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Don’t blame the quants: Fannie edition

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This article in the Times gives some details about the collapse of Fannie Mae. It’s pretty clear that the quants at Fannie knew they were undercharging for risky loans, and that senior management knowingly pushed the firm into dangerous territory.

Fannie’s business: repackaging mortgages into collateralized securities. But it operated under political pressure to help low-income buyers achieve home ownership and under financial pressure to compete with investment banks getting aggressively into the mortgage securitization business.

NYTimes: …When Mr. Mudd arrived at Fannie eight years ago, it was beginning a dramatic expansion that, at its peak, had it buying 40 percent of all domestic mortgages.

…So Fannie constructed a vast network of computer programs and mathematical formulas that analyzed its millions of daily transactions and ranked borrowers according to their risk.

Those computer programs seemingly turned Fannie into a divining rod, capable of separating pools of similar-seeming borrowers into safe and risky bets. The riskier the loan, the more Fannie charged to handle it. In theory, those high fees would offset any losses.

With that self-assurance, the company announced in 2000 that it would buy $2 trillion in loans from low-income, minority and risky borrowers by 2010.

All this helped supercharge Fannie’s stock price and rewarded top executives with tens of millions of dollars. Mr. Raines received about $90 million between 1998 and 2004, while Mr. Howard was paid about $30.8 million, according to regulators. Mr. Mudd collected more than $10 million in his first four years at Fannie.

Take aggressive risks, or “get out of the company”:

…But Fannie’s computer systems could not fully analyze many of the risky loans that customers, investors and lawmakers wanted Mr. Mudd to buy. Many of them — like balloon-rate mortgages or mortgages that did not require paperwork — were so new that dangerous bets could not be identified, according to company executives.

Even so, Fannie began buying huge numbers of riskier loans.

In one meeting, according to two people present, Mr. Mudd told employees to “get aggressive on risk-taking, or get out of the company.”

In the interview, Mr. Mudd said he did not recall that conversation and that he always stressed taking only prudent risks.

Employees, however, say they got a different message.

“Everybody understood that we were now buying loans that we would have previously rejected, and that the models were telling us that we were charging way too little,” said a former senior Fannie executive. “But our mandate was to stay relevant and to serve low-income borrowers. So that’s what we did.”

I complained about Frankin Raines, who embroiled Fannie in a derivatives accounting scandal, back in 2004-5.

Mr. Raines and Mr. Howard, who kept most of their millions, are living well. Mr. Raines has improved his golf game. Mr. Howard divides his time between large homes outside Washington and Cancun, Mexico, where his staff is learning how to cook American meals.

Written by infoproc

October 4, 2008 at 9:55 pm

Hank in charge

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This Times article details who is running the show when it comes to the Fannie and Freddie bailout.

NYTimes: …“Bush was in charge when it was cut taxes, deregulate, have free trade, etc.,” said Representative Barney Frank, the Massachusetts Democrat and chairman of the House Financial Services Committee. “But then the old paradigm broke down, and it fell, frankly, to more serious thinkers to figure out how to cope with the current reality.”

…Mr. Paulson, a former chairman of Goldman Sachs, joined the White House in July 2006 after an intense courtship by Mr. Bush’s chief of staff, Joshua B. Bolten. He demanded clout and got it, in part because “Paulson did not need the job; the administration needed Paulson,” said Vincent R. Reinhart, a monetary economist at the American Enterprise Institute in Washington.

Mr. Reinhart says Mr. Paulson, like Mr. Bush, would ordinarily resist government intervention. “I think the economy is taking Bush and Paulson to a place where they wouldn’t go on their own,” he said. “In a crisis, you start bending principles, and Paulson bent principles.”

By relying so heavily on Mr. Paulson, Mr. Bush is doing more than bend conservative principles. He is taking himself out of public view in the one area of policy making that matters most to Americans: the economy. Mr. Wehner, Mr. Bush’s former adviser, does not see that as a problem so long as the markets stabilize. And Mr. Frank, the Democratic congressman, said Mr. Bush’s reliance on the Treasury secretary is “one of those things that, historically, will be to his credit.”

Do the people who think Sarah Palin is up to the job of President of the United States think she could have been CEO of Goldman Sachs as Paulson was? (“After all, Alaska is a lot bigger than Goldman Sachs! And, it’s closer to Russia! How much oil does Goldman have, anyway? Hey, she does have a journalism degree from U Idaho!”) Anti-elitism can only go so far…

Who has more responsibility, the President or CEO of Goldman?

Written by infoproc

September 9, 2008 at 5:16 pm

Bye bye Fannie and Freddie

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On my way back from Europe, I noticed that Fannie and Freddie have been nationalized, with shareholder value going to zero! It’s a huge development — much bigger than Bear earlier in the year. The housing bubble still has further to pop, so stay tuned!

Here’s economic guru John McCain on the subject — his sentiments are right, but the fact that he can’t get the exec compensation to within 3 orders of magnitude is a bit worrisome. (I suppose Palin could have nailed it within two orders of magnitude or better 😉

NYTimes: “It’s hard, it’s tough, but it’s also the classic example of why we need change in Washington. It’s an example of cronyism, special interest, lobbyists. A quasi-governmental organization, where the executives were making hundreds of — hundred some billion dollars a year, while things were going downhill, going to hell in a handbasket,” Mr. McCain said, adding that the two companies need “more regulation, more oversight, more transparency, more of everything, and frankly, a dramatic reduction in what they do.”

But not to worry, McCain / Palin’s grasp of economics and finance is every bit as solid as that of our most recent great Republican leader George W. Bush, and look how well he did!

Video: [Bush, blathering off the record on something he doesn’t understand — was that Bush on July 18, or McCain this weekend?] “There’s no question about it. Wall Street got drunk —that’s one of the reasons I asked you to turn off the TV cameras — it got drunk and now it’s got a hangover. The question is how long will it sober up and not try to do all these fancy financial instruments.”

I’d post the video itself here except it’s old news, and, well, nobody wants to talk about GW anymore — especially not the people (the same ones who are backing McCain and Palin, more or less) who predicted what a great president he’d be. Too bad we don’t judge voters on their records like we do traders. I know who I’d fire.

You voted for GW? Twice?!? Your P&L is negative one trillion dollars for the united states. Put your stuff in this box and follow the security guard out the door. No, you don’t get to take a position on this election or advise any geneticists on evolution.

Note I’m not trying to blame Bush for the credit disaster — the trillion dollars is for Iraq alone.

Written by infoproc

September 7, 2008 at 7:27 pm