Analytical Wealth

It's no secret that I'm of the opinion that Congressional hearings are often a waste of time, that the politicians on the Senate Banking and House Financial Services Committee are clueless and that Congress is to blame for mismanaging the Mortgage GSEs. Lest you think that I simply like bashing politicians for fun and sport, here is a look at some excerpts from the hearings on Fannie and Freddie after the latter's accounting issues came to light:

(From the WSJ): "Rep. Barney Frank (D., Mass.): I worry, frankly, that there's a tension here. The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see. I think we see entities that are fundamentally sound financially and withstand some of the disaster scenarios. . .

Rep. Maxine Waters (D., Calif.), speaking to Housing and Urban Development Secretary Mel Martinez: Secretary Martinez, if it ain't broke, why do you want to fix it? Have the GSEs [government-sponsored enterprises] ever missed their housing goals?

House Financial Services Committee hearing, Sept. 25, 2003:

Rep. Frank: I do think I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision]. I want to roll the dice a little bit more in this situation towards subsidized housing. . . .

House Financial Services Committee hearing, Sept. 25, 2003:

Rep. Gregory Meeks, (D., N.Y.): . . . I am just pissed off at Ofheo [Office of Federal Housing Enterprise Oversight] because if it wasn't for you I don't think that we would be here in the first place.

And Freddie Mac, who on its own, you know, came out front and indicated it is wrong, and now the problem that we have and that we are faced with is maybe some individuals who wanted to do away with GSEs in the first place, you have given them an excuse to try to have this forum so that we can talk about it and maybe change the direction and the mission of what the GSEs had, which they have done a tremendous job. . .

Senate Banking Committee, Oct. 16, 2003:

Sen. Charles Schumer (D., N.Y.): And my worry is that we're using the recent safety and soundness concerns, particularly with Freddie, and with a poor regulator, as a straw man to curtail Fannie and Freddie's mission. And I don't think there is any doubt that there are some in the administration who don't believe in Fannie and Freddie altogether, say let the private sector do it. That would be sort of an ideological position.

Mr. Raines: But more importantly, banks are in a far more risky business than we are.

Senate Banking Committee, Feb. 24-25, 2004:

Sen. Thomas Carper (D., Del.): What is the wrong that we're trying to right here? What is the potential harm that we're trying to avert?

Federal Reserve Chairman Alan Greenspan: Well, I think that that is a very good question, senator.

What we're trying to avert is we have in our financial system right now two very large and growing financial institutions which are very effective and are essentially capable of gaining market shares in a very major market to a large extent as a consequence of what is perceived to be a subsidy that prevents the markets from adjusting appropriately, prevents competition and the normal adjustment processes that we see on a day-by-day basis from functioning in a way that creates stability. . . . And so what we have is a structure here in which a very rapidly growing organization, holding assets and financing them by subsidized debt, is growing in a manner which really does not in and of itself contribute to either home ownership or necessarily liquidity or other aspects of the financial markets. . . .

Sen. Richard Shelby (R., Ala.): [T]he federal government has [an] ambiguous relationship with the GSEs. And how do we actually get rid of that ambiguity is a complicated, tricky thing. I don't know how we do it.

I mean, you've alluded to it a little bit, but how do we define the relationship? It's important, is it not?

Mr. Greenspan: Yes. Of all the issues that have been discussed today, I think that is the most difficult one. Because you cannot have, in a rational government or a rational society, two fundamentally different views as to what will happen under a certain event. Because it invites crisis, and it invites instability. . .

Sen. Christopher Dodd (D., Conn.): I, just briefly will say, Mr. Chairman, obviously, like most of us here, this is one of the great success stories of all time. And we don't want to lose sight of that and [what] has been pointed out by all of our witnesses here, obviously, the 70% of Americans who own their own homes today, in no small measure, due because of the work that's been done here. And that shouldn't be lost in this debate and discussion. . .

* * *

Senate Banking Committee, April 6, 2005:

Sen. Schumer: I'll lay my marker down right now, Mr. Chairman. I think Fannie and Freddie need some changes, but I don't think they need dramatic restructuring in terms of their mission, in terms of their role in the secondary mortgage market, et cetera. Change some of the accounting and regulatory issues, yes, but don't undo Fannie and Freddie"

So what's missing from these conversations? A constructive dialogue around the risks to the global economy if the mortgage GSEs were to run into trouble (let alone fail), how best to manage the mortgage GSEs and a frank discussion around their financial health. After all shouldn't  these discussions have been focused on financial health and management strategy, with the goal of reducing the risks the GSEs posed to the economy and insuring their on-going financial health?

So why is it that the dialogue was really about one party believing that the other simply didn't believe in the mission of the GSEs and was just out to destroy them for ideological reasons? Why weren't our politicians able to put aside the political grand standing on homeownership, put away their partisan politics, read the balance sheets of the two companies and focus on the core issue: maintaining the financial health of Fannie Mae and Freddie Mac on a go-forward basis?

In my view the answer is that the mortgage GSEs were seen more as vehicles for politician gain then they were seen as vital parts of the global financial system; as long as home ownership rates were going up, as long as someone felt their community "needed the GSEs", and as long as touting the mission of Fannie and Freddie served their purposes they had zero interest in tinkering with the two companies.

For evidence of this look no further than the fact that Congress authorized the GSEs to expand the scope of their investment activities after the onset of the credit crunch, despite the fact that both companies began losing money once the housing downturn hit (and even when they did it was due to tax treatment). Again, Congress wasn't especially interested in maintaining the financial health of the mortgage GSEs, they just wanted to appear as if they were doing something to halt the slide in housing prices.

Apparently speaking honestly with the American people about the fact that housing prices were hyper-inflated during the boom, and that the real estate market was going through a very necessary correction, was simply not an option for them.

The recent problems with the mortgage GSEs could've been avoided if Congress had reined them in years ago (or the very least in the wake of the credit crunch), instead of choosing politics over common business sense. After all there were many analysts and notables (such as Warren Buffett) who warned about the risks posed by Fannie and Freddie, so it's not like Congress can say that no one warned them. While it's fair to deride their executives for running the companies into the ground, the politicians on Congress' banking and financial services committees deserve a large share of the blame as well.

All of this begs the question: can we really trust politicians to manage entities like the GSEs or any other key private sector investments/companies, et al, if there is a risk that their political aims, partisan politics/bickering, et al could prevent them from making the right decisions?

Final thought: does anyone else  feel nervous about the fact that the very people who ran the GSEs into the ground are now working on the bailout bill? How about the fact that they will be working on additional solutions to the current crisis, new banking regulations, etc?

You can read the transcript excerpts in full here.

Sources:

The WSJ: "What They Said About Fan and Fred" -- October 2, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.