By Ronald D. Orol, MarketWatch
WASHINGTON (MarketWatch) -- Facing a barrage of questions about problems with Fannie Mae's capital, leverage and risk management during the buildup to the financial crisis, two former housing officials defended their tenure and said the mortgage giant was engulfed by an unprecedented decline in home prices that was catastrophic and unforeseeable.
"Few if any predicted the unusual and rapid destruction of real-estate values that occurred," Robert Levin, former executive vice president and chief business officer of Fannie Mae told a financial-crisis inquiry panel.
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"In hindsight, if we and the industry as a whole had been able to appreciate the nature and extent of the crisis, it is clear we all would have conducted our business differently during this period, but we like everyone else were surprised by the unprecedented extent of the economic crisis."
Both Levin, who spent 27 years at Fannie until 2008 and Daniel Mudd, president of Fannie between 2005 and 2008, argued that the growth on Wall Street of the private-label mortgage securities market drove the mortgage-finance giants into problematic loans.
Fannie Mae and Freddie Mac purchase whole mortgages from banks and other direct lenders and package them, as a means of ensuring that adequate capital is available to banks and other financial institutions that lend money to home buyers.
During the buildup to the financial crisis, the two entities were hybrid public-private entities -- so-called government-sponsored entities -- that sought to increase their stock price and compete with Wall Street, while meeting low-income housing goals set by the Housing and Urban Development Department.
Reuters
Starting in the 1990s through 2006, Fannie and Freddie experienced a dramatic rise in the risk they took on their balance sheets, along with an erosion of underwriting standards. At the height of the financial crisis, on Sept. 7, 2008, they were essentially nationalized to avoid losses and stem the credit contagion. They were taken over by the government in a conservatorship.
Members of the crisis-inquiry panel, known as the Financial Crisis Inquiry Panel, grilled the two executives over how they failed to hold sufficient capital to survive the meltdown. One panel member expressed outrage over the entities' leverage, and another charged both Mudd and Levin with retaining pay packages that drove the two entities to compete more heavily with riskier investments made by Wall Street. Yet another indicated that Fannie Mae's expansion into riskier loans contributed to an expansion of riskier loans across the whole housing market.
Panel member Peter Wallison, a fellow at the American Enterprise Institute, insisted that the housing giants' affordable-housing goals -- which increased during the period leading up to the crisis -- contributed to their downfall.
"HUD was pressing you to continue to make more investments in these affordable-housing loans between 2005 and 2007," he said.
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Levin and Mudd argued that in a key period, in 2005 and early 2006, the dollar volume of private-label mortgage securities issued by Wall Street outpaced mortgages securities issued by Fannie Mae, Freddie Mac and Ginnie Mae combined.
The two executives said that they needed to expand into riskier mortgages to compete with the private industry. Private-label mortgage securities, or PLS, "posed a financial threat to the company because there was less business going into our market," added Mudd. "It posed a mission threat, because many of the products financed by PLS had affordability features that threatened our ability to meet our housing goals, and it threatened our customers, who didn't want to do business to us."
Levin contended that during that period in 2006 he and other executives at Fannie Mae asked, "would we best be able to deliver competitive returns to shareholders, stay relevant to customers and meet our mission requirements by doing nothing new, or by increasing our participation in these markets to some degree?"
He said that eventually the considerations led to a management consensus to expand Fannie Mae's already existing Alt-A business over time. Alt-A loans are alternative-documentation loans primarily driven by credit scores, where borrowers tend to lack proof of income from traditional employment..
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