Friday, November 09, 2007

OFHEO to Andrew Cuomo: Point that thing someplace else

It seems Jim Lockhart, Director of the Office of Federal Housing Enterprise Oversight (OFHEO), who is the primary regulator of Fannie Mae and Freddie Mac, did not take too kindly to New York Attorney General Andrew Cuomo's subpoena of the GSEs.

Here is his letter in full. The letter does a cursory job of sounding nice, but it isn't hard to read between the lines. So I thought I'd speculate on what Lockhart was really thinking as he was writing.


I read with interest and concern the letters you sent to Fannie Mae and Freddie Mac... [The whole time thinking, who the fuck do you think you are?] As the former Secretary of HUD, you know that the Office of Federal Housing Enterprise Oversight (OFHEO), is the federal safety and soundness regulator of Fannie Mae and Freddie Mac... [so you in my house now bitch.]

After reviewing these materials, I feel that you and your staff may not fully understand the differences between mortgage-backed securities (MBS) issued by the GSEs and those issued by other entities. [Why don't you get your shit together before plopping your New York ass in my sandbox?] In particular, unlike issuers of private label MBS, when Fannie Mae or Freddie Mac issues an [sic] MBS, they retain the credit risk on the underlying mortgages by guaranteeing repayment to MBS holders. [blindlyambitiousassholesayswhat]. Consequently they have no economic incentive to knowingly purchase or guarantee mortgages with inflated appraisals...

I am disappointed that your office did not contract OFHEO before or even after subpoenaing the GSEs and issuing certain threats regarding their future business activity... [Again, who the fuck do you think you are?] As I see it, we each have responsibility, as part of our respective mandates to help ensure that fraud is not perpetrated on mortgage borrowers or on market participants [as in check your jurisdiction]. Pursuing this mutual goal will be more effectively accomplished, at less disruption to the integrity and soundness of the mortgage market [which you apparently don't give a fig about], by cooperation. Indeed, it is OFHEO's mission to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac. [So why don't you back the fuck off?]

Given the importance of the mortgage markets to the U.S. and world economies [which unfortunately take priority over your political career], we need to meet with you at your earliest convenience. Some of the issues we believe need to be discussed include:

  • The Enterprises' efforts to monitor and prevent appraisal fraud and OFHEO's oversight of that activity. As you know, there is pervasive Federal law, regulation and guidance about appraisal fraud. [Maybe you heard something about the supremacy clause back in law school?]
  • Your demand that two federally chartered and federally regulated Enterprises cease doing business with a major federally-chartered bank, which you have not charged or subpoenaed, unless certain conditions stipulated by you are met. [I'm still trying to figure out who the fuck you think you are]...
  • Since purchases of the Enterprises' MBS receive a corporate guarantee of repayment from the Enterprises, whether the issue is more of a safety and soundness matter than a securities issue. [You aren't causing a bank run just so you can get your face in the papers.]

Again, OFHEO shares your concern that mortgage fraud, including fraudulent appraisals, be eliminated. I also recognize that the mortgage market in recent months has been subject to much turmoil. [Maybe you've heard something about this?] I believe that all relevant government agencies shoulder a responsibility [key word here jack ass] to eliminate fraudulent and otherwise bad actors from the mortgage market while also respecting the many legitimate parties -- borrowers, appraisers, lenders, and investors -- trying to participate in this market during this uncertain period. We need not aggravate the latter in pursuit of the former. [I wonder if you care about anything. Or anybody.]

I look forward to [kicking your ass] to hearing from you soon and discussing ways that we and our staffs can work together [like you can get us coffee and stuff] on addressing these issues that are important to all of us.

[P.S. Back off]


First, I think Lockhart glosses over reality when he says that the GSEs have no incentive to inflate loan appraisals. On one hand, that's true, because it increases their loss potential. But on the other hand, I suspect this practice is pretty pervasive. And I'm betting in most cases its the appraiser tacks on an extra 8% to the value or something on that order. Even if the GSE sees that in their random check, a number like 8% might be considered within the error range. Of course, if it were really a random error, then half the loans would be slightly undervalued and the over half overvalued. Something tells me this wasn't the case.

I'd also argue that this could only apply to refinanced loans. Valuing a purchase loan at the price the purchaser just paid is called "mark to market" even if the purchaser vastly overpaid. And if an appraiser grossly overvalues a property off a purchase, that would be too obvious for anyone to ignore.

Now, if WaMu or anyone else was actually fraudulent in any step of underwriting MBS securities, that should be punishable. But this is extremely different than Elliot Spitzer's crusade against bad street research, which occurred around the time of the bust. While I thought Spitzer was entirely self-serving in his actions, and I thought street research had little to do with either the internet boom or subsequent bust, I still didn't give a damn what happened to the brokerages. They were, in fact, pushing bad research, and so they got what they deserved.

Here, there is potential damage to the overall banking system, with dire consequences for tax payers. The fact is that if something happens to Fannie or Freddie, we'll have little choice but to bail them out. And if any bank goes bust, tax payers will at least have to bail out the depositors.

I think what will happen here is that the Federal government will conduct a probe of WaMu, and probably other banks. They'll undoubted find that some appraisals were overstated. But they'll also conclude that there was no mandate from management to overstate home values. Therefore proceedings will turn into minor fines at the corporate level.

Someone like Henry Paulson understands the danger here. Ben Bernanke does too. The U.S. economy is like a car with two wheels hanging off a large cliff. Hopefully we can carefully put the car in reverse and carefully back away from the abyss. We really don't need Cuomo jumping up and down on the hood, thanks.

Disclosure: I own WaMu bonds through client accounts. I also own large amounts of Freddie Mac and Fannie Mae debt and MBS securities.


Anonymous said...

AI - try not to fall off your chair, but I agree with you 100%

I would even go a little further than you and say most appraisals (more than half) were overvalued... but was this at the direction of management? Seems unlikely they would issue a memo to that effect, and Cuomo would have exhibited a memo if he had one.

Without a memo, could you prove collusion in court? Almost certainly no. Its pretty reasonable to think that appraisers were victims of the same absurd optimism as everyone else.

As for Cumomo: I am not an atty, but I think wild and absurd accusations made as part of a lawsuit and/or during trial are considered "protected speech". I don't know that this applies to a press conference held as part of a preliminary investigation that may or may not eventually lead to a lawsuit.

Yelling "Fire!" for personal (political) gain when you know it is likely to incite a riot (bank run) -- it hardly seems to be what the founding fathers had in mind when they thought of freedom of speech.

Anonymous said...

Sorry, but the political gain is evenly distributed here. Very, very, sorry.

James Lockhart is a Bush family fixer, and his sole purpose at OFHEO is to contain the pus at Fannie and Freddie until Bush is out of office. That's his only job. Period.

Finally, who made money out of fraudulent appraisals? Did it boost fees on MBS's?

Follow the money.

Accrued Interest said...

I am editing my post a little to make it clear that Lockhart glossed things over a little when he said that the GSE has "no incentive" to allow inflated loans. I don't think they have a strong incentive to collude, and I doubt they did, but they do have an incentive to kind of look the other way. Tanta puts it well here.

And I think she hits on some important points, that Fannie/Freddie's real disincentive is to have WaMu go under. That would cause all sorts of headaches. Even forgetting about the contagion problems of such a big bank failure...

Anonymous said...

AI -- please explain... why does FNMA/FHLMC care if WaMu goes under? The loans, once sold to FNMA, don't have much to do with WaMu anymore (another servicer can be appointed). And if WaMu were somehow shown to have colluded, the loans would be a fraudulent sale, and FNMA could put them back to WaMu (albeit WaMu may not have the cash to take them back?)

BTW - the link you give doesn't work

Anonymous said...

Working link to Tanta's post at Calculated Risk is (I suspect AI used the trackback address but that's unreliable as a direct link).

WaMu is apparently in the mix because there appear to be incriminating emails between WaMu and a major appraisal outfit; the latter was the direct object of Cuomo's probe AFAIK.

Anonymous said...

Thanks for the new link rw

The e-mail I heard Cuomo citing said that WaMu wanted the First American subsidiary to use "proven appraisers"... that doesn't sound like a smoking gun.

If an appraiser picks a number that is too small, the deal gets scuttled and the mtge broker gets no commissions. It seems the mtge broker, without any "help" from management, might start "picking appraisers carefully" to make sure deals didnt get scuttled.

The mtge broker has zero incentive to pick the most conservative appraiser-- why would he?

And if you were an appraiser, the last paragraph is pretty obvious to foresee -- why would an appraiser err on the conservative side? Valuing a house is an art, not a science, you cannot "prove" any number unless there is an actual sale of the house (and even then, that doesn't prove another buyer would pay the same amount). There is a lot of fudge room, and the appraiser knows he won't get hired if he is overly conservative.

Both mtge brokers and appraisers can easily work these incentives out on their own.

Borrower, broker, bank, appraiser, lawyer ... There is no one involved in a mtge transaction who has an incentive to be conservative on appraising the house.

Anonymous said...


The operative statement in your post is:

The U.S. economy is like a car with two wheels hanging off a large cliff. Hopefully we can carefully put the car in reverse and carefully back away from the abyss. We really don't need Cuomo jumping up and down on the hood, thanks.

I have, at times, jousted with you in the past as to whether you were a "bear". And, in fact, there have been long discussions on this blog about "bearishness".


Beyond bear? Bear to the max? Bear in Grim Reaper's clothing?

It seems to me that you've become a bear. Why so late to the party?

It is a dark day in our blessed land, when someone as intelligent as you cozies up to the likes of James Lockhart out of fear of Andrew Cuomo.

After all, in any reasonable country, Andrew Cuomo would be incapable of doing harm.

Accrued Interest said...

Well, I've become more and more worried about the banking system. I think the Fed has the tools to resolve any problems, but stupid legislation can foul up the Fed's plans.

And my posts on ultra bearishness were aimed at people who are always bearish, not people who take a rational bearish position.

Anonymous said...

"an MBS" is actually correct, since the rule is to use "an" where the next sound is a vowel sound, even if the letter is a consonant.

Anonymous said...

ttdg, could you put a post on the different layers on CDO, super seniors, mezz, etc. Would be helpful to some of us as we get lost in the various names.

DAB said...

One thing to remember here is that the New York Attorney General has a much longer standing role in regulating financial markets and institutions in this country than the federal government. Prior to the 1930's, if there was any capital to be moved it was largely moving in New York and prior to the 1930s there was no place for federal regulation. The federal reserve was set up in the 1910's sometime, but it was basically the New York bank that had primacy. The central body had little power. Thus, if there was any regulating to be done from a legal standpoint, it was the New York AG doing it for about the first hundred and fifty years of the republic.

Do not be so quick to dismiss the role of the New York AG in regulating the financial system.

Now, I have absolutely no opinion on whether Cuomo has firm grounds for doing anything and do suspect that part of his motivation, as was Spitzer's some of the time, is to get on Television. However, historically speaking, his claim to regulate financial activity is quite firm.

Anonymous said...

Bernanke's recent proposal to Congress to raise the conforming limit to $1M makes Cuomo's lawsuit more important to the American taxpayer, not less.

Let's be honest - Citigroup is no longer too big to fail. Rather, it is too big to bail out.

Cuomo is the voice of the taxpayer.. if Lockhart was successful in doing his job, Fannie and Freddie would be reporting financial statements.

Accrued Interest said...

I have no idea why NY's move here is speaking for the tax payers. No idea at all. Look, think what you will about Lockhart's job at OFHEO. I don't know what's he's accomplished at his time there, and you might say that he's followed a stealth Bush directive of under-regulating. That appears to be common in this administration.

My contention is that Cuomo is playing with fire here and I doubt he appreciates the consequences of his actions. So forgetting about your view of Lockhart the man or OFHEO the institution, f'ing with the banking system right now is the wrong move.

Accrued Interest said...


Super senior is usually a AAA-rated bond which is senior to some other AAA-rated bond.

I don't know if there is a "official" definition of "senior" but I've heard AAA-rated bonds which are not at the top of the structure still referred to as "senior." Sometimes people will also say something like "the more-senior tranches should perform better" and there they might be referring to various tranches near the top of the structure.

Mezz usually refers to anything below the senior, but not the first loss tranche. If someone generically says "A CDO backed by Mezz ABS" they are usually talking stuff that was originally rated A or BBB.

Then "sub" is usually the first loss tranche, or else the first loss tranche other than the equity or the residual piece. In a CDO this would be especially am originally non-IG tranche.

Anonymous said...

hi ttdg, many thanks.learning a lot, i am.

Anonymous said...

" why NY's move here is speaking for the tax payers. "

combining with..

" I don't know what's he's accomplished at his time there "

Nothing. Not being snarky at you, ai, but if I was his boss, my question would be.. show me a deliverable! I've looked, and can't find one thing.

Why is this supporting the taxpayers? This is America, and that means fiscal responsibility is the name of the game.. not the 3-card monte brought to us by the Bush administration.

" f'ing with the banking system right now is the wrong move. "

OK.. point taken.. conversely, when is a good time to rattle the cages of the banking system to show execs that the taxpayers want them to get off their collective tuchus and SOLVE their problems instead of just passing time by improving their golf game?

When was the last time Fannie and Freddie reported financials? Why? More to the point, what exactly have they been doing that makes them unable to restate and report?

I, for one, can't wait for that day.. not even so much for the actual numbers but more for Tanta's take on them. Also, I don't think either are solvent yet, and I'd rather take the medicine now (of blowing one up and starting over) than later because it will be a bigger kerfluffle a decade down the line.

Point it elsewhere? Sure thing.. but what action is Lockhart going to take?

Accrued Interest said...

Anon: Just for the record, I was saying I didn't know what Lockhart had accomplished at OFHEO. Its ridiculous that the GSE's haven't reported in so long. I don't really care what the reason is. I don't think they are insolvent and just hiding it, although without any financial reports, I can't say that with much confidence!