Regulator for Fannie and Freddie
Juan Williams and NPR

Fannie, Freddie and Fraud

Fannie, Freddie and Fraud

My last post was about the growing crisis in the mortgage industry that results from the subprime loans written by banks for homeowners who qualified for these mortgages only because of lax or nonexistent underwriting policies. Loans were made with little or no verification of income, inflated appraised values, and the failure to assess borrowers’ credit worthiness. The financial institutions that made the loans, including Citigroup, JP Morgan Chase, Bank of America, and Wells Fargo, were not too concerned about collectibility since they had sold off their loans as asset-based mortgages to Fannie Mae and Freddie Mac, the two government-sponsored-entities that assumed the risk of default. It sounded good in theory until the banks sold fraudulent-based mortgages to Fannie and Freddie and left them holding the bag as a result of record foreclosures and falling home prices. 

Let’s take a look at what happened from an ethical perspective. A cynic might say that unethical financial institutions took advantage of unsuspecting homeowners by placing them in homes the banks knew they couldn’t afford with mortgages way beyond their financial means in order to earn loan fees and other closing costs and without any concern about eventual repayment of the mortgages because they had transferred the risk of nonpayment to Fannie and Freddie. In a previous blog I referred to the concept of moral hazard that accompanies the transfer of risk without any consequences to the transferor. In some cases the homeowners acted unethically by providing false documents to secure the loans perhaps aided by mortgage brokers.

The housing bubble that burst in 2007 and related mortgage meltdown is just another example of how unethical conduct negatively affects our economy. It has been estimated that home equity dropped by about $4.2 trillion through mid-2008 and is still declining. Total retirement assets lost $2.3 trillion during the same time period. Savings and investment assets were down by $1.2 trillion and pension plan assets by $1.3 trillion.

3489124074_bd5bcae95f_m (2) “Fraud-itis” infected banking once before when in the late 1980s the savings and loan industry became the focus of Congressional hearings about failures at 1,043 failed thrift institutions during the 1986-1995 period that was reported to be $152.9 billion including $123.8 billion of U.S. taxpayer losses. Yes, there also was a housing bubble during this time. The most publicized failure was that of Lincoln Savings & Loan where thousands of California retirees lost their life savings after buying uninsured, worthless bonds.  The period became known as the greatest collapse of U.S. financial institutions since the Great Depression. 

It’s been said that Albert Einstein  defined insanity as doing the same thing over and over again and expecting different results. How true this is in the U.S. today as we seemingly look for new and “creative” ways to make a quick buck rather than invest the time and energy into creating true and lasting value for our economy and society. Unfortunately, the question is not whether these bouts of fraud will occur again in the future but when will they occur and what will be the driving force? We need to wise up as a nation before it’s too late and get back to the core values of honesty, integrity, trustworthiness and personal responsibility that built the foundation of our economic and financial institutions that served us so well in the past but are now at risk of crumbling.