Last month, Fannie Mae and Freddie Mac requested another $19 billion (combined) from U.S. taxpayers, bringing their running total of taxpayer assistance (uncapped by the U.S. Treasury last December 24, 2009) to $145 billion and counting. That’s already 145 times the collective loss of those on the wrong side of Abacus AC1-2007. This massive loss was generated by government sponsored enterprises on a U.S. government-led mission to expand and subsidize homeownership that ultimately undermined mortgage underwriting standards and loan quality. For decades, Fannie and Freddie were coddled by many high-ranking politicians, and protected by a formidable lobbying apparatus. The GSEs only had to answer to a chronically under-funded and toothless regulator, and they were highly leveraged and grossly undercapitalized. Alas, even the multi-year, multi-billion dollar accounting frauds at Freddie and Fannie (discovered in 2003 and 2004, respectively) failed to tighten oversight or improve risk management of these institutions. Indeed, the inherent risks in their combination of hybrid purpose and compromised oversight worsened dramatically when the home price and credit bubbles fed on each other, and fueled the demand for “affordable” mortgage products to unprecedented levels.

"The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deem these events 'unlikely’." - Nassim Taleb, The Black Swan (2007)

Although it remains unclear how much longer GSE liabilities will remain an off-balance sheet liability for federal government budgeting purposes, they became unambiguous obligations of current and future generations of American taxpayers when Fannie and Freddie were put into conservatorship by The Federal Housing Finance Agency on September 7, 2008. The $145 billion (and counting) taxpayer bill is the result grossly conflicted and negligent government sponsored enterprises, ineffective regulation, and many feckless politicians. The eye-popping, still-growing and open-ended losses at Fannie and Freddie make it all the more puzzling that recent scrutiny of financial system failures has been pointed almost exclusively at Wall Street and the banking industry. After all, most analysts seem to agree that the catalyst for the global financial crisis was the creation and subsequent failure of mountains of lousy subprime and “Alt-A” loans amidst a sharp and broad reversal in U.S. home prices. Numbering 26.7 million and $4.6 trillion in aggregate unpaid principal balance by mid-2008, these sketchy loans grew to comprise about half of the approximately 55 million in first mortgages outstanding.

Contrary to popular belief, Wall Street banks were not the primary driver of subprime and Alt-A products. A thorough analysis by mortgage finance expert Edward Pinto reveals how instrumental and dominant U.S. government-controlled institutions – Fannie Mae, Freddie Mac, The Federal Housing Administration (FHA), The Veterans Adminstration (VA), The Federal Home Loan Banks (FHLBs) – were in this market³.

“One of the reasons for confusion about the number of subprime and Alt-A mortgages outstanding at any time in the U.S. is that many of the participants and reporting agencies used different definitions of the same terms. In many cases these definitions did not classify subprime and Alt-A loans based on objective risk characteristics… For example, Fannie Mae classified a loan as subprime if the mortgage loan was originated by a lender specializing in the subprime business or by subprime divisions of large lenders. This had the effect of reducing its subprime loan count to a very small number.” - Edward Pinto, former Fannie Mae Chief Credit Officer

Pinto’s cogent analysis also reveals that, for years, Fannie and Freddie misclassified subprime and Alt-A mortgages as prime (see sidebar). Now there’s a risk disclosure controversy. One would think that with their legacy and staggering, still-mounting losses (and that, along with the Federal Housing Administration, Fannie Mae and Freddie Mac guaranteed almost 97% of all new housing loans in Q1 this year) that the GSEs would be the poster children of this year’s FinReg reform legislation. After several weeks of debate, on May 20, the Senate passed S 3217, The Restoring American Financial Stability Act, a bill described by its supporters as “comprehensive financial regulatory reform”. The bill proposes no fundamental reforms to the GSEs, which begs a few questions: How can American financial stability be restored without addressing what, arguably, were and continue to be the largest and most obvious catalysts for financial system destabilization? How can supporters keep a straight face when they characterize this bill as “comprehensive”? The bill’s requirement that the Treasury Department “study” the feasibility and desirability of ending the GSE conservatorships and, more broadly, the future of the housing finance system, is not reform - it is stalling. It seems that politics are prevailing over common sense (again). Onto reconciliation with the House.