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 dot.com 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.