to four or more consecutive monthly payments (or eight biweekly payments), however, we have the option to purchase the delinquent loan out of the pool. ”
Think about it. This says they reserve the right to purchase the loan out of the pool. That means a transaction could take place, but did not necessarily take place. It is my opinion that in nearly all instances, no such transactions took place. FNMA is simply allowing others to claim that the transaction took place and makes it look like that if the loan is reported as delinquent — and they do so by making an entry on their website that could be taken to mean any number of things about what transactions occurred. This would be the reason why the GSE’s are so reluctant to give any details whereas numerous public securitization packages are right out there on the SEC site. In any event, if they have not shown the transaction by which FNMA acquired the transaction, there is a lack of foundation as to their proffer that the loan is owned by FNMA. The wording clearly establishes that FNMA might either pay the investor or acquire the loan and pay the investor. Either way the investor gets paid — at least I think so — even if not in full.
Each seller that sells loans to us makes various representations and warranties about the seller and the loans. For a description of the subjects covered by these representations and warranties, see “”FANNIE MAE PURCHASE PROGRAM Seller Representations and Warranties,” below. If these representations and warranties were not true when they were
made, we can require the seller to repurchase the affected loans at any time. The affected loans could be all of the loans in the pool or only a portion of the pool. When a loan is repurchased, its stated principal balance is passed through to certificate holders on the distribution date in the month following the month of repurchase. Thus, a breach of a
representation and warranty may accelerate the rate of repayment of principal on your certificates.
So even if FNMA acts in one way or another, the party who came up the loan to offer it as part of the pool makes representations and warranties that could trigger its obligation to repurchase it. We all know that FNMA is demanding exactly that You have a right to know if such demand was
made, what were the reasons stated, and whether they have repurchased or otherwise reached a settlement if so what the settlement terms were. Then you have this clear as mud statement on page 16 —
USE OF PROCEEDS
We usually issue certificates in swap transactions, in which the certificates are issued in exchange for the mortgage loans in the pool that backs the certificates. In some instances, we may issue certificates backed by pools of mortgage loans that we already own. In those transactions, we would receive cash proceeds. Unless stated otherwise in the prospectus
supplement, we would apply the cash proceeds to the purchase of other mortgage loans and for other general corporate purposes.
This is sleight of hand. Here they are saying that they issue certificates in exchange for loans. Think about that. from whom are they acquiring the loans? The certificates are issued to investors. Did they own the loans? When? How did they come to own the loans? Are they now in the title chain? Are the certificates first issued to an investment banker affiliate and then distributed to investors with this prospectus? Wouldn’t there be another
DISCOVERY ITEM PAGE 17:
We will issue the certificates in book-entry form using the book-entry system of the U.S. Federal Reserve Banks, unless we specify a different method in the applicable prospectus supplement. Physical certificates are not available. The reason you want it is that it goes to whether an actual transaction took place or just a stated transaction without any actual assets or money exchanging hands. You also want it to check with the investor as to whether they were paid in full and whether they signed or received any
additional documentation in connection with settling their claims.
Buydown Mortgage Loans To induce people to buy homes, builders and sellers of homes, or other interested parties, including lenders, may agree to pay some of the costs of the loan, including subsidizing the
monthly mortgage payments for an agreed period of time. This arrangement, which we refer to as a “buydown,” may enable borrowers to qualify for loans, even though their available funds ordinarily would not enable them to do so. Curious provision I never noticed before. This indicates that notwithstanding what the note says, third parties may contractually be bound to make payments on the same loan. Who is secured?
For what amount?
“Here is the crazy thing – the SEC, OFHEO, and the Department of Justice all failed to prevent Fannie and Freddie from using perverse executive compensation systems that made the executives wealthy through fraud and put the entities and the government at risk.”
The new compensation systems at Fannie and Freddie remained exceptionally perverse after the changes. Their CEOs continued to cause them to engage in systematic accounting fraud by not providing remotely adequate loss reserves and allowances for loan losses despite purchasing massive amounts of fraudulent liar’s loans and fraudulent subprime liar’s loans. The same scam that made the officers rich was certain to destroy Fannie and Freddie.
“The report details an arrogant and unethical corporate culture where Fannie Mae employees manipulated accounting and earnings to trigger bonuses for senior executives from 1998 to 2004. The report also prescribes corrective actions to ensure the safety and soundness of the company.”
“The combination of earnings manipulation, mismanagement and unconstrained growth resulted in an estimated $10.6 billion of losses, well over a billion dollars in expenses to fix the problems, and ill-gotten bonuses in the hundreds of millions of dollars.”
“By deliberately and intentionally manipulating accounting to hit earnings targets, senior management maximized the bonuses and other executive compensation they received, at the expense of shareholders. Earnings management made a significant contribution to the compensation of Fannie Mae Chairman and CEO Franklin Raines, which totaled over $90 million from 1998 through 2003. Of that total, over $52 million was directly tied to achieving earnings per share targets.”
When it comes to the steps that Lockhart considered critical, however, executive compensation was not specifically mentioned.
The report ends with recommendations from OFHEO’s staff to [Lockhart], which he has accepted. Some of the key recommendations include:Fannie Mae must meet all of its commitments for remediation and do so with an emphasis on implementation – with dates certain – of plans already presented to OFHEO.Fannie Mae must review OFHEO’s report to determine additional steps to take to improve its controls, accounting systems, risk management practices and systems, external relations program, data quality, and corporate culture. Emphasis must be placed on implementation of those plans.Fannie Mae must strengthen its Board of Directors procedures to enhance Board oversight of Fannie Mae’s management.Fannie Mae must undertake a review of individuals currently with the Enterprise that are mentioned in OFHEO’s report.Due to Fannie Mae’s current operational and internal control deficiencies and other risks, the Enterprise’s growth should be limited.OFHEO should continue to support legislation to provide the powers essential to meeting its mission of assuring safe and sound operations at the Enterprises.
“Fannie Mae must take additional steps to improve its internal controls, accounting systems, operational and other risk management practices and systems, data quality, and journal entries. Emphasis must be placed on implementation with dates certain.”
Executive compensation, the most critical problem at Fannie and Freddie, the problem that drove their accounting control frauds, received minimal attention from OFHEO’s head. Fannie and Freddie’s CEOs proceeded to become wealthy through bonuses “earned” through business strategies that were sure to destroy Fannie and Freddie. OFHEO took no effective action to remove these perverse incentives.
Armando Falcon, Lockhart’s predecessor as head of OFHEO, achieved the remarkable – his revulsion for Fannie’s controlling officers exceeded Lockhart’s. “While all of this political power satisfied the egos of Fannie and Freddie executives, it ultimately served one primary purpose: the speedy accumulation of personal wealth by any means.” Testimony of Armando Falcon, submitted to the Financial Crisis Inquiry Commission (April 9, 2010). His testimony details how Fannie’s controlling officers used accounting fraud to attain massive bonuses.
The Terrible Cost of Failing to Understand Accounting Control Fraud
The sad irony is that immediately after Falcon explained the perverse incentives arising from Fannie’s compensation system he went on to be only half right in his analysis of Fannie and Freddie’s eventual failure. The half he got wrong stemmed from his failure to understand the interplay of accounting control fraud and perverse executive compensation.
“Your letter also asked me about the impact of the affordable housing goals on the enterprises’ financial problems. In my opinion, the goals were not the cause of the enterprises demise. The firms would not engage in any activity, goal fulfilling or otherwise, unless there was a profit to be made. Fannie and Freddie invested in subprime and Alt A mortgages in order to increase profits and regain market share. Any impact on meeting affordable housing goals was a byproduct of the activity.”
In addition, OFHEO made it very clear to both enterprises that safety and soundness was always a higher priority than the affordable housing goals. They should not take on excessive risk in order to meet any one of the goals.”
Falcon almost gets this right, but his failure to understand the most destructive financial fraud mechanism leads him to miss what happened at Fannie and Freddie even with the benefit of hindsight. His analytical failures exemplify OFHEO’s central analytical failure. He is correct that only the exceptionally naïve could believe that Fannie and Freddie’s controlling officers based their business decisions on meeting the affordable housing goals. He is grotesquely incorrect in assuming that their controlling officers only engaged in an activity if “there was a profit to be made.” His error is bizarre given the fact that he had explained that Fannie’s controlling officers engaged in activity that caused large losses and then used accounting fraud to transmute real losses into fictional gains in order to maximize their bonuses.
Falcon is correct that Fannie’s controlling officers had “one primary purpose” at all times – “the speedy accumulation of personal wealth by any means.” What he fails to understand is that accounting control fraud is a “sure thing” and that the formula for maximizing fictional income (and real bonuses) maximizes real losses. Fannie and Freddie’s controlling officers “one primary purpose” was making themselves wealthy. Accounting fraud was their “weapon of choice” to produce great wealth very quickly. Purchasing large amounts of “liar’s” loans guaranteed that Fannie and Freddie would suffer massive losses. Purchasing large amounts of subprime liar’s loans guaranteed that they would suffer catastrophic losses. Liar’s (home) loans create such intense “adverse selection” that they have a sharply negative “expected value.” In plain English, the purchaser will lose money. It’s equivalent to betting against the House, except that the odds are so bad that the expected value is more negative than playing the lottery. Liar’s loans can only fail to produce obvious severe losses temporarily while the bubble is expanding. Refinancing hides the losses during the rapid expansion phase of the bubble. The saying in the trade is that “a rolling loan gathers no loss.” Bubbles, however, are only temporary and liar’s loans will begin blowing as soon as the bubble starts inflating, which can be over a year prior to the bubble bursting.
Fannie and Freddie’s CEOs chased higher nominal yields, not real “profit” for the firms. Their strategy exemplified the logic of George Akerlof and Paul Romer’s famous 1993 article, captured in their title (“Looting: the Economic Underworld of Bankruptcy for Profit”). The firm fails, but the controlling officers walk away rich because the frauds they lead produce fictional income and real bonuses. (Akerlof and Romer’s use of the word “profit” is ironic. It refers to gains to the controlling officers from fraudulent business strategies that cause fatal losses to the firm.) Akerlof and Romer aptly termed the accounting control fraud strategy a “sure thing.”
Fannie and Freddie’s risk officers alerted their CEOs to the fact that nonprime loans were likely to produce far greater losses, that the rapid rise in home prices was temporarily suppressing default rates, and that the rapid rise in home prices could not continue indefinitely. It is inconceivable that Fannie and Freddie did not know of the FBI’s September 2004 warning that there was an “epidemic” of mortgage fraud and their prediction that the fraud epidemic would cause an economic “crisis” if it were not contained. Fannie and Freddie’s purchase of liar’s loans that cause severe losses overwhelmingly occurred after the FBI’s warning. “The government” never required any entity to make or purchase liar’s loans. Most of the liar’s loans that caused Fannie and Freddie’s severe losses were purchased after MARI’s five-part warning to the mortgage industry in April 2006. “The Mortgage Asset Research Institute’s (MARI) EIGHTH PERIODIC MORTGAGE FRAUD CASE REPORT TO the MORTGAGE BANKERS ASSOCIATION.” (It is inconceivable that Fannie and Freddie’s controlling officers, or OFHEO, were unaware of these warnings. Louis Freeh, former head of the FBI, joined Fannie’s board of directors in mid-2007.)
MARI paired it first two warnings:
“Stated income and reduced documentation loans speed up the approval process, but they are open invitations to fraudsters. It appears that many members of the industry have little historical appreciation for the havoc created by low-doc/no-doc products that were the rage in the early 1990s. Those loans produced hundreds of millions of dollars in losses for their users.”
MARI’s third warning quantified the incidence of fraud in such loans. It paired these data with its fourth warning dealing with the revealing label the industry used internally for such loans.
“One of MARI’s customers recently reviewed a sample of 100 stated income loans upon which they had IRS Forms 4506. When the stated incomes were compared to the IRS figures, the resulting differences were dramatic. Ninety percent of the stated incomes were exaggerated by 5% or more. More disturbingly, almost 60% of the stated amounts were exaggerated by more than 50%. These results suggest that the stated income loan deserves the nickname used by many in the industry, the “liar’s loan.””
MARI’s fifth warning reported the views of federal banking regulators.
Federal regulators of insured financial institutions have expressed safety and soundness concerns over these loans with lower documentation requirements and other “nontraditional” loans.
To summarize, MARI warned every member of the Mortgage Bankers Association (MBA) in writing in early 2006 that so-called “stated income” loans:
- Were “open invitations to fraudsters”
- Had produced hundreds of millions of dollars of losses when they became common in the early 1990s
- Had a fraud incidence of 90%
- Deserved the industry term for such loans: “liar’s loans”
- Were opposed by federal banking regulators because of safety and soundness concerns
It was in this context that (1) lenders moved massively to increase their origination of fraudulent liar’s loans and to sell such loans through fraudulent “reps and warranties” (2) Fannie and Freddie (and their investment banker counterparts) moved massively to purchase these endemically fraudulent loans, and (3) OFHEO did nothing meaningful to prevent Fannie and Freddie from purchasing fatal amounts of fraudulent liar’s loans.
Fannie and Freddie (and the FHFA) still get it wrong
Indeed, even after the second wave of accounting control fraud caused the failure of Fannie and Freddie, OFHEO failed to end their perverse executive compensation practices. Steve Linick, the FHFA’s Inspector General (FHFA is the successor agency to OFHEO) reported:
“Linick said the FHFA rejected his recommendation that it test and independently verify the annual pay packages, which are set by the boards of Fannie and Freddie and approved by the agency in consultation with the Treasury Department.
The FHFA “lacks key controls necessary to monitor the enterprises’ ongoing executive compensation decisions under the approved packages,” the inspector general wrote. “FHFA has neither developed written procedures to evaluate the enterprises’ recommended compensation levels each year, nor required FHFA staff to verify and test independently the means by which the Enterprises calculate their recommended compensation levels.”
Further, the agency “lacks independent testing and verification of the Enterprises’ submissions in support of executive compensation packages,” the report said.”