Tuesday, August 5, 2008

There Will Be Blood

The GSEs are in a race for their lives, but they are not racing each other.
The race is between the huge amounts of red ink saturating the entire financial services world--and virtually every single mortgage lender/investor--and the amount of capital Fannie and Freddie have on hand or can raise to staunch that bloody flow.

Not to belabor the metaphor, but the Treasury/Fed relief is a triage, which neither company ever wants to apply. To do so will signal their corporate demise just as assuredly as swallowing poison would herald a human death.

We’ll get first hints and know more by the end of the week, when both Freddie and Fannie, apparently in that order, will have announced their Second Quarter

If the GSEs can manage their losses or can supplement their existing capital—via market means--they can survive the blood loss now and keep their unique status. Having thus succeeded, their managers will have earned the right to stay and prosper, along with the companies.

If they can’t and eventually need Uncle Sam’s financial help then the company’s leaders deserve to be kicked to the curb for errors of commission which bankrupted their enterprises.

In one sense it won’t matter because inviting or allowing the federal government in, will effectively nationalize the companies and end private management’s discretion, no matter what facade is erected to pretend that isn’t the case.

Simply stated the GSEs should always have sufficient capital to stave off catastrophic damage, if their portfolios were overflowing with the traditional GSE product. But neither is.

Both have some (too much?) of the subprime and Alt-A cancer which could drain their capacity to survive this “financial Armageddon.”

It is those stressed assets which are hemorrhaging and costing them, not the overall size of their portfolios, the cost of their debt, whether they lobby Congress effectively or not, or how much they pay their officers,

In retrospect those non traditional GSE “investment decisions” were the wrong ones, for several reasons, not the least of which was that they were inconsistent with historical GSE underwriting standards.

But, when you look at decisions like these, I’m reminded of the Orange County, California, Treasurer Bob Citron, who back in 1994 presided over a $1.7 billion loss of county tax revenues because he invested that money in Wall Street securities which bet that rates were coming when the Fed kept them up.

Citron—who would have had statues built in his honor, if he only had invested in the opposite direction--lost his job and was shamed into retirement.

Citron bet red, but it came up black.

No stealing, nothing unethical, Bob Citron just looked at the financial/economic tea leaves and chose wrong.

Yet, private money managers or corporate officials who direct huge private investment face something of the same choice and if you make a mistake, like Citron, you should pay at least with your job.

I don’t think any Chairman/CEO in their right mind would drive decisions based on the belief that federal government would bail out his/her business mistakes. That person would go down in infamy, if a federal bailout was necessary. Bad judgments and decisions, sure, but—I hate to disappoint you right wingers—nobody who is rational factors in Uncle Sam’s help and thinks they or their company would survive its application..

The jury is still out looking at all of the GSEs 2005-2007 investment decisions which will decide the companies’ fates. There have been no lengthy commentaries about loading up on poorly underwritten or priced “liar loans” (where everyone, borrower and lender alike lies).

But, if these loans come back and fatally bite them, any GSE postmortem alleging “subprime and associated problems in the primary mortgage markets,” as the sole explanation for corporate failure should be rejected as a white wash.

As someone who called themselves “Anonymous” claimed in the comments section of one of my earlier blogs, he/she attended a Fannie Mae senior officials meeting where it an important personage lamented that Wall Street was doing a better job securitizing mortgages than the GSEs, implying the company needed to compete better against the investment banking giants and their mortgage broker networks.

If that exchange occurred, I hope it wasn’t codified as an on high directive since the Street guys were packaging poison in high yielding private label securities, which succeeded in horribly sickening the entire mortgage finance system and large parts of the broader economy.

That’s one competition from which they should have stayed away.

Mistakes have been made by the GSEs, mistakes made by people who should have known better and who gambled. Whether they bet “too much,” and the bets prove business fatal, we’ll know soon, possibly not this week, but soon after that.

(This blog was completed before I read today’s New York Times front page story on Dick Syron and the Fortune magazine article noting 10 CEOs on the Hot Seat.)

Maloni 8-5-2008

(Happy third birthday to Rex Ostos Maloni, Grandma Heidi's and Grandpa Cheerios's favorite three year old boy!)


Anonymous said...

Yes, FNM staffers were regularly exhorted that FNM's default rates were too low, as proof that FNM wasn't taking enough risk, that Wall Street was eating our lunch, and that the GSEs were losing their relevance. The Muddster complained peevishly that he kept asking for more aggressive risk taking, but the troops weren't responding! Eventually, unfortunately, the troops did respond by buying tens of billions worth of liar loans and underpriced risk from IndyMac, Greenpoint, Countrywide, and other lenders who cajoled, browbeat, and threatened FNM staffers and execs to man-up and be more like the savvy suits on Wall St. As the NY Times reports, there were voices reminding management that it was unwise to weaken underwriting standards and increase high-risk lending in the late stages of an overinflated bubble, but management seemed more willing to risk being wrong with the crowd than to risk being wrong and alone--and branded as a wuss. Plus, the pay structure rewarded aggressive action rather than thoughtful restraint. The few staffers who had the foresight to believe that it was Wall St that was underpricing risk and just "moving product" for short-term gain, were marginalized and sometimes ridiculed as hidebound worryworts who didn't embrace change or understand the new paradigm.

John M said...

Hi Bill,

And I thought that was you ghost-writing the Freddie response to the NYT piece ;-)

Two years ago I posted an article "Wallflowers at the Alt-A dance" which rehearsed some of the points you are making towards the end of your piece. I think your effort today is an important post.

Bill Maloni said...

John--I wouldn't have wanted to be quoted as Dick Syron was, today.

Please be sure--in reading any of my blogs--to understand that I truly believe in the GSE secondary mortgage market model. Properly managed, some of these calamities wouldn't have hit them.

As I said, let's see if their capital outlasts their losses, in which case something else about the GSE model will be proven.

The primary market lending structure is too unreliable to insure a working secondary market "in good times and bad."

In fact, if anything happens to Fannie and Freddie, I expect that the next step would be to recreate their function under a new name(s) but with similar responsibilities.

John M said...

Debi has communicated your permission to repost on Housing Doom. "There Will Be Blood" is scheduled to go live there in about thirty minutes.

I hope our exposure gives your article a few more readers, it deserves them.

Bill Maloni said...

"More is better!"