Unsealed Documents Reveal Former White House Officials Violated Fannie/Freddie Conservatorship Rules, Apparently to Advance Bank-Enriching “Reforms”

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The Administration has refused to turn over over 12,000 documents in a lawsuit against how the government operated Fannie and Freddie in their conservatorship. The major bone of contention is that Treasury stripped them of all profits, which damaged the remaining private shareholders.

But the unsealing of a small batch of government records shows why the Administration is fighting to hard to keep this affair under wraps. Josh Rosner, a former GSE analyst, discusses in new report on the how the Administration implemented rules requiring Fannie and Freddie to sweep all profits to Treasury just as they were turning into huge cash cows. Aside from tapping into a source of additional funding when deficit hawkery was all the rage, depriving Fannie and Freddie of the ability to retain earnings prevented them from strengthening their equity bases. That fed into the narrative that they were beyond redemption and the best solution was to “reform” them. As we wrote when the GSE reform debate was in full swing, the proposals amounted to another form of bank looting. From a 2011 post:

As time goes on, the various Ministries of Truth just get better and better at their stock in trade. We’ve gone from artful obfuscation like “extraordinary rendition”, and “Public Private Investment Partnerships” to stress free “stress tests” (particularly the Eurozone version) designed to get bank stocks up and credit default swap spreads down, to even grosser debasement of language. What passes for the left has for the most part been dragged so far to the right that the use of once well understood terms like “liberal” and “progressive” virtually call for definition. And the word “reform” has virtually been turned on its head. Financial services reform was so weak as to be the equivalent of a jaywalking ticket; health care reform was a Trojan horse for even large subsidies to Big Pharma and the health care insurers. But GSE reform takes NewSpeak one step further by turning the “reform” concept on its head and using the label to describe an effort to institutionalize even bigger subsidies to the mortgage industrial complex.

While Team Obama appears to have backed down from the trial balloon floated by the Center for American Progress (note that press reports give another rationale) and is expected to offer a menu of choices for “reform” in its overdue white paper on Friday, don’t be fooled. The proposals coming from the lobbyists expected to have real influence on which ideas get the green light are virtually without exception serving up such a narrow menu of choices as to constitute unanimity. We offered our take as of the release of the CAP report; a subsequent proposal by Moody’s Mark Zandi (see details here) is more of the same.

It’s as if a population suffering from a toxic reaction to mustard was now offered options ranging from Dijon to pommery to spicy brown as meaningful improvements. And this is not an exaggeration. The new GSEs (and let us not kid ourselves that that this is where the Powers That Be are driving this effort) would have an explicit government guarantee, be larger in number, and supposedly have higher capital buffers.

The problem is that any government sector guarantee for a private sector entity is a terrible idea absent very tough constraints on operations, which is the still-unlearned lesson of the financial crisis. And the idea that any higher capital standards will hold over time is dubious. Fannie and Freddie were enormously powerful lobbying forces, a de facto mainly Democrat slush fund; any new GSEs will have similar collective clout and will press for their agenda on a unified basis, which is certain to include waivers that will amount to lower equity requirements. Increasing leverage is one of the easiest ways to improve performance in a financial firm.

Now the Administration is also allegedly presenting some elements of securitization reform on Friday. We’d be glad to be proven wrong, but we anticipate any proposals will be cosmetic and/or insufficient in scope. The real problem is that the coming staged fight over GSE reform will serve as a useful distraction for what is really needed, which is much broader mortgage market reform. Pursing the GSE question largely in isolation is sure to produce bad outcomes.

Our subsequent posts, Our Response to the Center for American Progress Objection to Our Post on Its GSE Reform Proposal, The 7 Things Really Wrong with the Treasury’s GSE Reform Plan, and GSE 2.0 Scare Tactics: False Claim That No Government Guarantee = No Thirty-Year Mortgage showed that our initial take was correct. From the GSE 2.0 Scare Tactics post:

So let us be VERY clear about this: this is GSE non-reform. It’s merely reconstituting the GSEs with better capital cushions but also a full faith and credit guarantee on their mortgages, which is a better backstop than Fannie and Freddie enjoy now. And the only compelling reason for continuing to offer government guaranteed mortgages is to escape exposing and cleaning up mortgage and securitization industry abuses.

Rosner, as usual, does a fine job of presenting the legal and political issues. A key section of his analysis, which we’ve embedded at the end of the post:

The documents demonstrate that former Obama Administration officials violated the intent and purpose of HERA [Housing and Economic Recovery Act of 2008]. The goal of HERA was to rectify shortcomings in the oversight of Fannie Mae while choosing a path not provided for in that statute or any other. In 2012, as the GSEs were on the verge of massive and sustainable profitability, the Administration rushed to change the terms of the Preferred Stock Purchase Agreement (“PSPA”) which governed Treasury’s financial support to the GSEs in conservatorship.

That agreement was originally put into place in 2008 and amended twice in 2009. The 2012 changes, referred to as the “Net Worth Sweep,” demanded terms that forced the GSEs to “sweep” any future profits directly into Treasury’s coffers in perpetuity. Rather than retaining earnings and building capital in accordance with the goal of rehabilitation (as required in a conservatorship pursuant to HERA, and as was demanded of every other financial institution after the crisis), the Third Amendment ensured that the GSEs could never rebuild capital nor – no matter how much money they returned to the Treasury – be allowed to ever repay the government. These actions clearly violate the most basic requirement of HERA that instruct the Director of FHFAiii “to oversee the prudential operations of each regulated entity and to ensure that … each regulated entity operates in a safe and sound manner, including maintenance of adequate capital and internal controls.”

The newly-released documents also show the actions of these former senior officials were premeditated and defended with false public statements which falsely articulated there was an imminent risk the GSEs would need more financial assistance.

GSE reform was one of the few post-crisis bank-enrichment programs that the Administration failed to bring to fruition. While it appears to be a dead letter now, don’t underestimate the odds that a Clinton or Trump administration would seek to revive it. But if the Administration is forced to cough up some of the documents is it keeping from the court, the stench of corruption may be rank enough to keep the banks from creating yet another source of enrichment at public expense.

GF&Co. – GSEs- Former WH Officials Involved in GSE Scandal

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  1. Harry

    I was as outraged as Josh. Clearly these people as completely invulnerable, because they are happy to chat and steal with absolutely no fear of being caught.

    1. RBHoughton

      “What need we fear who knows it, when none can bring our power to account.” Lady Macbeth

      1. Chauncey Gardiner

        Similarly, Studio C has an updated version of “French Revolution Manhunt” on YouTube. The end is the tell.

  2. tony

    It appears that the Obama admin’s position has been to make sure that as long as the GSE’s very existence is based on their government charter and an implicit or explicit guarantee of their debt, their “profits” should not benefit the private sector. It is hard to understand what is wrong with this position given the problems and abuses of the GSEs for years leading up to the financial crisis – not to mention that the “profits” would likely be non-existent if the GSE’s were required to pay market-rate fees for their government backing.

    All of the complaining about the profit-sweep arrangement is backed by people and organizations that would benefit from returning the GSEs to their pre-crisis position which was clearly a disaster. There has yet to be a proposal made that would improve the status quo for the American people over the current structure – as ugly as that may be. Arguing that the GSEs require capital as long as their debt and obligations are backed by the U.S. government is either ignorant or self-serving because the arguement makes no sense.

    1. Yves Smith Post author

      The executive can’t make up theories to do what it wants. And the GSEs are not public. They have minority shareholders. What the administration can and cannot go is governed by law, in this case, HERA, which was passed solely and explicitly to govern how the GSEs were to be operated in conservatorship. The US is not an absolute monarchy or dictatorship, which is basically the theory of legitimacy that you are espousing.

      The executive used similar logic to make an extra-legal grab of AIG. The court ruled the government’s actions to be illegal but found the plaintiffs had no basis for damages. Here there most assuredly is a basis for damages, which is the minority shareholders getting their share of the profits that Treasury took in full.

    2. anonymous

      One can stick their heads in the sand and think. Then that is what you end up getting as in your case.

      When vested political appointees exercise absolute power of authority, power of money, and power of media with no transparency, no openness, no oversight, no press scrutiny, no court challenges then that is what you get as in the case of FnF (GSEs).

      Rule of Law is a system of rules that must be set in advance so that all can understand how laws work and follow them. When one starts making up laws (as in the case of conservatorship) through private contract agreements, then that is what you get as in the case of FnF (GSEs).

      Current FnF Controversies are not about laws, it is about lawlessness, it is about abuse of position of authority to benefit favored ones at the cost of genuine investors. It is not about helping the cause of greater good, it is about harming the cause of greater good to benefit few favored ones.

  3. Rhondda

    So let me get this straight. This bi-partisan knee-capping — with handy collusion by Center for American Progress (#scumbags) and the American Enterprise Institute (“fellow travelers”?) was perpetrated as a kind of faked-up TINA. “We have no choice! Don’t you see? The right AND the left agree so it must be true!” Those charged with conservatorship created the illusion of failure so they could “sweep” the money into the banks — aka their pals and collaborators. The thing is, you know it’s ALL like this. There is no reform — only “shock doctrine” positioning to take advantage of the “crisis” you create. 12k documents…bring it! And I’d like to see the pencil sharpened up for some RICO charges. Because it’s a racket and a con.

    Thanks so much to Josh and Yves for shining some light on this rot.

  4. RUKidding

    No more and no less than what most of us suspected, and now we have it in writing. How do any of us effect the changes needed to ensure these crooks are stopped?? The hits just keep coming at the tax payers in the 99%. Perp walks would be ever so nice, but I won’t hold my breath.

    Thanks for this information. Good work.

    1. polecat

      if this corrupt shit continues to come to light, at this pace, those Perps will be walking all right ……. right off the gallows…..

  5. ke

    RICO protects the rackets, from other rackets, but most importantly from public inquiry. Afghanistan wasn’t a failure; the psychologists have plenty of product and a captive market.

  6. TedWa

    And this illusion of failure was created and perpetuated by the government so that the GSE’s (through FHFA) couldn’t help homeowners whose paper they held even if it would have benefited the country – because it was not in the banks best interests to have taxpayer funded entities like the GSE’s standing on their own.

    FHFA adopted A. Cuomo’s HVCC which handed over real estate appraiser independence to the banks and turned appraisers into the banksters ATM’s – and they could only do that while the GSE’s were in conservatorship as it was illegal. Give banksters that caused the crash by using corrupt appraisers to inflate values, the power to always (or when they need them again) use corrupt appraisers, is FHFA’s gift to the world. Backed by Treasury and the government of course.
    This “sweep” ensured they would remain wards of the state and the appraiser profession could not be independent.

    Thinking about it now, It’s clear that the ridiculously high bonuses/golden parachutes, paid to leaving CEO’s from the GSE’s was to pay for their silence.

    “Earlier this year, Federal Housing Finance Agency Director Mel Watt authorized the GSEs to propose new executive compensation plans for the position of CEO that may be as high as the 25th percentile of the market, or approximately $7.26 million a year.”

    1. polecat

      Mel Watt…Eric Holder….etc. ABBBMC**

      ++ Above and Beyond the Black Misleadership Class

      1. polecat

        opps… one too many B’s in that acronym……..time to lay off the caffeine…..

        ..time to look at some bees…instead of typing them :’)

  7. perpetualWAR

    Right. The entire reason politicians these days are talking about “homelessness” and “rising rents” and refusing to talk about continued “unlawful foreclosures,” is because the crooked politicians would have to expose that they have knowingly allowed the criminal banks to steal the homes of their constituents. So rather than accept that failing to end the unlawful foreclosures and tell us that the CONSEQUENCES of not stopping the looting of the American populace would allow for more looting, the politicians are determined to end homelessness and discourage the tide of rising rents. It’s like these crooked politicians think that the populace cannot put two and two together.

    Again, anyone ready to roll out the guillotines yet? I’d say it’s far past the time somepeople lose their heads. I, for one, would celebrate the first head rolling down into the waiting basket.

  8. Harry

    Josh makes the point that this is not so much a GSE (yawn) issue as it is ‘Gate type issue – as in Watergate, Iraq-gate, Obamacare-gate.

    Sell HRC futures.

    1. Sammy Maudlin

      Yep, he is tweeting about the possibility (likelihood?) that the funds from the net-worth sweep were used to fund the ACA.

      It’s awfully suspicious that the amount appropriated via the net worth sweep happens to match up to the $130 billion that was needed to reimburse health insurers that reduce cost sharing for eligible individuals and families as they are required to do under the ACA. Congress wouldn’t appropriate the money, so where was Treasury going to get it?

      From the big, fat piggy bank that Treasury just took over, that’s where.

  9. JimTan

    It should be noted that the Federal Reserve still purchases about $30 billion per month in Agency MBS bonds (TBA Passthroughs) through their FOMC Permanent Open Market Operations (POMO) which rounds to about 70% of everything Fannie, Freddie, and Ginnie issue in a year.


    My two cents is that if the US Government guarantees all Credit Risk and hold (70%) of new Agency Conforming Mortgages, then taxpayers basically back the entire Agency Mortgage market. We are on the hook for any problems that come up down the road. This includes Federal Agency-Private Equity projects like Blackstone Group (a Private Equity Firm) purchasing Stuyvesant Town-Peter Cooper Village for $5.3 billion, with a $3 billion credit guarantee from Fannie Mae:


    I suspect down the road that we’ll need every penny of current Agency profits to mitigate future loan losses. Private mortgage originators already take a (risk-free) spread for making agency mortgage loans. If taxpayers are responsible for all other funding and risk associated with these mortgages than why should anyone else share in the (current) profits?

  10. Chauncey Gardiner

    Appears that Freddie and Fannie are also continuing to pay out billions to the big Wall Street banks under derivatives contracts. Gives new meaning to the term “Public-Private Partnership”. The AIG/State & Local Governments template lives.

    See: http://wallstreetonparade.com/2016/05/the-u-s-government-is-quietly-paying-billions-to-wall-street-banks/

    “According to Freddie Mac’s first quarter 10K filed with the Securities and Exchange Commission, this is how much it has paid to its derivatives counterparties in just the past four years: $2.1 billion in 2015; $2.6 billion in 2014; $3.46 billion in 2013; and $3.8 billion in 2012.”… “We could not find comparable data for Freddie Mac for the crisis years but its 10K for the first quarter of 2011 shows total derivative losses (declines in the value of its derivatives portfolio plus payouts to counterparties) as follows: $8 billion in 2010; $1.9 billion in 2009; and a stunning $14.95 billion in 2008.”

    Wonder what the Bernanke Fed’s QE-ZIRP policy role was in all this? And why are US government agencies entering into these derivatives contracts in the first place? FOIA indeed.

  11. Sean

    I wouldn’t be too quick to assume the derivative payments are something nefarious. They also have a massive (although rapidly shrinking) retained portfolio of assets. I’m assuming FN/FR are hedging against rising rates. So when interest rates fall, their hedges go against them and they have to pay out. Also regardless of rate direction, many hedges like options have a cost as time goes on – i.e. if nothing happens, the option becomes less valuable as you’re closer to maturity. In anycase, as you can see from the #s you posted these deriv losses keep coming down.

    The larger issue is that their capital LITERALLY will go to zero by 2017, BY LAW. You can’t insure many trillion in assets with literally no capital.

  12. zapster

    Ok, I’m confused. If they’re fully backed by the government, why do they need capital? Government capital is essentially infinite.

    1. anonymous

      If they’re fully backed by the government, why do they need capital?
      Excellent question.

      FnF are not backed by Gov. If FnF were backed by Gov, then FnF never needed Gov bailouts. Besides FnF could have borrowed from market as well as from Fed/Tsy(Tarp) at much cheaper rates.

      It has been false narrative used by some to take advantage of the 2008 crisis to grab the business of FnF.

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