FANNIE MAE, FREDDIE MAC AND ELMER FUDD

Senator McCain is on the stumps this week touting his support for a Senate bill proposed in 2005 that he claims would have proactively dealt with the crisis that engulfed Fannie Mae and Freddie Mac. In the right-wing blogosphere, McCain's support for the Federal Housing Enterprise Regulatory Reform Act of 2005, introduced by Senators Hagel, Dole and Sununu, has been placed on a par with his support for the surge in Iraq. Once again, Senator McCain demonstrates his extraordinary prescience in anticipating and recommending courses of action that improved a disastrous situation (in Iraq) and would have headed off the federal bailout of Fannie Mae and Freddie Mac.

Once again, oversimplification rules the land. Just as McCain's recommendation to the president that a "surge" of troops be dispatched to Baghdad in order to avert civil war and stabilize Iraq so that its politicians might be given space to achieve political reconciliation has been deemed an unqualified success in some quarters, so too his support of the Federal Housing Enterprise Regulatory Reform Act of 2005 and 2007 would have been an equally profound success had the Democrats not blocked the way.

Well, there is some truth in this. With respect to Iraq, the dispatch of additional troops to Baghdad probably helped in some small way to defuse the bloodbath that was unfolding daily on the streets of Baghdad and in other Iraqi cities undergoing ethnic cleansing. However, the willingness of Sunni tribal chiefs to put an end to the insurrection in Anbar Province and the perspicacity of American military leaders in Anbar to meet the Sunni chiefs and agree to finance the Sunni Awakening by placing former Sunni insurgents on the American payroll probably was a more important factor.

With respect to the Federal Housing Enterprise Regulatory Reform Act, it is much less clear what this act would have accomplished. Prompted by the outrage at the financial shenanigans at Fannie Mae under CEO Franklin Raines who left his position at Fannie Mae with a golden parachute after the scandals that surfaced during the first Bush Administration, Senators Dole, Hagel and Sununu proposed to place Fannie Mae and Freddie Mac, as well as the Federal Home Loan Bank Board, under an independent regulatory agency. Among other things, the legislation would have dealt with golden parachutes of the like that rewarded Raines for his incompetence and gross abuse of power.

On the other hand, the Federal Housing Enterprise Regulatory Reform Act would have been charged with seeing to the continued expansion of home ownership throughout the United States. Would this act have continued the strict lending standards usually pushed by Fannie Mae and Freddie Mac or loosened them and encouraged these agencies to guarantee subprime mortgage lending that did not meet Fannie Mae and Freddie Mac guidelines is unclear. What it did seek was to rein in Fannie Mae and Freddie Mac lobbying that had attempted to lobby Congress in order to thwart the Housing and Urban Development's (HUD) ability to investigate Fannie Mae and to gain Congressional acquiesence in corporate pursuits that Fannie Mae endeavored to follow.

An important distinction must be made. Although charged with guaranteeing mortgages privately arrived at that met Fannie Mae and Freddie Mac requirements, neither entity was a government agency. These were shareholder own corporations that performed a quasi-governmental role: a mortage guarantor that lent stability to the private mortgage market.

What Raines had done was to play loose with accounting rules in order to overstate earnings and thereby enrich himself and other senior officers of Fannie Mae. Restated, these earnings showed that Fannie Mae had not achieved the results claimed and thus the bonuses paid to its senior executives were unwarranted. In this respect, Fannie Mae was just another Enron type scandal that rocked the early Bush administration.

Like Enron, the roots of Fannie Mae's troubles lay in the regulatory lapses of the Clinton Administration which took a hands off approach to Wall Street. Coupled with the desire of a Republican controlled Congress to deregulate Wall Street wherever possible, the hands off approach of Robert Rubin, Secretary of Treasury, conspired to allow slipshod accounting practices to run amok until the bubble burst in the early 2000s.

Enter Elmer Fudd.

Sporting his double-barrelled shotgun, McCain takes aim at Fannie Mae 2008. Neither his support of the Federal Housing Executive Regulatory Act of 2005 or 2007 had met with Congressional approval. Neither a Republican controlled Congress nor a Democratic controlled Congress acted on the bill. It died in committee. Somehow, McCain construes the troubles that afflicted Fannie Mae to be the same as those that plagued Fannie Mae in 2002. Has he been asleep for six years? Did he miss everything that transpired in 2007?

What happened to Fannie Mae and Freddie Mac in many respects was collateral damaged inflicted by the subprime mortgage crisis that saw the destruction of Ameriquest, a leader in subprime mortgages, and the takeover of Countrywide by Bank of America after BofA's lending of millions of dollars to Countrywide failed to staunch the bleeding of capital in Countrywide. Neither Fannie Mae nor Freddie Mac held many subprime mortgages nor were they the guarantor of subprime mortgages, many of which were not worth the paper printed on since income verifications were largely absent and many involved financial chicanery that overstated the true value of the mortgages negotiated. Despite many Congressional leaders desire to push Fannie Mae and Freddie Mac to guarantee or even purchase outright many of these worthless mortgages, neither corporation was at risk.

However, once the subprime crisis unfolded, banks and investors grew skitterish. The collapse of the housing market as the pool of potential buyers shrank once the subprime market evaporated led to a fall in housing prices. Now, many homeowners who had good mortgages found an uncomfortable inversion in their portfolios. Too many houses were worth less than the mortgages that financed their purchase. Such negative value caused many homeowners to default on their mortgages or even walk away from negative value homes. A cascading effect began to take hold as entire neighborhoods took on more and more the resemblances of ghost towns, boarded up as lenders pursued foreclosure. Property values for the remaining homeowners declined and pushed even more homeowners into foreclosure.

For investment banks, mortgage security insurers, as well as Fannie Mae and Freddie Mac, the implosion the housing market meant that credit markets began to seize. Banks tightened lending requirements and companies that needed to borrow on the credit markets in order to shore up their own capitalization found it difficult to acquire the necessary cash. Though subprime mortgages amounted to a small percentage of the total portfolio of mortgages held by Fannie Mae and Freddie Mac, their total value exceeded the capitalization of both firms. If either firm had to guarantee these suspect mortgages, they themselves could have seen a wiping out of their own capital.

In short, the subprime crisis had morphed into a general financial crisis that dwarfed the Savings and Loan crisis of the early 1990s when the market value of assets held by many S&L's was below the value of S&L deposits. Thus, a run on the banks would have brought ruin to any entity that didn't have enough capital on hand and whose holdings were not worth near the amount of money required to indemnify depositors.

Thus, it was unsurprising that Bear, Stearns collapsed under the weight of a run on the bank. The precipitous decline in its stock valuation indicated that the market did not believe Bear, Stearns could honor its obligations.

After a pause, during which a minor bank - Indy Mac - but a major player in the subprime industry experienced a run on the bank which required FDIC intervention, the pressure built up over the summer and culminated in an attack on Freddie Mac and Fannie Mae. Bailing out these corporations only led a panicked financial industry to go after new suspects: Lehman Brothers, AIG, Merrill Lynch and possibly Morgan Stanley, which, despite posting profits, became the target of a lack of investor confidence.

Mr. McCain's support of the Federal Housing Executive Regulatory Reform Act of 2005 may have been laudatory in the abstract, but this act would have done nothing to stem the destruction wrought by the subprime crisis. Indeed, as the subprime meltdown gathered strength in 2006 and 2007, McCain lent his support once again to the Federal Housing Executive Regulatory Act of 2007 that again would not have addressed the problem at hand.

So. claim what you will, Senator McCain. None of it is compelling. It is but another attempt to present you as an all-seeing Senator who has the solution, if only we elect him president. On the other hand, Senator Obama has made specific proposals with respect to the ongoing subprime mortgage crisis and its ripple effects that you attempt to dismiss by attempting to link him to the disgraced Franklin Raines who contrary to the claims of some of your supporters is not an advisor to the Obama campaign.

You call for a 9/11 commission to investigate the current mess as if that would contribute anything to a resolution of the problem. Worse: it's ironic that the commission you tout - the 9/11 commission was virtually ignored by policymakers. Yes, it made for good press and used up a fair amount of money, but it didn't lead to the resignation of Bush administration officials who ignored the warnings before 9/11. It didn't cause the Bush administration to tender their resignations en masse. Nor did it lead to the resignation of Bush or Cheney.

While your proposed commission might meet interminably, discuss, debate and deliberate the chain of events that has brought us to the current global crisis and even produce a weighty tome amenable to holding down worthless mortgage paper, the crisis goes on. Worse: you waffle. Was it wise to bail out Fannie Mae and Freddie Mac? Was taxpayer money put to good use in buying out AIG? Frankly, I place much greater faith in President Paulson and Vice-President Bernanke who have been tasked with saving what can be saved. Yet, you're the man with a plan. Fire them all and fulminate against the greedy who walked away from the mess they wrought with millions of dollars in bonuses. Elmer Fudd would be proud.