Sunday, April 22, 2012

Jim Johnson, Fannie Mae Chairman and CEO (1991-1998)

(I was Fannie Mae’s SVP for government and industry relations when Jim Johnson first served aa Fannie’s Vice Chairman and later its Chairman and CEO.)

You don’t have to be a Jim Johnson “Facebook” friend to be offended by a current campaign conducted by a rump group of Goldman Sachs shareholders--headed by New York investment managers Ruane, Cunnif & Goldfarb--opposing Johnson’s re-election to that board. The RC&G assault—in a communication with GS shareholders--seems to rely on a host of Fannie myths about the 1990’s, when Johnson was Fannie’s Chairman and CEO.

The arguments go beyond criticizing his work at Fannie Mae, but since the lion’s share of their criticism deals with Fannie, I’ll limit what I write to what I observed when Johnson was Fannie Mae Chair/CEO.

In challenging Johnson and Goldman’s support for him, RC&G just spews a ton of Fannie Mae falsehoods—similar to those touted by “researchers” at the conservative American Enterprise Institute (AEI) --suggesting that Fannie, under Johnson, invested heavily in poor quality mortgage loans which later led to the 2008 international financial meltdown 10 years beyond Johnson’s tenure.

Except little of that is true, as evidenced by contrary reports from the Federal Reserve, the Treasury Department, Fannie’s current financial regulator, the Securities and Exchange Commission, the President’s Financial Crisis Inquiry Commission, assorted media and think tanks from the New York Times to Vanity Fair and financial columnists Ezra Klein, Barry Rithholz, Nobel winner Paul Krugman, and most recently by the St. Louis Federal Reserve Bank, which seldom has been a Fannie fan.

Most observers, except the hard Right, understand that Fannie Mae’s major financial problems came from billions invested in flawed subprime and no documentation (“Alt A”) mortgage loans, approved by its then Chairman Dan Mudd, beginning in 2005, which was seven years after Johnson left Fannie. The millions of home mortgages Fannie Mae originated in the Johnson era in the 1990’s—stimulated in part by growing demand for homeownership as well as political pressure from both political parties to make it easier to finance homes—featured an amazingly low number of defaults, foreclosures, or losses. That stellar default and foreclosure behavior continued for five or so years after Johnson departed.

(Everything I’ve noted is documented in a variety of reports to Fannie’s original financial regulator the Office of Financial Housing Enterprise Oversight (OFHEO), now renamed the Federal Housing Financial Agency (FHFA), the Securities and Exchange Commission (SEC), the Department of Housing and Urban Development, plus a variety of congressional committees.) If a mortgage loan is poorly underwritten--as RC&G and others suggest occurred regularly under Johnson--those loans would have gone bad, often in their first three years of existence.

That seldom happened in the Johnson years, as Fannie Mae and its lender customers relied greatly on the company’s vaunted automated underwriting systems. The RC&G investment managers appear to reproduce talking points shared by a legion of political and business detractors regarding Fannie’s Washington role and business methods. Most of it just was factually wrong.

Once the company’s risk based capital rules, shaped by Paul Volcker once he left government, were adopted first by Fannie and later in statute, Fannie never lobbied the Congress to change that model. Nor did the company ever ask the Congress to undo the law governing its underwriting standards, since the existing statute offered management sufficient latitude to accommodate changes.

In its letter to Goldman shareholders, RC&G writes: “As a government-sponsored entity (GSE), Fannie Mae enjoyed an implicit federal guarantee of its obligations. Originally structured to provide liquidity to the mortgage market, in the 1990s Fannie dramatically expanded its portfolio of retained mortgages. It used the implied guarantee of its debt to borrow money at low rates and then buy higher-yielding mortgages. Much of Fannie’s profit was directly attributable to its ability to borrow money cheaply as a GSE.”

I’ll only observe two things about the above quote from the letter. Using their GSE status to borrow money and then buy mortgage assets is exactly what Congress designed Fannie Mae (and later Freddie Mac) to do. Their implicit federal agency status was just that, implicit. By law, all of Fannie’s securities had disclosures that they “were not the full faith and credit of the federal government.” Until 2008 there never was one instance of the US Government coming to the financial aid of Fannie nor did Uncle Sam ever spend one taxpayer penny on the company, until the Bush Administration took it over that year.

I have to offer a subtle second point rebutting this silliness. Banks—which love to claim they are “the private sector” and historically alleged that the GSEs enjoyed government supported borrowing rates—were major investors in Fannie Mae debt, acquiring copious amounts of those bonds.

How could banks profitably buy so much of an asset (GSE debt), if bank borrowing costs were so much higher than Fannie’s?

The point is that they weren’t and aren’t, since federal deposit insurance—a major federal subsidy in itself-- always has allowed banking institutions to borrow at lower rates than the GSEs. (Think about what you earn on you savings and checking accounts.)

One would hope that BC&G would understand that fundamental financial reality.

The New York challengers cite other “facts” which suggest wrong doing, but they ignore that many elements of their indictment were produced by a choreographed and virulent political campaign run against Fannie Mae by a variety of government entities.

A motivated Administration (think “W”), with a compliant regulatory regime, can get those agencies to act in whatever manner the White House wants.

In Fannie’s case, that Bush Administration agenda was nicknamed “Operation Noriega” and it was spelled out in the book “All the Devils are Here,” by Bethany McLean and Joe Nocera.

The “Noriega” scheme included trumped up charges claiming Fannie failed to properly implement complex new securities accounting standards and resulted in two senior officers forced out in 2004. Those departures ironically paved the way for the disastrous subprime and no-doc investments by their successors.

Goldman Sachs shareholders can vote for or against whomever they choose. But if they rely on RC&G’s analysis of Jim Johnson’s Fannie Mae stewardship, they will operate not only without all of the facts, but worse, rely on falsehoods.

Maloni, 4-22-12

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