Were Fannie and Freddie Really Innocent Bystanders?

When we learned of the Federal Housing Finance Agency's lawsuits against big banks last week, I wondered how we should be expected to believe that Fannie Mae and Freddie Mac -- the biggest players in the mortgage industry -- could have really been tricked so easily by the big banks. Jim Boswell, mortgage-backed security analyst and former Ginnie Mae consultant, also doubts that the two government-sponsored enterprises are really the innocent bystanders that these lawsuits imply that they were. He says that the FHFA should verify that the firms weren't just as bad as the banks when crafting their own MBS -- and he explains how it could easily do so.

You can check out his explanation for the details of the methodology he suggests that the FHFA use. It's a pretty fair request, really -- and the banks should be listening. If the GSEs were guilty of the same alleged misdeeds as banks, then a court will probably be more likely to frown at the lawsuits.

Here's one of the most interesting parts of Boswell's column:

I have been told personally from an inside source that each month Fannie Mae ran analytical jobs prior to deciding what securities they wanted to purchase and sell. Now the FHFA may think that I am being overly skeptical of the GSEs, but in running those analytical jobs, I believe the GSEs were using loan level information only available to the GSEs (and not available to the rest of the investing public) to stack the bets in their favor--purchasing the securities backed with loans that the GSEs felt were likely to pay down slower before offering up the remainder of their new monthly security issues to the rest of unsuspecting world investors.

And while the FHFA runs the above analysis they should try to find out who was the driving force behind the "first real mortgage-backed security derivative product" that dealt with differing pay down rates, the REMIC? And who first began buying and selling that product to an unsuspecting public? Now I hate to give anything away, but I believe the FHFA would find out that it was the GSEs. REMICs have been around since the late 1980s--and somewhat coincidentally, since right after the first refinancing boom in 1986.

So Fannie and Freddie may have been guilty of cherry picking the best loans to keep for themselves while selling the rotten ones to investors. And as Boswell says, the market for complex mortgage securities wasn't a game that they merely participated in: they played a part in creating it.

The toxic private label MBS created by banks ended up costing investors billions of dollars. By contrast, Fannie and Freddie's agency MBS was implicitly backed by the government -- so investors had nothing to worry about. The resulting profits went to Fannie and Freddie executives. The big losers here were taxpayers.

Read the full story at Business Insider.