Saturday, September 3, 2011

The Alphabet Soup of Subprime Loans

I have been reading 'Reckles$ Endangerment'.  It is the true life expose of Fannie Mae.  No, that is not an exotic dancer, that was Fanne Foxe.  But the story is set in Washington, D.C. and congressmen are involved.  Lots of them.

I am appalled at what I am reading.  I am wondering where all of this information was in the mid-90's.  Oh right.  It was being held under-wraps so that folks like James Johnson who ran Fannie could make lots of money doing so. 

In the mid-90's I and a few of my finance professional colleagues were busy rewriting the investment act in the State of Michigan, popularly known as P.A. 20.  After the Orange County bankruptcy in 1994, we felt it was time to both tighten up investments in Michigan, including a mandate for written policies, and broaden some choices into 'safe' investments.

At the time, we considered that the 'implicit' Federal guarantee of Fannie Mae and Freddie Mac securities made then a 'safe' bet for local units.  They carried the highest credit rating by all of the rating agencies.  What could be risky in that?

What none of us realized at the time was the way Fannie and Freddie were running their businesses.  The book tells all and I suggest you read it a few pages at a time so as not to endanger your mental and/or physical health.

In September, 2008, the government took over Fannie and Freddie (I guess that is like having your kids move back home).  Thanks to the American taxpayer, investors got their money.  The implicit guarantee had been realized.  But at what cost?

Now we have a lawsuit by the Federal Housing Finance Agency over these subprime loans.  The tale in the book about how all of this came about is fascinating.

I was at a conference in September 2008 when an investment banker came up to me and told me that AIG was  declaring bankruptcy.  I was holding some commercial paper, top-rated no less, that was maturing within the month.  I held my breath and with the government bailout the Township suffered no losses.

How are any of us investing money for our local communities supposed to do it safely when the rating agencies are telling us these are 'safe bets'?  I remember the Savings and Loan crisis.  One local bank had CD rates far above what anyone else was offering.  A friend called and asked me what I was holding and I said I had one CD due within a few weeks and I was holding my breath.  I had not been purchasing anything from them for some time.  When rates are too good to be true, there is usually something wrong.  At least in my opinion.

If you are interested in the inter-play of all these agencies, I suggest you read the book.  Reading it with wine and cheese works well too.

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