Jerry's Reviews > Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon

Reckless Endangerment by Gretchen Morgenson
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Jan 02, 2012

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bookshelves: economics
Read in September, 2011

The story of how politicians and investment banks caused the collapse of the financial system in 2008. It all started in January 1991 when James A. Johnson became CEO of Fannie Mae. Johnson was a political operative brought in to protect Fannie Mae's government association which was worth 0.5% in interest rates due to the assumption that Fannie was backed by the federal government. Johnson received a master's in public policy at Princeton's Woodrow Wilson School in 1968. He was active in the antiwar movement and worked on the McCarthy and McGovern campaigns. As an antiwar activist he became acquainted with Bill Clinton. Johnson was an aid to Senator Walter Mondale and later managed his presidential campaign.
In addition to the lower interest rates Fannie enjoyed a $2.5 billion line of credit with the U.S. Treasury, an exemption from state and local taxes, and exemption from SEC regulation. One third of the monetized value of the government connection went to management compensation. Johnson tied the management compensation to earnings growth and took out $100 million for himself over 9 years. To grow earnings, Johnson led the mortgage industry into ever more risky mortgages. Between 1989 and 2009 Fannie spent $100 million on lobbying and political contributions.
The Enterprises Financial Safety and Soundness Act of 1992 assigned Fannie a new mission of affordable housing. Mortgages now had to go to “low-income and under served families.” Initially 30% of housing units financed by Fannie and Freddie must go to low and moderate income families; another 30% would go to housing in inner cities. ACORN helped Congress come up with these goals. Fannie had to take a new approach to underwriting standards from banks whose loans they would buy. Down payments were lowered from 20% to 5% or less. Also Fannie lobbied to get a capital requirement of 2.5% compared to the customary 10% demanded of banks. In 1998 Fannie held 3.64% of its assets compared to 8.22% held by FDIC insured banks. Also instead of its regulatory being funded by a % of the regulated industry, Fannie's regulator had to get its funding from Congress, severely handicapping it as a regulator.
A report commissioned by HUD in 1999 concluded Fannie and Freddie were not doing enough for low-income buyers because their underwriting standards were too high. Cuomo raised Fannie's goals for financing of low and moderate-income units from 30% of mortgages to 50%. Penalty for not meeting the goal was $10,000 per day. By 2008 Fannie & Freddie would have $1.6 trillion of toxic mortgages, almost half of those that were written were purchased or guaranteed by Fannie and Freddie.
In 2004 Countrywide was the nation's largest mortgage lender generating 200,000 loans a month and booking revenues of $8.6 billion a year. Countrywide profit margins were 3% on $350K-$500K loans, 5% on $100K-$200K loans and 15% on subprime loans. Often the loan documentation was falsified to gain approval. Of the loans generated in 2004 more than half were adjustable rate loans with low teaser rates that sky-rocket in a few years. Among the most successful mortgage brokers were ex-used car salesmen and ex cell phone salesmen. From 2004 to 2007 almost 45% of subprime loans were low documentation or ” liar loans”.
By 2006 the loan sampling by Wall Street's due-diligence firms was finding that loan quality had deteriorated. In some cases 60% of an entire mortgage pool was showing material defects in underwriting. Former employees of due-diligence firms say almost half of loans sampled in 2006 had material defects. Instead of demanding lenders buy back defective loans, Wall Street demanded discounts which it pocketed while the pools were sold as if nothing was wrong. The due-diligence reports were closely guarded secrets. In the third quarter of 2006 Goldman Sachs began betting against CDOs while continuing to sell them to investors.
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