Bernanke, Geithner, and Paulson tell their story: "For all our crisis experience, we failed to anticipate the worst crisis of our lifetimes."
Timothy Howard’s The Mortgage Wars focuses on his unique perspective on the lead-up to the financial crisis. He is not a high-profile personality like former Treasury Secretaries Geithner or Paulson or Chairman Bair of the FDIC, as most people probably are unfamiliar with him. From his position as a former chief financial officer of Fannie Mae with decades of experience in senior management there, he certainly has much technical knowledge to share about the buildup of Fannie Mae to its status as a mega financial institution and then its spectacular crash landing in September 2008 when it was placed under government control and into conservatorship by its regulator, the Federal Housing Finance Agency (FHFA) (backstopped by hundreds of billions of dollars of federal funding). It has been nearly six years since that meltdown, but due to pending legal cases against Howard for alleged questionable financial accounting and reporting, which were ultimately dismissed in October 2012, he can only now reveal his perspective on these issues.
The book’s title, The Mortgage Wars, refers to the conflict between Fannie Mae and Freddie Mac and those who tried to reign in the legislative advantages granted to these so-called government sponsored enterprises (GSEs). Howard sets the tone early in the book in Chapter two that his side is fighting the good fight for homeowners:
The mortgage fight was rooted in a fundamental disagreement over the role of government in housing. Supporters of the [GSEs], Fannie Mae and Freddie Mac, argued that housing was sufficiently important to society that the government should sponsor special-purpose institutions to provide low-cost financing to home buyers on an advantaged basis. The GSEs’ opponents argued that their activities distorted capital flows and subjected taxpayers to unnecessary financial risk. The disagreement was ideological, but what fueled it was money. At issue was whether the GSEs or fully private firms—principally commercial banks and bank-owned mortgage companies—should be allowed to control the largest single credit market in the world.
Howard criticizes the opponents of the GSEs by referencing their “unprecedented disinformation campaign carried out through the media…to convince opinion leaders, policy makers, and the general public that the two GSEs were dangerously risky companies that were able to maintain their positions of market prominence only because of bare-knuckled lobbying prowess.” He does this without placing equivalent scrutiny on the hardball tactics and distortions of Fannie Mae over the same period, instead choosing to put it in the best light noting that “Fannie Mae was providing record amounts of low-cost, fixed rate financing to home buyers at minimal risk to taxpayers.”
So what was this war over? Howard traces how, before its nationalization, Fannie Mae was granted a special, quasi-government status that was constructed over the course of decades beginning in the 1930s. The most important aspect of this special status is that it ultimately led to the markets’ perception that the GSEs would be backstopped by the government if they ever approached failure (which they ultimately were in 2008). As a result, Fannie benefited from a capacity to borrow at rates that were lower than what they would pay absent this special status (and thus pass some of this benefit on to borrowers), giving them enormous market power, essentially a duopoly with its sister agency Freddie Mac.
In chronicling the changes at Fannie Mae, Howard reveals how it became famous for its high-profile management team that fought the necessary political battles to maintain this privileged status. He narrates how this really started with the appointment of Jim Johnson in 1991, former executive assistant to and campaign manager for Vice President Mondale. Johnson led the firm as “Fannie Mae catapulted to a position of prominence in the mortgage finance system while building a broad and bipartisan base of support in Congress….” Johnson hired “well-connected and experienced people to work in [Fannie’s] legal, government affairs, regulatory policy and public relations areas…” Similarly Frank Raines, who Howard also profiles in the book, rotated between senior positions in the Carter Administration, then as Vice Chairman of Fannie Mae, then as President Clinton’s Director of the Office of Management and Budget, and then finally as Chairman of Fannie Mae.
In contrast, Howard is not a typical revolving door Washington agent maneuvering between various senior positions at Fannie Mae and senior presidential administrative positions in order to leverage his political acumen for the benefit of this massive institution. As he details the story of Fannie Mae in parallel with his own career, he tells how he spent over 20 years at Fannie Mae, working in the trenches on the key risk management, financial policy and accounting issues for the firm, ultimately becoming its chief financial officer. He is in fact such a financial technician that some people may bore of the details of his descriptions, such as his comprehensive thoughts regarding Financial Accounting Statement 133, which addresses accounting for derivatives.
Howard is obviously biased in his views and cannot be considered an objective observer of the events he describes throughout the book. He also displays an extreme case of resentment against the FHFA’s predecessor agency, Office of Federal Housing Enterprise Oversight (OFHEO), given that they brought a lawsuit against him claiming that he intentionally and fraudulently misstated Fannie Mae’s financial results regarding accounting for derivatives and amortizing of mortgage assets. These charges caused him tremendous personal angst, which is obvious in his description of the ‘politicization’ of decision-making on housing matters and in particular the decisions by Armando Falcon, OFHEO’s director, whose accusations were at the core of this line of cases. Howard notes that prior to the dismissal of the cases and the writing of his book he was advised by his personal counsel not to speak publicly about his experience given the pending lawsuits.
What are to me the most interesting chapters of the book are those focused on the accusations by OFHEO that Howard and others intentionally and fraudulently filed financial reports on behalf of Fannie Mae. No one that I am aware of has publicly told this story before and a great many lessons can be drawn from it. Howard tells of his initial reaction that he was “confident we would acquit ourselves well” of the accusations. He details that Falcon who was caught off-guard when Freddie Mac, prior to Fannie Mae, was found to have accounting, internal control and reporting irregularities for the years 1999 to 2002, which was followed by a dramatic management shake-up. Falcon first ordered a special examination of Freddie Mac and then he turned his focus to a similar examination of Fannie Mae, what Howard calls Falcon’s “path to redemption” after missing the signs of the problems at Freddie Mac.
In his initial statement, Falcon clearly telegraphed that his desired outcome for the probe would be restatement of prior period results, all before the examination even began. Howard also alleges that Falcon regularly leaked internal documents to the Wall Street Journal to raise questions in the minds of politicians predisposed to think the worst of Fannie Mae. He quotes extensively from an inspector general’s report that noted Falcon’s animus against the firm, and which led to a criminal referral of Falcon to the Department of Justice. The examination by OFHEO was in the words of Howard “withering,” detailing the alleged intentional and fraudulent accounting and misreporting. The SEC was left as the final arbiter on the accounting issues and to Howard’s surprise the Commission sided with OFHEO and Falcon in what Howard describes as “extraordinarily vague” language. Fannie Mae’s accountant, KPMG, reportedly sought clarification for the reasoning from the SEC, but was never able to obtain it. Raines and Howard were ultimately forced out of their positions in December 2004, with Falcon pushing for this outcome.
Howard then turns to his ultimate vindication on the “eight actual or threatened legal actions” against him, including possible criminal charges from the Justice Department, possible SEC charges regarding securities law violations, an administrative action by OFHEO, and a class action civil suit. Justice ultimately dropped their charges, the SEC charges slowly went away, and OFHEO chose to settle its case for what Howard describes as “next to nothing.” The civil suit was dismissed in late 2012. After hearing of these outcomes, I am reminded of the classic quote from former Labor Secretary Raymond Donovan to the effect of “Which office do I go to to get my reputation back?”
In comparison to these other issues, Howard spends comparatively little time on the actual ‘meltdown’ of Fannie Mae which receives all of about fifteen pages near the end of the book. At the core of his argument here is that Fannie Mae should not have been placed into conservatorship, presumably because it was in fine shape. One of the most difficult arguments of Howard’s to accept is his contention, stated in chapter two of the book, and argued in more detail in this later chapter, that “Treasury put Fannie Mae and Freddie Mac into conservatorship in spite of the fact that both companies met their statutory capital requirements at the time.” In the chapter near the end of the book on the meltdown of Fannie Mae, he argues that “Fannie Mae had forty-seven billion in regulatory capital and was in full compliance with all of its statutory capital requirements on the day it was put into conservatorship…” You would think that a former CFO of Fannie Mae would be able to get this right, but apparently not. The forty-seven billion figure was not from the date in September when Fannie was placed into conservatorship, but rather June 30th well before that date. Obviously there was analysis by FHFA and Treasury after the June 30 results, which involved adjustments to stated capital which might have taken into account more information on Fannie Mae’s financial position. Howard apparently made no effort to find out how FHFA and Treasury determined that Fannie Mae should be placed into conservatorship.
In later chapters, Howard also descends into speculation and conspiracy theorizing which he presents with no supporting documentation: “On the day of the Bear Stearns rescue, there can be little question that Paulson already was thinking of the GSEs as instrumentalities of the government.” And yet again: “Given the opportunity to eliminate Fannie Mae and Freddie Mac as private entities—which had always been their objective—they eagerly had taken it. “ In general, Howard’s documentation is poor as he does not provide detailed endnotes or footnotes for what he has to say, only a brief three-page section at the end on articles and books he used with no specific supporting citations.
Throughout the book Howard is largely an apologist for the Fannie Mae business model. He never makes a convincing case for his contention that Fannie Mae was not a risky firm, or that it was wrongfully placed into conservatorship. However, he rightfully blames outside political forces for many of the problems at the core of Fannie Mae’s meltdown, but the primary lesson to be learned from Howard’s book is the absolute bastardization and distortion of financial housing policy caused by the GSE structure. This informative book adds to the evidence that Fannie Mae and Freddie Mac are politicized methods of credit allocation that should be entirely privatized.