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September 8th, 2011

Who is responsible for Fannie Mae and Freddie Mac losses?

by Peter Miller


Buying justice macroNews that the government is suing 17 major lenders hardly comes as a surprise.

The Federal Housing Finance Agency (FHFA)–the regulator that oversees the now-nationalized Fannie Mae and Freddie Mac–faces massive losses, and it follows that in a litigious world a variety of issues would wind up in court.

You might think the lawsuits would involve allegations concerning loans sold to Fannie Mae or Freddie Mac that didn’t pan out because applications were somehow hinky, or that mortgage rates were somehow impacted.

Instead, the suits involve claims which stem from the role of Fannie Mae and Freddie Mac as Wall Street investors.

Fannie & Freddie: Private-label investors

Like most large financial entities, Fannie Mae and Freddie Mac have invested in private-label mortgage-backed securities.

In the same way that Fannie Mae and Freddie Mac gather mortgages together and package them as mortgage-backed securities, the same is also true on Wall Street. Now the FHFA is saying the investments it made were based on information which was allegedly incorrect.

How is it possible for Fannie Mae and Freddie Mac to buy mortgage interests and now question the information received from Wall Street firms, the folks who pull together loans and package them as mortgage-backed securities?

The FHFA has now come out with a ringing defense:

It says size and sophistication don’t matter, and that Wall Street had an obligation to present proper information:

At the heart of the suits is FHFA’s conclusion that the actual mortgages backing many of the securities had characteristics that differed in a material way from what had been represented in securities filings. Under the securities laws at issue here, it does not matter how “big” or “sophisticated” a security purchaser is, the seller has a legal responsibility to accurately represent the characteristics of the loans backing the securities being sold. 

Did Fannie & Freddie not do their homework?

There must be a legal analysis to support the FHFA’s conclusion, but you have to wonder if Wall Street has a different legal opinion, one which says, “Wait a minute, doesn’t an investor in mortgage-backed securities have a due-diligence obligation?”

The FHFA also says something else which catches the eye:

…press reports that FHFA is seeking nearly $200 billion in damages or recoveries are excessive; such numbers reflect the original amount of such securities purchased, not the losses incurred or the potential recoveries at the end of this process. In particular, use of original unpaid principal balance as a measure of potential recoveries is incorrect as it does not equate with the losses incurred and it does not reflect the repayments of principal that have already occurred or the remaining value of the securities.

Okay, exactly how much is FHFA seeking?

This is an important question because Fannie Mae and Freddie Mac have constantly been hectored for making “bad” loans to consumers.

In fact, Fannie Mae and Freddie Mac don’t actually originate any loans or set mortgage rates–they buy conforming mortgages from private-sector lenders, loans that are supposed to meet certain standards.

It may be–finally–that with these suits we can find out how many of the problems associated with Fannie Mae and Freddie Mac involve the home mortgages they’ve bought–and how much, if any, of their losses are related to dealings on Wall Street.

4 Responses to “Who is responsible for Fannie Mae and Freddie Mac losses?”

  1. Ebano Says: September 8th, 2011 at 10:33 am

    Don’t mistake the losses in the quarterly results for the losses when a home is foreclosured. FnF’s losses are caused mainly by the provision to build up a Reserve Fund. Freddie Mac’s Reserve Fund for future losses was just 0.30% of the mortgage portfolio just before conservatorship (2Q 2008) and now stands at 2.01%. FnF have a combined $113.9 billion Reserve Fund as of end of June. The U.S. governmetn just has scared the taxpayer, but the reality is that the losses are caused by an over-reseved Fund. More provisions, more losses ,then less Tier1 capital, then more Reserve Fund, more Tier 2 capital. Less Tier1 captial in exchange of more Tier2 capital. Not big deal.

  2. Mortgage Rates Fall to Record Lows of 4.12% on Average – Fannie Mae « John Murphy Reports Says: September 8th, 2011 at 2:08 pm

    […] Who is responsible for Fannie Mae and Freddie Mac losses? (hsh.com) […]

  3. larry Says: September 9th, 2011 at 10:04 am

    That is BS. It’s liberal government pressures that bullied backs into making bad loans. Listen to Maxine Waters comments on “gangsta banks”. “We’ll just tax them out of biness”. That is a recap of the pressures applied that created a bubble. Bad appraisers, look again to these communities.

  4. OurBroker Says: September 9th, 2011 at 4:29 pm

    Ebano — The banking sector is reducing reserves to report larger profits. In the second quarter reserve set asides were reduced by $21.4 billion when compared with 2010. See: http://www.fdic.gov/news/news/press/2011/pr11141.html

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