Securitizing Fannie- guaranteed to fail

James Johnson, who, for most of the 1990s, ran Fannie Mae, the largest of the Government Backed Mortgage Companies (GSEs). Tall, charming and politically shrewd, Mr Johnson spotted a golden opportunity to use a popular cause—increasing home ownership—as a means of building Fannie’s power in Washington, and also feather his and his fellow executives’ nests along the way.

BUY CONGRESS

His strategy rested on three pillars. The first was to buy Congress, which Fannie did through a combination of lobbying, campaign contributions and perks, such as sweetheart mortgage deals for key political figures (a ruse later copied by private mortgage lenders). Between 1989 and 2009, Fannie spent around $100m securing lawmakers’ affections. Among its biggest boosters were Chris Dodd and Barney Frank, the architects of the massive financial-reform bill passed in 2010 (which contained almost nothing on the GSEs). Helping to keep the politicians onside were the dozens of community groups and charities that Fannie funded, directly or indirectly. These groups were also fooled into believing that the huge financial benefits accrued from the implicit government guarantee enjoyed by Fannie Mae and Freddie Mac, its smaller sibling, flowed mostly to their borrowers, not to their managers and shareholders.

EVISCERATE REGULATORS

The second task, was to eviscerate regulators. Friends of Fannie and Freddie on Capitol Hill ensured that the agency overseeing the firms remained “a 98-pound weakling” and that their capital requirements stayed dangerously flimsy. As the GSEs ramped up their risk-taking, the Federal Reserve seemed, until it was too late, oddly unworried. As Fannie led the way in what Mr Johnson proudly called “underwriting experiments” (read: lending to ever-dodgier types), regulators mostly applauded. The few who expressed alarm were quickly drowned out.

COURT MORTGAGE LENDERS

The third leg of the strategy was to court mortgage lenders. Countrywide’s Angelo Mozilo once described Mr Johnson as so slick that “he could cut off your balls and you’d still be wearing your pants.” Other mortgage lenders ensured Fannie a steady supply of raw material to grow its balance-sheet (which came increasingly to resemble that of a hedge fund), and helped to boost its profits, to which executive pay was increasingly linked. Mr Johnson alone extracted nearly $100m in his nine years at the helm. The final tab for bailing out Fannie could be several hundred times that.

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