Fannie and Freddie: Duped by Big Banks?

While everyone discusses the likelihood that Fannie and Freddie were duped into buying subprime mortgages that didn't meet their investing criteria, we may finally get a definitive answer when banks answer the 64 subpoenas issued this week by the Federal Housing Finance Agency. The agency didn't release the names of the banks subpoenaed, but The Wall Street Journal did speculate on the likely recipients.

Fannie and Freddie gobbled up these securities in huge numbers starting in 2005. These securities held triple-A ratings when sold. Now the FHFA wants to take a closer look at what types of loans were actually placed in these securities and whether or not they truly deserved those high ratings.

"By obtaining these documents we can assess whether contractual violations or other breaches have taken place leading to losses for the Enterprises and the taxpayers," FHFA acting director Edward J. DeMarco said in statement when he announced the subpoenas.

While he didn't say what the FHFA would do if they find breaches, the lawsuit filed by the Federal Home Loan Bank of San Francisco certainly shows what can be done.
As of the end of the first quarter, Freddie held $97 billion in securities backed by subprime and Alt A loans and forecast $30 billion in losses on these loans. Fannie Mae held $44 billion with projected losses of $16 billion. Those loses will be paid by the taxpayers unless Fannie and Freddie are able to rescind the purchases.

Right now the subpoenas are the first step in the process to find out whether or not the underlying mortgages met the requirements for the private-label mortgage-backed securities held by Fannie and Freddie to be sold as triple-A. The FHFA wants documents used in the underwriting process, such as loan applications and property appraisals. The banks have 30 days to answer the subpoenas. The FHFA filed these subpoenas because it said the banks were dragging their feet on supplying the documents.

Many of the mortgages in these securities required little or no documentation of the borrowers' income. They are among the worst-performing mortgages. Even though they make up just 10 percent of outstanding mortgages, by the end of the first quarter about 27 percent of all mortgages that were 90 days or more past due were in these private-label securities.

As Fannie Mae and Freddie Mac losses mount for the taxpayers, let's hope FHFA pursues legal action to protect the taxpayers if they find that these securities did not meet contractual obligations. The banks got bailed out. They shouldn't get to keep their profits if they just pushed the problem onto the taxpayers.

Lita Epstein has written more than 25 books, including "Reading Financial Reports for Dummies."

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