Recent news concerning bad lending practices by Bank of America has really been stirring up the Blogosphere. It is amusing to hear the popular retort in comments around the Internet concerning this story that Fannie, Freddie and other GSE’s (Government Sponsored Enterprise) were the sole culprits of our financial woes, and firms like B & A are just pawns in some massive big-government conspiracy. Hogwash! The notion that Fannie and Freddie were at the heart of the sub-prime meltdown makes for a great Unfair and Unbalanced Fox News sound-bite, but it’s hardly the case.
Here's what really happened. For years Wall Street had been trying to find a way to avoid the GSE’s for mortgage liquidity. They finally succeeded by convincing the major rating agencies such as Moody’s and S&P to give them Triple-A ratings on senior tranches of mortgages in exchange for big fees. This way Wall Street no longer needed Fannie or Freddie. The ratings agencies simply looked the other way and Wall Street made them rich. They sold out.
Then with Triple-A in hand Wall Street packaged high yielding sub-prime junk into CDO’s (basically mortgage-backed securities) and sold them directly to investors without any need for Fannie. This junk was sold to large funds, many of whom where charged with protecting retirement accounts. They did this only because the ratings were Triple-A. In other words, they trusted the ratings agencies.
And when that wasn't enough profit to satisfy them they placed side-bets on these junk assets, called derivatives. This got really interesting when Casino Wall Street made “naked” (un-backed) bets to the tune of Trillions! So how could this happen? Ask Alan Greenspan and the Bush Administration, neither of which gave a hoot about regulating financial behavior that created “too big to fail” resulting in the financial mess. And what’s really hilarious is how conservatives now rail against the so-called bailout when they were the ones who allowed the mess to reach critical mass on their watch. Were the GSE’s blameless? Of course not. They were key facilitators, as were both sides of the political aisle for the past four decades who collectively pushed for expanded home ownership at all costs. Put it all together and it added up to the Great Financial Meltdown. Fannie and Freddie were just one piece of this puzzle, yet have become convenient scapegoats for partisan sound-bites…..although I’m certainly no fan of either institution!