An overhaul of Fannie Mae and Freddie Mac continues to draw chatter in Washington, prompting a number of people to break long-held silence on the legacy of the government-sponsored enterprises.
Adding his voice to the conversation is former Fannie Mae CFO Timothy Howard, who was ousted in late 2004 along with then-CEO Franklin Raines. Howard, who spent 15 of his 22 years at Fannie Mae running its mortgage investment portfolio, is releasing a book Dec. 2, "The Mortgage Wars," to present his view of what burst the housing bubble and created the 2008 financial crisis.
To hear Howard explain the issue, Fannie Mae bears little responsibility for the chaos that blew up other financial institutions, led to the creation of the Troubled Asset Relief Program and is spurring ongoing debate over the fate of GSEs. To him, the crisis was caused by a handful of greedy banks and mortgage lenders; Fannie was merely collateral damage in a series of battles.
"The mortgage wars were fought not over reducing risk to the taxpayers or providing the lowest-cost and safest types of home loans to consumers," he writes. Rather the war was over "ideology, market power and money."
Internal mishaps do not play a major role in Howard's telling of the Fannie Mae story. Instead, he asserts that the GSE remained fundamentally sound throughout the crisis and was the victim of vicious smear campaigns from groups such as FM Watch and "free market ideologues" at the Federal Reserve Board and Treasury Department. Issues at the GSE were merely a case of shaped perceptions and slight of hand, rather than real problems.
Howard offers very few mea culpas. He acknowledges that Fannie took too long to address the size of its portfolio and reliance on derivatives, and he second guesses the GSE's dalliance with manufactured housing. A lack of significant reflection is, at first blush, disconcerting but, then again, he perhaps should be commended for standing his ground. From his perspective, Fannie has little to apologize for, so he has no reason to do so by proxy.
He doesn't even acknowledge mistakes in the accounting scandal that resulted in his departure. Rather, Howard claims that the OFHEO found signs of fraud and forced Fannie to restate years of earnings offered to endear itself to the GSE's detractors. "I was confident we would acquit ourselves well in the OFHEO exam but I also was keenly aware of what was being said on the political side," he writes.
There's an interesting, and largely unknown, aside to this part of the story. Howard details a trip he and Raines made to lobby Warren Buffett for an eleventh-hour capital infusion in December 2004. The Buffett-owned private jet lost an engine in flight and had to make an emergency landing. While Buffett agreed to the investment, OFHEO refused to accept the terms and the two executives were forced out.
"In the end, Raines's many supporters on the board concluded that the cost of a protracted fight with OFHEO would be too great, and reluctantly they agreed to ask Raines to leave," Howard writes. "His and my departures were made public simultaneously."
It is worth noting that, in October 2012, U.S. District Court Judge Richard Leon dismissed the last major shareholder lawsuit against Howard tied to the fraud allegations, ruling that "no witnesses testified that Howard knew that Fannie Mae's financial statements were materially inaccurate."
Rather than issue apologies, Howard opts to make a case for the GSE's actions. Adding adjustable-rate mortgages to the portfolio was necessary to reduce interest rate exposure. Easing loan-to-value standards was needed to fulfill a duty to affordable housing. Soaring debt was "entirely market driven," he writes.
Furthermore, Howard asserts that Fannie implemented new discipline that was "uniquely prepared" for the implosion of the housing market. "The timing was nearly perfect," he adds.
At some point, though, a responsible manager should own up to shortcomings. Instead, Howard quotes the 2001 book "Good to Great" by Jim Collins, which touted Fannie as the "best capital market player in the world at managing mortgage interest risk."
Howard overlooks the fact that Collins has a less-than-flattering view of management under Raines. "We found little evidence that the company's executives seriously considered the possibility of failure," Collins writes in his 2009 work, "How the Mighty Fall".
In his newer book, Collins writes that his researchers found signs of managerial hubris, an undisciplined pursuit of growth and "denial of risk and peril" at Fannie leading up to the financial crisis.
"What's the upside of increasing leverage dramatically and increasing exposure to mortgage-backed securities?" Collins writes in "How the Mighty Fall", lumping Fannie in with other financial firms. "More profit, if the weather remains clear and calm."
"The Mortgage Wars" serves as an intriguing counterweight to "The Financial Crisis and the Free Market Cure" by retired BB&T CEO John Allison. Like Collins, Allison takes Fannie and Freddie to task over excessive leverage ratios. The GSEs "could operate with this much leverage only because the government had effectively guaranteed their debts," he writes.
(Allison's book, like Howard's, was published by McGraw Hill.)
Therein rests a big debate between Howard and Allison. The former alleges that forces in Washington wanted the GSEs privatized; the latter is adamant that the GSEs existed only because of strong allies in the nation's capital. In this regard, they highlight a lingering debate over the fate of both entities.
Allison also faults the GSEs for driving a number of lenders out of the prime mortgage market, while Howard faults the banks for all but forcing Fannie to progressively take on more risk.
Howard and Allison do share a clear distaste for regulators. Howard writes that regulators' "blindness to what they did not wish to see was a failure of monumental consequence." At one point, he accuses former Fed Chairman Alan Greenspan of purposefully mischaracterizing Fannie's business due to "ideological" issues with its portfolio.
To be sure, Howard makes some good points. He draws a clear distinction between Fannie's mortgage-backed securities and the private-label equivalent, noting that the GSE's securities had an independent guarantor to absorb excess losses. He also contrasts the two by noting that Fannie has risk alignment in a way that was largely absent from private-label MBS.
"The Mortgage Wars" also offers Howard's plan to overhaul the mortgage market. For him, it is critical to keep the 30-year fixed-rate mortgage broadly available and avoid substituting ARMs or balloon mortgages. He pushes for a mortgage guaranty mechanism "that attracts international capital at the lowest achievable interest rate" to fund originations.
Finally, he urges lawmakers to try and reduce costs for consumers before providing any more government assistance to financial institutions.
What about the GSEs? He argues that Fannie is much healthier than what many in Washington claim. He asserts that the Treasury and Federal Housing Finance Agency threw anchors at the GSEs after the financial crisis, while regulators tossed out lifelines to banks. By forcing Fannie to reduce the size of its mortgage portfolio and obligating it to pay outsized dividends, the Treasury all but issued the GSE "a death sentence."
Still, he acknowledges that the GSEs should be "wound down over time" but only because of controversy not poor performance. "Critics' claims notwithstanding, the 'GSE model' for the secondary mortgage market was not flawed," he defiantly writes. "It was sabotaged by hostile and inept regulation. And the alternative free-market model proved to be an unqualified disaster."
Fannie and Freddie "could be de novo companies or rechartered" with the Fed or Treasury regulating returns. Government support, in the form of a catastrophic risk reinsurance fee, could be implicit or explicit.
"If we can succeed in devising such a system, something positive will have come out of the mortgage wars after all," he concludes.