The New York Times and the Failure of Fannie and Freddy

Even the NYT gets it.


Pressured to Take More Risk, Fannie Reached Tipping Point
By CHARLES DUHIGG
Published: October 4, 2008
“Almost no one expected what was coming. It’s not fair to blame us for not predicting the unthinkable.“— Daniel H. Mudd, former chief executive, Fannie Mae
Skip to next paragraph The Reckoning

Inflating the Bubble Articles in this series are exploring the causes of the financial crisis.
Previous Articles in the Series »

Multimedia

Graphic Leaning on Risks




Related

Times Topics: Federal National Mortgage Association (Fannie Mae)

Times Topics: Freddie Mac


Add to Portfolio

• Federal National Mortgage Association (Fannie Mae)
• Freddie Mac

Go to your Portfolio »

Larry Downing/Reuters
THE BUILDERS By 2000, chief executives like Franklin D. Raines, above, and the chief financial officer J. Timothy Howard had greatly expanded Fannie Mae.

Ken Cedeno/Bloomberg News
J. Timothy Howard.



');}//-->

When the mortgage giant Fannie Mae recruited Daniel H. Mudd, he told a friend he wanted to work for an altruistic business. Already a decorated marine and a successful executive, he wanted to be a role model to his four children — just as his father, the television journalist Roger Mudd, had been to him.
Fannie, a government-sponsored company, had long helped Americans get cheaper home loans by serving as a powerful middleman, buying mortgages from lenders and banks and then holding or reselling them to Wall Street investors. This allowed banks to make even more loans — expanding the pool of homeowners and permitting Fannie to ring up handsome profits along the way.
But by the time Mr. Mudd became Fannie’s chief executive in 2004, his company was under siege. Competitors were snatching lucrative parts of its business. Congress was demanding that Mr. Mudd help steer more loans to low-income borrowers. Lenders were threatening to sell directly to Wall Street unless Fannie bought a bigger chunk of their riskiest loans.
So Mr. Mudd made a fateful choice. Disregarding warnings from his managers that lenders were making too many loans that would never be repaid, he steered Fannie into more treacherous corners of the mortgage market, according to executives.
For a time, that decision proved profitable. In the end, it nearly destroyed the company and threatened to drag down the housing market and the economy.
Dozens of interviews, most from people who requested anonymity to avoid legal repercussions, offer an inside account of the critical juncture when Fannie Mae’s new chief executive, under pressure from Wall Street firms, Congress and company shareholders, took additional risks that pushed his company, and, in turn, a large part of the nation’s financial health, to the brink.
Between 2005 and 2008, Fannie purchased or guaranteed at least $270 billion in loans to risky borrowers — more than three times as much as in all its earlier years combined, according to company filings and industry data.
“We didn’t really know what we were buying,” said Marc Gott, a former director in Fannie’s loan servicing department. “This system was designed for plain vanilla loans, and we were trying to push chocolate sundaes through the gears.”
Last month, the White House was forced to orchestrate a $200 billion rescue of Fannie and its corporate cousin, Freddie Mac. On Sept. 26, the companies disclosed that federal prosecutors and the Securities and Exchange Commission were investigating potential accounting and governance problems.
Mr. Mudd said in an interview that he responded as best he could given the company’s challenges, and worked to balance risks prudently.
“Fannie Mae faced the danger that the market would pass us by,” he said. “We were afraid that lenders would be selling products we weren’t buying and Congress would feel like we weren’t fulfilling our mission. The market was changing, and it’s our job to buy loans, so we had to change as well.”
Dealing With Risk
When Mr. Mudd arrived at Fannie eight years ago, it was beginning a dramatic expansion that, at its peak, had it buying 40 percent of all domestic mortgages.
Just two decades earlier, Fannie had been on the brink of bankruptcy. But chief executives like Franklin D. Raines and the chief financial officer J. Timothy Howard built it into a financial juggernaut by aiming at new markets.
Fannie never actually made loans. It was essentially a mortgage insurance company, buying mortgages, keeping some but reselling most to investors and, for a fee, promising to pay off a loan if the borrower defaulted. The only real danger was that the company might guarantee questionable mortgages and lose out when large numbers of borrowers walked away from their obligations.
So Fannie constructed a vast network of computer programs and mathematical formulas that analyzed its millions of daily transactions and ranked borrowers according to their risk.
Those computer programs seemingly turned Fannie into a divining rod, capable of separating pools of similar-seeming borrowers into safe and risky bets. The riskier the loan, the more Fannie charged to handle it. In theory, those high fees would offset any losses.
With that self-assurance, the company announced in 2000 that it would buy $2 trillion in loans from low-income, minority and risky borrowers by 2010.
All this helped supercharge Fannie’s stock price and rewarded top executives with tens of millions of dollars. Mr. Raines received about $90 million between 1998 and 2004, while Mr. Howard was paid about $30.8 million, according to regulators. Mr. Mudd collected more than $10 million in his first four years at Fannie.
Whenever competitors asked Congress to rein in the company, lawmakers were besieged with letters and phone calls from angry constituents, some orchestrated by Fannie itself. One automated phone call warned voters: “Your congressman is trying to make mortgages more expensive. Ask him why he opposes the American dream of home ownership.”

see the rest here:

http://www.nytimes.com/2008/10/05/business/05fannie.html?_r=1&ei=5065&partner=MYWAY&pagewanted=all