How Fannie Mae Lost Sight of Original Mission

The End Of A Prosperous Era

If you are a baseball aficionado, you know what the blog title means. If you're not, you still get a clue because the whole wide world knows that Fannie Mae has a very bad reputation, at present. The nickname is derived from pronouncing the acronym for the defamed Federal National Mortgage Association (FNMA).

My guess is that more Americans have learned how detrimental Fannie Mae has been than realize what a profitable investment environment the company created, along with Government National Mortgage Association (GNMA), from 1980 to the late 1990s.

As recently as just ten years ago, small investors could play the same game as investment banks and other institutions and earn 7% to 8% on their money. In an IRA account, that return on investment practically translates into a virtual windfall! Inside a tax-sheltered account, or out, mortgage-backed securities (MBS) out performed many stocks over a ten year period, thanks to falling interest rates.

Best Idea Since IRA

There was nothing wrong with the concept - buying mortgages from lenders and reselling the paper to another market with the security of knowing a government sanctioned agency would guarantee the deal - as long as home owners had good credit and market makers didn't let the game get out of hand.

In my view, the industry had a firm grip on the mortgage market by the time the Collateralized Mortgage Obligation (CMO) came on the scene. I worked for one of the most conservative investment firms in the country at that time, and I was thoroughly trained to understand the structure of CMOs and to whom I should offer these securitites.

I knew, for example, that mortgage bonds were good for the bond market and expecially beneficial to investors seeking a fixed income. Meanwhile, it was no secret that derivatives of this sort could be volatile if interest rates changed directions. I could also see a subtle influx of lower rated (less credit worthy) paper mixed in with the good paper as new players entered the market. However, that did not mean investors were exposed to impending risk.

I owe my perspective on the bond market to the exposure I received in the industry as well as a keen ambition to spend time on critical research. Slowly, but surely, I began to suspect a laxity on the part of market makers and leadership on Wall Street. Negative news began to proliferate throughout the equity and credit markets as their connection to the failing housing market became more pronounced.

Race For The Money

Looking back in 20-20 hindsight, investors all around can see where the "untouchables", Fannie and Freddie, were peddling high stakes to powerful entities in Congress and corporate America. If you start to be that the cash flow from poor credit sources can sustain liquidity, you have to be operating on the principles of self-interest and greed.

This travesty reminds me of the maleficence that evolved in the junk bond market during the mid-1980s. The same underlying forces prevailed in those days, fueled by greed, driving a good idea for corporate America far beyond the point of no return. Part of this scenario is depected in my recent novel, "Stock Power".

Fortunately, the junk bond market was revived and is alive and reasonably efficient today. Unfortunately,we are faced with an economy infested with bad loans, and a viable remedy for the housing market appears to be years down the road. It amazes me that, a little over a month ago, in the first week of September 2008, Herbert M. Allison, Jr., CEO of Fannie Mae testified before Congress, affirming the company's commitment to ethical practices.

"The government's actions have given Fannie Mae the responsibility and the flexibility to expand our service to the market and provide more liquidity," Allison said. "Under this conservatorship our job is to balance the needs of safety and soundness and taxpayer protection with the imperative that we provide the most support possible to the mortgage market. We are acutely aware of our public purpose."

Mr. Allison was named chief of Fannie Mae after rising to the position of Chief Operating Officer at Merrill Lynch in a period of 30 years. Although his testimony to Congress has the tenor most investors want to hear, Wall Street suffered significant declines in values since then. It is this writer's guess that more confidence will be lost around the globe until an intelligent commission (including mentors from academia), assigned to the conservation of the U.S. economy, is established. Obviously, bi-partisan cooperation from Congress will be critical toward achieving long-term restoration.

Prayer won't hurt right about now.

Hudster