Corrupt cronies

by Russ Roberts on January 18, 2011

in Financial Markets, Government Intervention

In the old days, when we pretended Fannie and Freddie were private, profit-maximizing organizations, banks and other originators who sold them bad mortgages that did not conform to Fannie and Freddie’s requirements would be on the hook for those mortgages if they ended up not paying off. In other words, Fannie and Freddie guaranteed payment unless a bank or an originator violated Fannie and Freddie’s rules.

It turns out that many of the mortgages that failed did not comply with Fannie and Freddie’s rules. That gives Fannie and Freddie the right to demand payment from the originators that defrauded them. But now Fannie and Freddie are under government “conservatorship” and they are negotiating settlements. Rather than demand the whole amount they (or should I say “we” now that they are publicly managed) are owed.

Bank of America, for example, recently agreed to pay us Fannie and Freddie $2.8 billion. Sounds like a lot of money. But as the Washington Post reports, this is not a lot of money relative to what it could have been:

Bank of America said its $1.3 billion payment to Freddie Mac extinguishes all outstanding and potential repurchase claims on 787,000 mortgages that had total unpaid principal balances of $127 billion.

What a good deal for Bank of America. What a lousy deal for you and me. Ally Bank also got a good deal:

The Bank of America agreement is Fannie Mae’s second recent settlement over mortgage issues. On Dec. 27, Ally Financial, formerly known as GMAC, announced that its mortgage unit agreed to pay Fannie Mae $461.5 million to eliminate its liability for loans with unpaid principal of $84 billion. Under that deal, the FHFA agreed to withdraw subpoenas it issued last year in a probe of industry practices.

It gets worse. CitiGroup is STILL MAKING BAD LOANS AND SELLING THEM TO YOU AND ME FANNIE AND FREDDIE! When I say “bad loans” I don’t mean loans that turn out badly. That is an inevitable part of lending. I’m talking about loans that violate the underwriting requirements of Fannie and Freddie. Bloomberg reports (HT to Tim Townsend):

Three years after bad home loans helped trigger the recession and six weeks after the government cashed in the last of its $45 billion Citigroup investment, the New York-based bank is still selling mortgages that violate quality standards, according to an internal Freddie Mac review obtained by Bloomberg.

Fifteen percent of the performing loans Citigroup sold to the government-owned mortgage-finance company in the second half of 2009 and the first half of 2010 had such flaws as missing appraisals or insurance documents or income miscalculations, according to the review of 375 mortgages. The target for defects should be about 5 percent, said Tim Rood, a former executive with Freddie’s sister agency, Fannie Mae, and now managing director at Washington-based advisory firm Collingwood Group LLC.

Bloomberg couldn’t get the CEO of Citi, Vikram Pandit, to comment on the story. But they did manage to get a fantasy quote from one executive:

Sanjiv Das, New York-based chief executive officer of CitiMortgage Inc., the Citigroup unit that originates loans and buys them from smaller lenders, declined to comment on the Freddie Mac findings. He said the bank’s own quality control reviews show an improvement in underwriting that “is one of the most outstanding stories in our business.” Freddie Mac has no published standard for defect levels.

“My own information based on our defect rates tells me we are doing a fantastic job,” Das said.

I love that word–fantastic. If you’re going to go out on a limb, go all the way out, baby. So when your defect rate is THREE TIMES what it should be, just claim you’re doing not just an acceptable job or a decent job or that the job is difficult and mistakes are inevitable. No. Claim you’re doing a FANTASTIC job. And what justifies that claim. Your own information. Perfect.

Here is some more data that is not from Citi:

In Freddie Mac’s review of Citigroup’s performing loans — those on which borrowers were still paying — the portion rated as “Not Acceptable Quality” fell to 9 percent in the third quarter’s sample from 32 percent in the fourth quarter of 2009, according to the Freddie Mac memo. The average defect rate in the 12 months through Sept. 30 was 15 percent.

But don’t worry:

Mortgage buyers such as McLean, Virginia-based Freddie Mac, which packages the loans into securities for sale to investors, can ask for their money back if they find that Citigroup or other originators sold them mortgages that failed to meet underwriting standards.

Doesn’t that inspire confidence, given the story on Bank of America?

And here’s a nice summary of how generous the government has been with my money and yours already:

Citigroup received $45 billion in investments from the U.S. government in 2008 and $301 billion in asset guarantees, making the bank the biggest recipient of U.S. taxpayer bailout support. The investment has been paid back and the guarantees canceled. Last week, the government, which still owns warrants to buy 465 million of the bank’s shares, announced a plan to auction them off before the end of March.

What we are living through now is the continuing of the looting process. Get the government out of the banking business. The process is corrupt. The cronies are winning. You and I are losing.

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