The Wall Street Journal had a very disturbing story on Wednesday about the “Fast and Easy” loan program of Countrywide Financial Corporation, many of whose mortgages were bought up by Fannie Mae.
Some of the problems are surfacing in a mortgage program called “Fast and Easy,” in which borrowers were asked to provide little or no documentation of their finances, according to [people with knowledge of a Federal probe] and to former Countrywide employees…. Fast and Easy borrowers aren’t required to produce pay stubs or tax forms to substantiate their claimed earnings. In many cases, Countrywide didn’t even require loan officers to verify employment, according to an October 2006 presentation by Countrywide’s consumer-lending division. That left the program vulnerable to abuse by Countrywide loan officers and outside mortgage brokers seeking loans for customers who might have been turned away if their finances had been more closely scrutinized, according to three current and former Countrywide senior executives and to several mortgage brokers who arranged loans through the program.
But here’s the part that really scared me:
Both Countrywide and Fannie Mae, the government-sponsored company that bought many of the loans, classify the loans as “prime,” meaning low-risk…. A Fannie spokesman agreed that the verification of employment wasn’t required on all loans, but added that Countrywide was expected to verify employment details on a “sampling” of loans. The Countrywide spokesman said his company fulfilled that obligation.
It’s news to me that Fannie was buying no-doc loans and calling them prime. I presume that if the WSJ article is correct as to the magnitude of fraud, Fannie would have a case in trying to recover any losses by suing Countrywide. But if Countrywide goes bankrupt, that plus a few dollars will get you a cup of coffee. Or perhaps we hope our Fannie is covered by credit default swaps that are supposed to pay if these loans default. Unfortunately, it doesn’t require much imagination to conjecture a scenario in which the counterparty to those CDS also lacks the resources to make good on their promises. So who’s holding the bag here?
From page 102 of Fannie’s 2007 Annual Report, as of the end of 2007, the enterprise had leveraged $44 B in stockholders’ equity with $796 B in short- and long-term debt to acquire $761 B in mortgages either held outright or intended for resale or trading. I read that as an equity cushion against a 5.8% loss on the mortgages held directly (44/761 = 0.058). But in addition (page 1), Fannie has guaranteed $2.1 trillion in separate mortgage-backed securities it has sold to outside investors, for a ratio of core capital to total book of business of 1.6%.
From the beginning, my conception of a really big financial meltdown would be one that pulls one of the GSEs into insolvency. Please tell me why it can’t happen.