FCIC report: Subprime loans by Fannie, Freddie performed 'better'

Written by Biloxi

From the Financial Crisis Inquiry Commission report released on Thursday, the commission found that Fannie Mae and Freddie Mac's portfolio of subprime loans  had “performed significantly better” than those loans packaged into mortgage-backed securities by private issuers. Here is an excerpt from the report:

FHFA hereby provides Fannie Mae with notice that the proposed capital classification of Fannie Mae is adequately capitalized at June 30, 2008. The proposed capital classification takes into account the capital management actions, as identified in the Capital Restoration Plan (Capital Plan), to ensure capital was maintained above the FHFA-directed 15 percent requirement as ofJune 30,2008.

This information certainly refutes claims that the two mortgage giants were the driving force that led to the downfall of the 2008 financial crisis. The report said that Fannie and Freddie which was in conservatorship with the govenment since September 2008 "contributed to but were not the cause of the financial crisis." However, Republicans on the committee disagreed. Republicans said that Fannie and Freddie  “contributed significantly in a number of ways” to the financial crisis. Fannie and Freddie's “failures were the result of policy makers using the power of government to blend public purpose with private gains and then socializing the losses.”

In addition, FCIC report studied Fannie and Freddie's loan performance:

In the study, FCIC staff examined loan performance in 2008 and 2009. They found that that mortgages bought by Fannie Mae and Freddie Mac were more likely than privately purchased loans to require a significant down payment when borrowers had weak credit, and were therefore less likely to go into default.

However, in a letter in September 2008, regulators propose that Fannie Mae be taken into conservatorship which is similar to bankruptcy. The regulators believed that Fannie Mae was experiencing unsafe
or unsound conditions. Here were some of their findings:

(6) Liquidity represents a critical risk to Fannie Mae. The Enterprise's liquidity strategy is significantly constrained by the current market. The Enterprise cannot use itsmortgage backed securities ("MBS") in repurchase agreements in any significant amount, nor can it sell significant amounts of its Liquidity Investment Portfolio ("LIP") rapidly because the market does not have the capacity to absorb them. Even if rapid significant sales were possible, such large transactions would send a negative signal to the markets. In addition, additional funds cannot be generated through the issuance of capital.


(7) Systems deficiencies and imprudent management priorities prevent the securitization of the whole loan book in the retained portfolio, reducing Fannie Mae's asset liquidity. The inability to securitize its whole loan portfolio significantly decreases assets available for liquidity.


(8) Over the years, the Board and senior management failed to establish and maintain a sufficient infrastructure, i.e., operations, data, and risk management systems andcontrols, to support new products and properly manage their risks.

It is interesting that in June 2008 that Fannie and Freddie subprime loans performed better than the mortgage backed securities by private issuers and was adquately capitalized. Yet, in three months, the Fannie Mae's liquidity was in credible risk and management system was broken. Unfortunately, the mortgage backed securities that two mortgage giants owned on their books did them in.