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A Death Knell for Fannie Mae and Freddie Mac

Wall Street eliminates competition

By Heide B. Malhotra
Epoch Times Staff

A Death Knell for Fannie Mae and Freddie Mac

Wall Street eliminates competition

By Heide B. Malhotra
Epoch Times Staff
Created: Feb 21, 2011 Last Updated: Feb 21, 2011
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Fannie Mae and Freddie Mac, the two government-sponsored mortgage giants finally received the long awaited death knell. (Win McNamee/Getty Images)
Financial Crisis

It is official! Fannie Mae and Freddie Mac, the two government-sponsored mortgage giants finally received the long awaited death knell.

“The Administration’s plan will wind down Fannie Mae and Freddie Mac and shrink the government’s current footprint in housing finance on a responsible timeline,” announced the U.S. Department of the Treasury in its Feb. 11 press release.

The Treasury, without admitting its own complicity through inaction and an out-of-date regulatory system that left the two companies to their own devices, repeats findings that have been already brought to light since the beginning of the financial meltdown.

Secondly, Fannie and Freddie are accused of disregarding their privileged position as government-sponsored enterprises (GSEs). Both embarked on a path of profit maximization that took unprecedented risks and moved away from their mandate as a market protector.

The Treasury report “Reforming America’s Housing Finance Market” agrees that both firms were left to their own devices and lacked adequate oversight. The firms were given a playing field that gave them monopoly power, preferential tax treatment, and inadequate capital requirements.

“Fundamental structural flaws and poor decision-making are the principal reasons these institutions failed,” according to the Treasury report.

The timeline is left up in the air with just a few tidbits thrown in. For example, the increase in the maximum size of loans the two have been allowed to guarantee since 2008 will return to its former limits in October of this year.

“However, given the still-fragile state of the housing market, implementing these reforms fully will take time. ... As the market begins to heal and private investors return, we will seek opportunities, wherever possible, to accelerate Fannie Mae and Freddie Mac’s withdrawal,” the Treasury report said.

The cost of winding down the two firms, or what the firms’ bailout would ultimately cost the taxpayers, was not addressed. Recapping, the bailout of the two firms has amounted to more than $150 billion so far, and the total bailout could reach between $221 billion and $336 billion, according to a 2010 Federal Housing Finance Agency (FHFA) press release.

“There is sufficient funding to ensure the orderly and deliberate wind down of Fannie Mae and Freddie Mac, as described in our plan,” according to the Treasury report.

America’s Experts Giving Their Two Cents

“Today, the two GSEs control about 90 percent of the mortgage-backed securities market, and this must not become a permanent situation,” according to a recent article by the Heritage Foundation.

The article stressed that market forces are well-suited for replacing all three securitization functions to be vacated by the GSEs, which is taking over the buying and packaging of mortgages from the originators of mortgages, purchasing mortgage-backed securities for investment purposes, and lastly, operating under a set of policies that ensure a healthy housing market.

“Creating Fannie Mae and Freddie Mac were serious policy mistakes, as were subsidizing them through privileged access to federal funds and implicit guarantees. These mistakes should never be repeated,” cautions the Heritage Foundation article.

Financial Stability Ignored

“Reform of the housing finance system should have financial stability as its main policy objective,” advises David Scharfstein, professor at Harvard Business School, in a recently released white paper “The Economics of Housing Finance Reform.”

The professor suggests that so far the major proposals, which are filling the vacuum left by the demise of the two mortgage giants, have ignored financial stability. Instead the proposals include continued government guarantee programs or full privatization.

Arguing that neither proposal has sufficient merit, Scharfstein proposes privatization, coupled with the creation of another GSE to become the “guarantor-of-last-resort,” and a foolproof regulatory system. The paper’s conclusion does not highlight how financial stability fits into the equation and leaves the reader wondering where to go from there.

Next: Hands Off GSEs and Government Guarantees
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