Moral hazard

OK, Maybe Poor People Are the Problem

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Commenter Voltaire may not agree with what I had to say on the topic of scapegoating poor home buyers over the weekend, but he raises a jumbo conforming question: Could the not-as-bad-as-advertised performance of subprime loans (relative to prime loans) be explained by fraud in Fannie Mae's accounting of prime loans?

My reason for not agreeing with Tim Cavanaugh's post is that apparently, since 1993, Fannie Mae and Freddie Mac have been increasingly systematically reporting as prime loans loans that were in fact subprime. It was the corruption of these GSE's that makes any statistical claims of the sort [Stan J.] Liebowitz makes suspect from the beginning.

I will gladly mail my keys in Tuesday for a house today.

The gist: Edward Pinto, a consultant who worked as chief credit officer at Fannie Mae during the Reagan Administration, is publicizing an enormous post-1992 increase in Community Reinvesmtent Act-guaranteed loan volume. Here's The Wall Street Journal explaining how Pinto… 

found that from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A.

In general, a subprime mortgage refers to the credit of the borrower. A FICO score of less than 660 is the dividing line between prime and subprime, but Fannie and Freddie were reporting these mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a third-quarter 10-Q report in 2008.

An Alt-A mortgage is one in which the quality of the mortgage or the underwriting was deficient; it might lack adequate documentation, have a low or no down payment, or in some other way be more likely than a prime mortgage to default. Fannie and Freddie were also reporting these mortgages as prime, according to Mr. Pinto.

It is easy to see how this misrepresentation was a principal cause of the financial crisis.

I'm not sure where that admission is in Fannie's third quarter 10-Q for 2008 [pdf], unless it's this reference:

Net investment losses were $1.6 billion in the quarter, compared with losses of $883 million in the second quarter. The third-quarter loss was driven by other-than-temporary impairments of $1.8 billion recorded primarily on private-label securities back by Alt-A and subprime mortgages, and reflected a reduction in expected cash flows for a portion of our private-label securities portfolio.

Anyway, Pinto claims about 19 million loans listed as prime in the GSEs' portfolio are actually high-risk, Option ARM, Alt-A and other junk. You can read him on the miscategorization of subprime loans at Slide 21 here, and you can watch him present his thesis at the Cato Institute's Apparatchik Fashion Show here.

I would not go to court on this evidence, but it's pretty intriguing. Pinto's broken-out numbers do not make a strong case for the CRA as the primary culprit in this Murder On the Orient Express plot wherein (spoiler) everybody is guilty. (If you want to read a very unpersuasive exoneration of the CRA by BusinessWeek's Aaron Pressman, here it is.) However, it would either shake or restore your confidence in Fannie's million-dollar men if there turned out to be this much bad medicine hidden in the mortgage giant's boot.

But what of poor Stan Liebowitz, whom we left arguing that mortgage resets, not borrowers' apparent quality, shaped the collapse? Liebowitz drew his data from the Mortgage Bankers Association, a private group of good reputation that, I hope, would not just gobble up whatever lies and propaganda the government gives out. Stay tuned.

And since the original had a cool clip, the rebuttal gets one too: