Oh What a mess….

The legacy of Democrats and Republicans approaches: Libertarianism by bankruptcy.

Nick Nuessle, 1992

            What a mess huh? Watching the last presidential debate was a glaring example as to how low both political parties are willing to sink to politicize this economic meltdown. Democratic pundits point out that Obama said last September that Fannie Mae and Freddie Mac were headed for trouble (Funny, I can’t seem to find that speech). On the other side of the aisle McCain stated, in a congressional budget meeting in 2005, that the Mortgage giants Fannie and Freddie were headed for trouble because of their sub-prime rates. Retired Fed. Chairman Alan Greenspan had warned congress the same thing in their quarterly economic review meetings. Was no one listening?

            Here is a brief history of just who Fannie Mae and Freddie Mac are. Fannie Mae was founded as a government agency in 1938 as part of Franklin Delano Roosevelt’s New Deal to provide liquidity to the mortgage market. Congress chartered Freddie Mac as a private corporation in 1968 to help balance the federal budget (and help pay for the Viet Nam war effort), part of Fannie Mae was converted to a private corporation solely to provide competition in the secondary mortgage market, and to end Fannie Mae’s monopoly. This is the critical part, when part was converted to a private corporation; congress has no constitutional authority to regulate it.

            This brings us up to 2007 and our current Domino effect economy. In 2006, the Office of Federal Housing Enterprise Oversight accused former Fannie Mae Chief Executive Franklin D. Raines, who was the budget director to former president Bill Clinton, of manipulating earnings from 1998 to 2004 so they would receive bonuses totaling $115 million. In a civil suit that was filed Raines, along with 2 others, J. Timothy Howard, former chief financial officer; and Leanne G. Spencer, former Fannie Mae controller, were assayed fines. Raines is paying a $24.7 million settlement, an additional $2 million fine and he was forced to forfeit $15.6 million in stock options. Howard agreed to pay $6.4 million, and Spencer agreed to pay $275,000. Fannie Mae has agreed to pay a $400 million civil settlement to the OFHEO and the Securities and Exchange Commission.

            On the Freddie Mac side last year, federal regulators had charged Freddie Mac with negligent conduct for its role in a four-year securities fraud accounting scandal. Former president and chief operating officer David Glenn, former chief financial officer Vaughn Clarke and former senior vice presidents Robert Dean and Nazir Dossani agreed to pay civil fines totaling $515,000 and restitution payments amounting to $275,548. Former Freddie Mac Chairman and Chief Executive Officer Richard Syron told MSNBC last year, “We take these charges seriously, and that’s why the Freddie Mac of today is a very different company than the Freddie Mac of the past.” This statement belays the fact that Syron was warned in 2004 by David Andrukonis, the chief risk officer of Freddie Mac, of the increasing risk in Freddie Mac’s portfolio because of their increased “Government mandated” sub-prime mortgage loans. Syron declined to act.

            In December 2007, Syron finally told financial analysts that he expected Freddie Mac would incur heavy losses because of the weakening housing market and rising mortgage defaults.  Despite these forecasts, and concerns over the fiscal stability of Freddie Mac AND due to larger-than-expected write-offs, Syron reportedly took home over $19 million in cash, stocks, and other executive compensation. Mr. Syron was terminated September 6, 2008, under a Federal Housing Finance Agency plan for conservatorship of Freddie Mac. It is unknown as of yet if he will receive a severance package. Anyone want to take bets?

Currently, according to the Wall Street Journal (another fine newspaper), Freddie and Fannie own or guarantee about $5.2 trillion worth of mortgages. The riskiest loans held by Freddie and Fannie are known as ” subprime mortgages”, worth about $780 billion, or about 15 percent of the total portfolio. The recent federal government takeover of Freddie and Fannie passes to U.S. taxpayers the contingent liability for failures in the entire $5.2 trillion loan portfolio held by the two mortgage giants.

            Both Sens. John McCain and Barack Obama have come under fire for allegedly having donors and campaign advisers tied to Fannie Mae and Freddie Mac, the New York Times reported. The companies are said to have contributed money to protect them from stricter regulations while purchasing risky mortgages.

            Now I ask a simple question “Who should take heat for accounting fraud, deliberately misleading Wall Street?” We already have a rogues gallery of financial disasters so who is to blame? As Congress works on a $700 billion bailout plan for the U.S. financial system, the FBI has extended fraud investigations to 26 companies involved in mortgage lending. Authorities are attempting to determine whether any of the firms have participated in accounting fraud, insider trading or inflating values of mortgage-related assets. The FBI has not disclosed the full list of companies under investigation but thru some massive and time-consuming web searches here are just a few.

            Countrywide Financial run by Angelo Mozilo. His company allowed special “friends of Angelo,” or FOAs to accept or obtain loans at below-market rates with preferential terms from his company, with the bonus that they could do away with points, fees and borrowing rules.

            IndyMac Bank Inc. was sent into freefall after Sen. Chuck Schumer, D-N.Y, escalated the crisis by publicly leaking his June 26 letter to the Office of Thrift Supervision and the Federal Deposit Insurance Corp. He warned that the bank was on the brink of collapse. Out of the goodness of his heart Sen. Schumer said he was “concerned that IndyMac’s financial deterioration poses significant risks to both taxpayers and borrowers and that the regulatory community may not be prepared to take measures that would help prevent the collapse of IndyMac”. As was expected Schumer’s letter sent IndyMac customers into widespread panic, and they quickly withdrew their money from the bank – to the tune of $1.3 billion. The total Bailout of just this one debacle directly traced to Schumer’s “letter” cost the taxpayer backed FDIC between $4 billion and $8 billion.

            Lehman Brothers CEO Richard Fuld was awarded a $22 million bonus in 2007 after the bank’s net profit was reported to have risen by 5 percent to a record $4.2 billion. Now the company, formerly known as Wall Street’s fourth largest investment bank, has filed one of the largest bankruptcies in U.S. history all because Fuld “played a game of brinksmanship, refusing to accept offers that could have rescued the firm because they didn’t reflect the value he saw in the bank.” His sheer arrogance was entirely at fault here. To avoid bankruptcy all this genius had to do was sell a 25 percent stake in the company to Korea Development Bank for $4 billion to $6 billion. Fuld declined the offer because he thought it was “too low”.

            Washington Mutual has been seized bt the FDIC because Wa-Mu lost 70% of its market value this year following mortgage-related losses, the Seattle-based bank has been seized by the Federal Deposit Insurance Corporations. The FDIC sold its banking assets to JPMorgan Chase for $1.9 billion. Total loss to the Taxpayers thru this FDIC bailout, between $19 billion and $28 billion. The bank financed at least 43 mortgages worth $24.5 million for one family of home flippers who had a history of fraud. Washington Mutual, like many banks, did not conduct criminal background checks on its borrowers and liberally granted loans.

            This is only a partial list but you get the point. American International Group, Inc (AIG), Bear Stearns, All are going down due to greed, corruption and no accountability to anyone. Now, while the FBI investigates 26 firms for fraud and 10 percent of the nation’s $11 million in mortgages are in default or foreclosure, Congress works to approve a $700 billion bailout plan to buy troubled investments and save financial institutions from their mounting debts. The president is also asking Congress to increase the limit on the nation’s debt from $10.6 trillion to $11.3 trillion – a move that could raise interest rates and weaken the dollar. This will do nothing but  reward irresponsible financial institutions and greedy executives, burdening taxpayers with the consequences in the midst of an already trouble economy.

            Can we as a country keep the bailout constitutional? HA kiddies you knew I could sneak that in there. Currently as it stood Friday 9/26/2008, the draft bailout legislation is deeply troubling from a constitutional perspective. My four principal constitutional concerns:

1. Congress’s enumerated power—or lack thereof—to intervene with private markets in the manner contemplated;
2. The lack of meaningful standards to guide the extremely broad grant of discretion to the Treasury secretary (the “legislative delegation” problem);
3. Limitations on judicial review over the exercise of that almost limitless discretion; and
4. Related separation of powers concerns.

            Instead of trying to employing narrow legalistic arguments to bypass the Constitution, I believe that lawmakers must be cautious and ensure they think through these very serious questions. To protect our Constitution the draft legislation must cabin the scope and character of the Treasury secretary’s discretion, connect the exercise of that discretion to legitimate government purposes, and allow Americans adversely affected to seek meaningful judicial review.

            Just a possible short list of what could work to fix the problem….

1.         Do not prop up failed or failing institutions. Government should not try to keep failed businesses afloat; instead, as with Bear Stearns, they should “ensure that they are restructured or wound down in a way that does not cause undue disruption in the financial system as a whole.”

2.         Do not try to support prices. “Policymakers should not attempt to keep stocks or housing prices from falling to their proper market-determined levels.”

3.         Do not allow the government to become the permanent “owner of last resort.” Any assets the government buys should be disposed of as expeditiously as possible.

4.         Strictly limit legislation to the immediate need to stabilize the financial situation. “Lawmakers should oppose any and all attempts to expand the legislation being proposed” into a bonanza for special interests or pet liberal or conservative causes.

5.         Avoid “moral hazard.” Policymakers must discourage others from seeking government support by ensuring businesses receiving taxpayer funds have “skin in the game” and suffer the consequences of their miscalculations.

6.         Carefully define the Fed’s role. The Federal Reserve must avoid “unwarranted mission creep” as it exercises its “lender of last resort” responsibilities to ensure liquidity.

7.         Limit taxpayer exposure and keep actions temporary. “Any new mechanism or authority to halt the deterioration in the market should ensure that affected firms pay a cost and be strictly limited in time and scope to minimize taxpayer exposure.”

8.         Assure liquidity in markets but require full pricing of government insurance. As it considers providing insurance to money market funds, “the Treasury must ensure that the price of that insurance fully reflects the market risk.”

            As presidential candidates call for a “bipartisan” effort to rescue the economy and as Congress debates a deal on a $700 billion bailout for Wall Street, From my documented examples from past blogs there seems to be a rule that permeates Washington politics, “Congress is good at two things: (1) Doing nothing at all. (2) Overreacting.” Our government already intervenes heavily in the economy. Washington could encourage growth on the Street just by getting out of the way. The long-term answer isn’t more federal control, it’s a return to free-market principles,” We need to find the correct balance point. The bailout needs to be small, both to minimize taxpayer liability and to ensure company managers and stockholders “suffer the consequences of their bad investments.”

            While the world watches for the other shoe to drop the Democrats in congress continue to play political games with the bailout, insisting on support from conservatives while “pushing for expanded government power to rewrite mortgage contracts and diverting taxpayer revenue from the sale of distressed assets into a housing slush fund.”