Burning Down The House
Call me wacky, but I don’t think a convicted arsonist should be able to collect insurance for burning down his house.
If you agree, you’ll understand why I am a little uneasy about an announcement last evening of a settlement of more than $9 billion between Bank of America (BoA) and the Federal Housing Finance Administration (FHFA). This puts to bed claims that Countrywide and Merrill Lynch duped Fannie Mae and Freddie Mac into purchasing mortgage-backed securities that crashed, causing billions of dollars in losses and contributing to the eventual bankruptcy of the GSE’s.
I’m a bit more impressed, however, by a related announcement. New York’s Attorney General Eric Schneiderman was able to get former BoA CEO Ken Lewis to contribute $10 million to a settlement of claims that BoA deceived shareholders as part of the bank’s efforts to acquire the aforementioned Merrill Lynch and Countrywide. The AG’s settlement represents the first that I am aware of in which a CEO is taking personal responsibility for his actions during the mortgage crisis. What a concept! Lewis also accepted a three-year ban from serving as an officer or director of any public company.
Let’s take a trip down memory lane. As late as 2008, Fannie and Freddie were private corporations that specialized in buying mortgages and packaging them as mortgage-backed securities. Many of our largest private banks, including Countrywide and Merrill Lynch, also purchased mortgages from banks and credit unions and packaged them as so-called private label securities for sale in the secondary market.
One of the great myths is that Fannie and Freddie caused the mortgage meltdown. They didn’t. Banks like Countrywide bought and sold poorly underwritten mortgages because they were making gobs of money. If Fannie and Freddie didn’t exist, they still would have made the same loans and bundled the same securities, they would have simply made more money. That being said, government policies promulgated under the Clinton Administration to expand home ownership combined with Fannie and Freddie’s desire to maximize their own profits made the GSE’s willing co-conspirators in the mortgage mess and it was the insolvency of these two institutions that triggered the cascade of events leading the Great Recession.
Remember that when the crisis hit, the government was scrambling to save as many institutions as it could. That’s why it strongly encouraged a few healthy banks, including BoA to purchase Merrill Lynch and Countrywide in the first place, This brings us back to yesterday’s settlement. The idea that somehow Fannie and Freddie, institutions that specialized in bundling mortgages into securities, were fooled into buying securities of poorly underwritten mortgages is a convenient legal myth. There were no institutions in the world better positioned to do their own due diligence, nor any institutions more cognizant of the state of the housing market. So when the history of the last seven years is written, let’s not let the government off the hook.
Why should credit unions care? Because there are no lenders that need a well-functioning secondary market more than credit unions. Just as home buyers should be held accountable for the terms of their mortgage, institutions that sell to the secondary market should sell these mortgages secure in the knowledge that they are no longer responsible for them. unfortunately, the secondary market has developed as a system of “seller beware.” The more liability that companies face for mortgages that they sell, the more expensive it will be to sell mortgages to the secondary market. Ultimately, your members will pay for yesterday’s settlement. As part of housing reform, the laws have to be strengthened to limit the ability of any secondary-market participant to hold others responsible for arm-length purchases.