Rethinking home loans without regulation means a repeat of crisis

Update:  Thursday, August 9. Today Fannie Mae announced a quarterly profit of $10 billion and projected profits for the foreseeable future. When this dividend is paid, Fannie will have repaid approximately $105 billion of $116 billion it received from taxpayer bailout.

The latest quarterly gain followed a record $58.7 billion net income in the first quarter, when Fannie capitalized on tax benefits it had saved from its losses on loans during the crisis. It paid a first-quarter dividend of $59.4 billion to the Treasury.

In a major policy speech yesterday President Obama announced plans to reshape federal rules for 30-year fixed mortgages. The idea is to preserve the policy goal of getting American workers and their families into affordable home loans, but in practice this has played out with troubling consequences.

Obama’s speech comes on the heels of news that Freddie Mac, the country’s largest home loan lending institution along with Fannie Mae, reported a $5 billion net profit in the second quarter, compared with $3 billion from the same period last year. The earnings will offset all losses from mortgage defaults, which continue to be a problem for the housing sector, banks, and consumers.

The federal bail out Freddie Mac and Fannie Mae during the financial crisis in 2008 amounted to $187 billion, but since a housing recovery started percolating last year both institutions have again become profitable. Roughly, they have paid back roughly $136 billion of government loans, which is helping to make the budget deficit this year the smallest since Obama took office.

In his speech yesterday the President proposed overhauling the home loan system, including the elimination of Freddie Mac and Fannie Mae from the mortgage guarantee business. Obama claimed taxpayers should not be in the position of “holding the bag” for the risky business strategies of such giant financial institutions. However, President Obama did not clarify the rationale of the goal to preserve the 30-year home loan, a financial instrument that does not appear in other industrialized countries.

One problem with the long-term strategy of home ownership is that the size and cost of owning property has increased while income has stagnated for those working individuals and families who need such long-term loans. Another problem is that banks and lending institutions still have no regulations that prohibit them from using mortgage guarantees in risky financial investments, including derivatives trading, which led to the sub-prime mortgage crisis and, by extension, the financial collapse of the economy. The preservation of this policy goal under the same economic circumstances therefore means a future catastrophe for lenders and borrowers alike. Why finance a 30-year home loan on a mortgage that consumers cannot afford, when it remains a risky investment strategy?

Justice Department to sue BofA over alleged Countrywide mortgage fraud

The news this week for Bank of American keeps getting worse. Today the Justice Department announced it was filing a lawsuit against the bank. The suit alleges that Countrywide Financial, formerly the country’s largest private mortgage lender, generated thousands of fraudulent mortgage loans and then sold them to Fannie Mae and Freddie Mac, the government institutions that underwrites mortgages for millions of American homeowners. The suit further alleges that the practice of streamlining and generating those fake and risky mortgages continued even after Bank of America purchased Countrywide in 2008.

“The fraudulent conduct alleged in today’s complaint was spectacularly brazen in scope,” said Preet Bharara, the United States attorney in Manhattan.

Those transactions became the tipping point of the “subprime” mortgage disaster that led to the Great Recession and the bankruptcy of some of the nation’s largest financial institutions including Countrywide and Lehman Brothers. The Justice Department is seeking $1 billion in damages for the actions of the bank for selling these knowingly “toxic” assets to the Fannie and Freddie, which then became insolvent and required taxpayers bailouts under the TARP program. The financial problems of these two housing lenders also led to thousands of foreclosures on the homes of American families.

The Countrywide case is a new addition to several other lawsuits being pursued by the government against Wall Street firm and financial institutions. For example, last year the Federal Housing Finance Agency sued 17 banks over losses sustained by Fannie Mae and Freddie Mac, and is relentlessly calling on firms like Bank of America to repurchase billions of dollars in the bad loans they fraudulently sold to the government-controlled housing lenders.

Bank of American did not have an immediate comment. The news will be disappointing to its shareholders as it comes in the same week the bank announced that its profits had declined by 95 percent in the third quarter. The new the lawsuit represents yet another obstacle to the financial solvency and longevity of the country’s second largest bank.