Ten Lessons Bankers Never Learn

"Arrogance and Accounting”

My friend Rob once reminded me, “The trouble with trouble is that it always starts out as fun.” And it’s true. It’s fun to watch baseball players who use steroids smack some really long home runs—until their bodies break down. We love the music from artists who use drugs—until they end up in rehab or drop dead from an overdose. It’s fun to work with or own stock or bonds in a high-flying, award-winning company—until it crashes and burns.

It’s not like we don’t know better. Don’t we all occasionally see things happening that we just know will lead to bad endings? At one time or another, haven’t we all seen red flags? If there are only one or two red flags, we can dismiss the danger signs. But if we see a lot of them, they scream out at us. The collapse of Fannie Mae and Freddie Mac was one of those train wrecks we knew was coming, but like deer in the headlights, we just couldn’t crank up the ol’ Chevy and get the hell off the tracks.

It is a compelling story, and it’s a great topic for the many books that will undoubtedly be published. Because Fannie and Freddie play such an important role in our economy, and because their failure put the taxpayers at such tremendous risk and cost taxpayers a fortune, we can spend some extra ink here. The stories behind failures at Bear Stearns, Lehman Brothers, Countrywide, Wachovia, and others are disturbing because they revealed so much greed and excess, but this isn’t our nation’s first rodeo and while disappointed and perhaps even angry, we aren’t really shocked that privately owned companies—even those subject to government oversight—are so greedy. We may not be shocked, but we certainly have the right to expect better from our government and, by extension, our government-sponsored enterprises.

Fannie and Freddie should have been different. These GSEs (government-sponsored enterprises) were established to promote a specific national objective—affordable housing—and got tremendous government support to do it. We gave them a $2.25 billion line of credit from the US Treasury, for goodness sake! We exempted them from a ton of taxes. Unlike other companies of their size, we excused them from onerous regulatory filing requirements with the SEC. We even let them operate with a razor-thin amount of capital, a benefit we would never allow our nation’s banks and thrifts.

They let us down. We should be pissed off. But the sad truth is, they failed because we allowed it to happen. For way too long, we liked the idea that a program we developed to ensure affordable home loans for everybody could continue to work with government support but without government intervention. We merely grumbled about the high salaries but didn’t complain too loudly because credit was readily available, and the money, it fl owed like wine. We bought into the simplistic slogan of less government is always better without giving enough thought to the repercussions. We bought into the hype.

Hey, it’s easy to get caught up in the euphoria of a booming housing market and the comments from its charismatic cheerleaders like those at Fannie Mae. And what’s not to like about a great American success story with Fannie Mae’s former Chairman and CEO Franklin Delano Raines?

Born in 1949 to a father who worked in the Seattle Parks Department and whose mother was a maintenance worker at the Boeing aviation company, it was yet another great story of a kid with modest beginnings who went on to achieve remarkable success. He served as a senior officer and board member of Fannie Mae beginning in 1998, and was their chairman of the board and chief executive officer from January 1999 until his official resignation on December 21, 2004. He had everything going for him, but he blew it.

It was Raines’s arrogance and failed leadership that not only caused irreparable damage to Fannie Mae’s reputation but to his own reputation as well. He resigned from the board and settled with the government for $24.7 million in exchange for not having to face charges for fraud.

As noted before, Fannie and Freddie were growing by leaps and bounds, and they were becoming so dominant that competitors began to complain openly that their being sponsored by the government was unfair, unnecessary, and risky. In June 1999, an advocacy group was formed to confront the unbridled expansion of both Fannie and Freddie. They cited Fannie Mae’s expansion into private mortgage insurance, home equity lines of credit, and home improvement loans (purchased from Home Depot stores) as examples of activities that exceeded Fannie’s charter. As if Fannie’s expansion wasn’t enough, such rapid growth also presented risks to taxpayers. After all, why should the taxpayers subsidize people buying hot tubs and chandeliers from Home Depot?

This advocacy group was called FM Watch, and its board included some very powerful CEOs. Raines fired back at FM Watch in his May 12, 2000, interview with National Journal magazine, declaring, “We have a very well organized group of financial companies who have banded together with the express purpose of doing harm to Fannie Mae. If you spend enough money in Washington on lobbyists and PR people, you will have an impact.” He should know. Fannie Mae spent $7 million lobbying that year alone and over $45 million during his tenure at Fannie Mae from 1999 to 2004! Did you catch that? They spent $45 million to lobby the politicians for favorable treatment!

At the same time, Fannie helped form the Homeownership Alliance. Its members also included some heavy hitters: Freddie Mac, the National Association of Homebuilders, the National Urban League, the National Association of Real Estate Brokers, and others. The Homeownership Alliance wanted to counter opposition from FM Watch and others who opposed Fannie and Freddie’s unbridled growth. In an obvious overreaction to FM Watch, the new Alliance president, Rick Davis (former presidential campaign manager for Arizona Republican Senator John McCain) declared, “Some critics of the system are implicitly calling for policy makers to reconstruct the system so it can be more like that of other industrialized countries. Forty-percent down payments, like they have in Germany, and huge prepayment penalties that are the norm for refinancing in some European countries are things we did away with decades ago, and we certainly don’t want to turn the clock back.” Wow, the only word missing in his diatribe was Nazi. Davis was paid over $30,000 a month for five years—until the group disbanded in 2005.

In another volley against FM Watch by the two GSEs, Gerald L. Friedman, chairman of the FM Watch board, issued a press release stating, “Each member of our board of directors has been systematically approached and threatened by these government-sponsored enterprises. In each instance the message was the same: Stop supporting the activities of FM Watch or be prepared to see your business opportunities and products suffer.”

Meanwhile, Fannie Mae continued to grow and report enormous profits. By the end of 2001, they owned or guaranteed about 43 percent of the country’s residential mortgage loans and were funding 60 percent of all multifamily loans. “We knew Fannie and Freddie were very aggressive and very hungry,” says Jay Brinkmann, the Mortgage Bankers Associations senior director of research and economics, “but no one expected [them] to grow [multifamily loans] that much in such a short time. That’s a little sobering,”

But heaven forbid you should complain about Fannie. In response to a critical article printed in the Washington Business Journal (April 2001), Arne Christenson, Fannie Mae’s senior vice president for regulatory policy (and chief of staff to former House Speaker Newt Gingrich, R-GA) wrote a blistering, over-the-top 1,296-word letter to...