Friday, October 3, 2008

A Financial Hurricane: Anatomy of a Congressional Catastrophe

“The Tolbert Report” is pleased to have a guest post this morning from State Rep. Ed Garner, who represents District 41 which includes Maumelle and portions of North Little Rock.


"The Federal Reserve has been unable to find any credible purpose for the huge balance sheets built by Fannie and Freddie other than the creation of profit through the exploitation of the market-granted subsidy," Alan Greenspan, May 2005.
This week in Washington, D.C., Congress will put final touches on legislation designed to ward off the greatest financial crisis since the Great Depression. That statement ought to scare the living daylights out of you. A quick poll of a few local bankers confirms the overnight fed funds market is far less liquid than normal and confidence has been greatly diminished lets all hope the $700 Billion bailout works without tanking the U.S. dollar.

American citizens should be worried and angry. Our politicians have given a couple of reasons for the debacle, greedy Wall Street and a lack of government regulation. The former is only half-true, the latter, and well, that’s not true at all.

I want to share a personal perspective with you about the beginnings of this perfect storm. Like any hurricane, this began as a small disturbance in the vast ocean of the financial world. In the early 90’s, I was an investment broker and one of my accounts was the Student Loan Marketing Association.

Sallie Mae, so nicknamed, is a Congressionally-chartered Government Sponsored Enterprise, GSE, which was created with the mission of providing low cost loans for college students. GSE's, including the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are entities which blur the lines between government agency and private corporation. They are private equity owned, their executives have compensation packages like any top financial company, yet they have operational budgets supplied by the Federal Government and they borrow funds from the fixed income markets at rates only slightly higher than direct U.S. Treasury obligations due to a “quasi-government” guarantee.

During one of my visits to the Sallie Mae trading room, I witnessed the birth of a new program that had nothing to do with the trading of U.S. Treasuries, the primary role of my contact who was the head of the trading desk. On one side of the austere 30 ft by 30 ft trading room were the representatives of three investment securities dealers ready to bid on a new issue of Sallie Mae bonds (borrowing). On the other side of the room were a few competing investment bankers ready to sell Sallie a custom-created Collateralized Mortgage Obligation or C.M.O. (buying). Both transactions were executed in less than a minute for $200 million on each side. The technique is known as arbitrage, trading in related markets to make money on the spread. Sallie Mae was filling her portfolio with these transactions.

“What does this have to do with providing low cost student loans?” I asked the head of the trading desk, who was also a long time friend. He just rolled his eyes and said grimly, “Nothing”. The program was being mandated by the Director of Portfolio Management. It was legal. In fact the right to buy these instruments had been lobbied for in Congress. But a moral line had been crossed. Sallie Mae would continue to expand its holdings in this fashion for more than a decade. The Director would go on to be Chairman and in the years from 1999 to 2004, would be compensated to the tune of approximately $200 million. It had nothing to do with student loans and everything to do with profit.

More importantly, the traders took their new found niche and went to work for Fannie Mae and Freddie Mac. It was no longer a small storm, for now it resided in the largest financial sector in the world, the U.S. mortgage market. Fueled by the warm water of a Federal Reserve printing dollars at full speed, a booming housing market with declining credit quality and overvalued assets, it gathered strength for the past 15 years and now this financial hurricane has made landfall.

Where was the government regulation? It was suppressed by the same Congressmen who today divert the blame exclusively to Wall Street. Why? According to campaign donation disclosures, they have been entirely too cozy with the executives of Fannie Mae and Freddie Mac. In fact, the same Congressmen which are playing leading roles in the drafting of this bailout legislation killed the legislation that would have put the brakes on this activity in 2005!

In a display of absolutely mind-blowing hypocrisy these same Congressmen included in the bailout package a provision which would have diverted 20% of profits on the resale of assets bought with taxpayer funds (should there be any) to pet special interest groups such as ACORN, La Raza and the Urban League. They also blamed the other political party for deregulation while being personally responsible for preventing any restraint.

In fact, it seems that the only regulation to be applied is the SEC’s mark-to-market rule which has caused the liquidity crunch to begin with.

Was the push for sub prime lending and affordable housing legislation motivated by the altruistic desires of Congress to help the poor or by portfolio profits, executive compensation and the lobbying efforts at Fannie and Freddie?

Here’s a better one…. How can we trust our government and Congressmen to have a solution when they won’t admit to being major contributors to the problem?

Rep. Ed Garner
garnere@arkleg.state.ar.us

1 comment:

Bryant Arms said...

The financiers are snookering us again. We, the taxpayers, will never see that money once Congress caves in to special interests, (as usual). If we try to get it back by taxing these businesses, then they will take the good parts of their portfolios and flee to other countries. Suckers!

If we use that money to enhance social security, then all of the retirees that lost their retirement funds in the stock market will at least be guaranteed a reasonably comfortable retirement. (The only ones who will still be unhappy are the ones trying to retire to their mansions.)

Finally! Congress has found the money to make social security work.

Let Congress know that if they get fooled by this bailout, then the only thing for voters to do is punish congress the way it was punished for the gulf war.

Bryant Arms