If ever we needed real-world examples of “moral hazard” and conflicts of interest, it’s Freddie Mac (FRE) and Fannie Mae (FNM).
In an interview with the New York Times, Freddie Mac’s former Chief Risk Officer David Andrukonis said that former Freddie CEO Richard Syron ignored numerous warnings that Freddie was about to blow itself up. Andrukonis said that he warned Syron about Freddie’s troubles as early as 2004, and sent a memo outlining the risks of the company’s mortgage profligacy. NYT:
David A. Andrukonis recalled telling Mr. Syron in mid-2004 that the company was buying bad loans that “would likely pose an enormous financial and reputational risk to the company and the country.”
Mr. Syron received a memo stating that the firm’s underwriting standards were becoming shoddier and that the company was becoming exposed to losses, according to Mr. Andrukonis and two others familiar with the document.
The Times says that it interviewed “more than two dozen current and former high-ranking executives at Freddie Mac,” all of whom said that Syron had ignored their reccomendations to change course. Syron’s apparent passivity has lead to an $80 billion loss in shareholder value.
Given the high profile implosion, many shareholders, regulators, and employees are calling for a change in leadership at both Freddie Mac and Fannie Mae (FNM). Syron and his defenders argue that the implosion wasn’t necesarily his fault, since he was pressured by Congress to purchase as many cheap loans as possible.
Mr. Syron and the Fannie Mae chief executive, Daniel H. Mudd, defended their choices, saying in interviews that they did not anticipate that the housing market would decline so quickly and that they were buffeted by conflicting pressures.
“This company has to answer to shareholders, to our regulator and to Congress, and those groups often demand completely contradictory things,” Mr. Syron said in an interview.
Therein lies the problem. The Times piece goes on to recount how a Democratic Congressman once called up Syron and screamed at him to buy more mortgages from low-income borrowers. Under pressure, Syron and his team capitualated, figuring if things went wrong, the government would bail them out anyway:
Mr. Syron and Mr. Mudd eventually yielded to those pressures, effectively wagering that if things got too bad, the government would bail them out.
“The thinking was that if something really bad happened to the housing market, then the government would need Freddie and Fannie more than ever, and would have to rescue them,” Mr. Andrukonis said. “Everybody understood that at some level the company was putting taxpayers at risk.”
And there’s the lesson. When this crisis is over, Fannie and Freddie should be privatised. Using tax payer money to subsidise cheaper housing and insure against risky lending behaviour shouldn’t be part of government’s mandate. But they won’t be privatized, of course. Because, by then, the crisis will be over, shareholders will want that government guarantee, and no one else will care anymore.
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