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The Fannie & Freddie Question

WASHINGTON -- In Henry M. Paulson's first month as Treasury secretary, two deputies flagged Fannie Mae and Freddie Mac as significant risks to the economy. He didn't share their level of concern. When he was at Goldman Sachs, he told the aides, the mortgage giants weren't on the list of things that kept him up at night.

Two years later, they're at the top of his list. Mr. Paulson is embroiled in emergency planning on ways to shore up the companies to avert a destabilizing jolt to the U.S. economy and the world's financial system.

Central bankers, Wall Streeters and members of Congress are waiting for what Mr. Paulson might do. He initially said he had no plans to use his authority -- won from Congress in July -- to inject funds into Fannie and Freddie. But he is meeting daily with his domestic finance staff as they hash out how to intervene if necessary. Scenarios range from buying preferred shares in the companies to various structures for lending.

Mr. Paulson is weighing whether to treat both mortgage companies equally, whether to leave management in place, and the effect on common and preferred shareholders, which include many pension funds. Among the concerns he's wrestling with: A large capital injection would essentially amount to a federal takeover of the companies, including responsibility for guaranteeing trillions of dollars worth of home mortgages.

Mr. Paulson didn't come to the Treasury to be an interventionist. He is a Wall Street pragmatist, a former deal maker whose focus isn't on ideology but on practical fixes and getting things done. It's a measure of the depth of the credit crisis that after joining a laissez-faire Republican administration, Mr. Paulson has helped engineer a transformation of the relationship between the federal government and financial markets.

In March, he joined Federal Reserve Chairman Ben Bernanke in forcing Bear Stearns Cos. into the hands of J.P. Morgan Chase & Co. Earlier, Mr. Paulson jawboned lenders into freezing interest rates for some stressed home buyers. His Treasury also took greater responsibility for financing student loans, and he has called for sweeping regulatory changes to give the Fed more power to police banks and Wall Street.

Fannie and Freddie are his biggest test. The companies are crucial to the housing market, owning or guaranteeing nearly half of U.S. mortgages outstanding -- some $5.2 trillion -- and buying most of the new ones being made. A federal intervention in these giants would be one of the largest and most complex in history.

Fannie and Freddie have said they exceed their regulatory capital requirements and don't need help from Treasury. While Mr. Paulson has authority to invest or take an equity stake in the firms, the companies would have to agree to either move.

Mr. Paulson's request for this authority in mid-July was meant to calm the financial markets. But some suggest it further exacerbated problems at Fannie and Freddie, by making investors unsure what the Treasury might do and how this would affect their investments. Some say the uncertainty is complicating the companies' already-difficult task of raising capital by selling common or preferred shares, though they continue to be able to fund themselves through the debt markets.

Mr. Paulson's efforts have drawn the ire of some fellow Republicans, including some in the White House. They say federal backstops only encourage the private sector to repeat its mistakes, and they lament the potential cost of bailouts to taxpayers.

"Wall Street has always had a tendency to seek government help when it benefited them," says Rep. Spencer Bachus, an Alabama Republican. "The whole philosophy of 'the government doesn't need to be in the markets' seems to change when companies start losing money."

Mr. Paulson says he sought authority to aid Fannie and Freddie to stabilize markets, "not because of wanting any favors for anyone on Wall Street." He adds: "This was not an easy thing to do emotionally. It's not something I came to Washington wanting to do."

Mr. Paulson, 62, arrived in July 2006 eager to tackle issues like Social Security, finishing global trade talks and pressing China to modify certain economic policies. He had spent 32 years on Wall Street, most recently as chief executive of Goldman Sachs Group Inc., where he was known as an aggressive deal maker. With a fortune estimated at $500 million, Mr. Paulson isn't ostentatious or even especially polished. He can stammer at times, or absent-mindedly rub his belly or head while talking.

His style is to dive into data and details. Just hours after issuing marching orders, he may phone to check on progress. In the Bush administration, his aggressive approach quickly earned him a reputation and a nickname, "Hurricane Hank."

But he wanted no part of a long-running argument over Fannie and Freddie. Critics said they were too big, posing a risk to the economy if they failed, and unfairly got to raise money cheaply because of an implied federal guarantee. Administration hard-liners wanted to shrink the pair and toughen regulation, such as by making them raise their relatively low ratios of capital to liabilities. But many in Congress, beneficiaries of the companies' lavish campaign giving, favored a softer approach.

Mr. Paulson wasn't happy to be dragged into what he called this "holy war." In September 2006, an assistant Treasury secretary told reporters the department was considering ways to rein in Fannie and Freddie if Congress didn't. Massachusetts Rep. Barney Frank called to blast Mr. Paulson, saying the statement jeopardized progress Congress had made on the issue.

Mr. Paulson ordered his deputies into his office and began furiously stamping on a marble coffee table, according to several people who were in the room. He yelled that he needed to establish a good relationship with Mr. Frank, then ranking Democrat (and now chairman) at the House Financial Services Committee. In subsequent months, Mr. Paulson got the White House to drop its demands for shrinking the companies and focus on toughening oversight, a step he agreed was needed.

Polling the Experts

In mid-2007, with defaults up and the market for mortgage securities faltering, Mr. Paulson's concerns about housing grew. He asked Robert Steel, then a Treasury undersecretary (and now Wachovia Corp.'s CEO), to canvass experts. Among those called was Lewis Ranieri, who years ago helped pioneer the repackaging of home loans into securities. Treasury officials gathered around a speakerphone as Mr. Ranieri told them the mortgage situation was "a bit more troubling" than most people realized, says a person familiar with the call.

Mr. Paulson began convening Sunday sessions at his home to focus on housing. As he sat on a couch, often nursing a Diet Coke, staff members arrayed in a semicircle on high-back chairs pitched ideas. They told him there were no easy public-policy options -- that the private sector needed to help financially stressed home buyers.

After Labor Day 2007, Mr. Paulson had his staff get officials of the biggest mortgage players in for meetings. At sessions with lenders, mortgage servicers and nonprofits that counsel troubled borrowers, Mr. Paulson said that foreclosure was in nobody's interest, and industry coordination was vital. Within weeks, he had his senior adviser, Neel Kashkari, now an assistant secretary, inform companies in the mortgage industry he wanted them to form an alliance to work case-by-case with stressed homeowners. On Oct. 10, the Treasury unveiled the alliance, called Hope Now.

In November, with the number of borrowers behind on their payments rising, Mr. Paulson shifted gears. At the Treasury's urging, companies in the alliance agreed to freeze interest rates temporarily on certain troubled loans.

Mr. Paulson demanded monthly updates on foreclosures prevented and loans modified. Some of what he wanted wasn't available, irritating him. He wanted company-specific data, but companies demanded the data be lumped together because they were rivals.

At times, told that a company was rumored to be shirking, Mr. Paulson demanded that an assistant get its CEO on the phone. Staff members persuaded him not to make such calls, arguing that doing so could fracture Hope Now.

Mr. Paulson attended housing town-hall meetings around the country, where he often heard from people fearing for their homes. "Hank came back from that tour and said things are worse than I thought they were," says Rep. Frank.

Prices of homes kept sliding, and inventories rising. Investors were shunning securities based on mortgages, having seen some collapse despite top safety ratings. That made Fannie and Freddie even more important, as places where lenders could still sell loans. Without the two government-sponsored enterprises, lending would dry up. But now, they, like banks that invested in mortgage securities, had started reporting sizable losses. Mr. Paulson began suggesting that Fannie and Freddie raise additional capital.

The Bear Stearns Case

Any illusions the government wouldn't have to get deeply involved in the credit crisis ended in March when Messrs. Paulson and Bernanke arranged for the takeover of Bear Stearns, fearing the uncertain ways a collapse might ripple through markets. But Mr. Paulson, worried the sale to J.P. Morgan Chase would look like a bailout, insisted on a low sale price so Bear Stearns shareholders wouldn't benefit.

Then in June, as home prices showed new declines, investors whipsawed the stocks of Fannie and Freddie. Mr. Paulson heard from his counterparts abroad and from central banks, big holders of Fannie and Freddie debt, wondering what was going on.

He urged his staff to think through what Treasury could do. While some contingency planning existed, staffers began compiling a firmer list of options, from lending the companies money to nationalizing and then reselling them in pieces. Mr. Paulson rejected the nationalization idea, partly because it would make the U.S. responsible for the companies' $1.6 trillion of debt as well as for all the mortgages they guarantee. It became clear the favored route was lending to them or buying equity in them.

Pressure rose on July 7, when a Lehman Brothers analyst speculated an accounting change could force the mortgage giants to raise tens of billions of dollars of new capital. The stocks went into a freefall. Mr. Paulson believed an accounting change wouldn't change the companies' capital situation, but he saw that confidence in them was waning.

On July 10, he decided to call Alan Greenspan for his view. At first, the Treasury couldn't find the former Fed chief's home number. Once Mr. Paulson got through, he and several of staff members hunched over a speakerphone, struggling to hear Mr. Greenspan's soft voice. They discussed the housing slump's impact on financial firms and whether they had the capital to weather it. (Mr. Greenspan has since said the administration should have recommended the mortgage giants be nationalized, recapitalized, split up and eventually sold to private investors.)

Time to Move

By Friday, July 11, Fannie's and Freddie's stocks were down so much Mr. Paulson decided he must act. "Friday morning it was just clear to me that we didn't want to stress the system, as fragile as it was," he says. At 7:15 a.m. he briefed President George W. Bush. He began calling members of Congress, asking them to approve a request he would soon make to let the government either invest in Fannie and Freddie or greatly expand their line of credit with the Treasury.

That weekend, as staffers worked out details of the proposal, they camped at the Treasury building, eating sandwiches from the Corner Bakery, the only nearby place open. An agitated Mr. Paulson began circling his staff's offices with questions. Would the markets be reassured? Would the proposal be done in time for the opening of Asian financial markets?

He queried staff members so frequently that before long they had nothing new to tell him. Finally, his chief of staff suggested Mr. Paulson return to his office, telling him that "you need to leave us alone so we can do our jobs," according to people familiar with the discussion.

At one point, Mr. Paulson went for a short bike ride to let off steam. As the deadline neared to get the plan in place before Asian markets opened, Mr. Paulson, at his staff's urging, went home to shave and change out of his jeans. At 6 p.m. he appeared on the Treasury's steps, calling for authority that would involve the federal government more deeply than ever before in the nation's financial markets.

Chevy Chase Bank - Wholesale - Wholesale

2008-01-14

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Reported incidents of mortgage fraud jumped 42% nationwide, with Florida reporting the highest number of cases, according to industry data released Monday.

Properties in the Sunshine State accounted for nearly a quarter of all mortgage fraud incidents, the Mortgage Asset Research Institute said. California was ranked second, followed by a three-way tie for third place among Illinois, Maryland and Michigan.

The report is based on data submitted by MARI subscribers about loans that were originated in the first quarter of this year and have since been classified as fraudulent. The most common mortgage-fraud cases included misrepresenting income, employment history, and debt and assets. Maryland, for example, had an unusually high percentage -- 69% -- of its cases involve tax-return and financial-statement misrepresentation.

Mortgage fraud has represented about $1 billion in losses over the past decade, the Mortgage Bankers Association has said.

The increase in reported incidents comes as lenders raise credit standards to curb rising foreclosures. Amid the wreckage of the housing slump and mortgage crisis, many banks have been criticized for their offering up of mortgages without asking for thorough documentation. Critics charge the industry with being too lax in qualifying risky borrowers during the boom, which fueled an overheated housing market.

"Tightening credit standards by itself doesn't eliminate fraud," especially in markets that typically attract a lot of speculators like Florida and California, said Merle Sharick, vice president and national manager of business development for MARI