Financial Crisis Inquiry Report by National Commission on the Causes of the Financial & Economic Crisis in the United States

Author:National Commission on the Causes of the Financial & Economic Crisis in the United States [Commission, The Financial Crisis Inquiry]
Language: eng
Format: epub
Publisher: United States Government Printing Office
Published: 2011-06-15T16:00:00+00:00

“THE IDEA STRIKES ME AS PERVERSE”

Regulators at OFHEO and the Treasury huddled with GSE executives to discuss lowering capital requirements if the GSEs would raise more capital. “The entire mortgage market was at risk,” Lockhart told the FCIC.29 The pushing and tugging continued. Paulson told the FCIC that personal commitments from Mudd and Freddie Mac CEO Richard Syron to raise capital cinched the deal.30 Just days earlier, on March 13, Syron had announced in a quarterly call to investors that his company would not raise new capital. Fannie and Freddie executives prepared a draft press release before a discussion with Lockhart and Steel. It announced a reduction in the capital surcharge from 30% to 20%. Lockhart was not pleased; the draft lacked a commitment to raise additional capital, stating instead that the GSEs planned to raise it “over time as needed.”31 It looked as if the GSEs were making the deal with their fingers crossed. In an email to Steel and the CEOs of both entities, Lockhart wrote: “The idea strikes me as perverse, and I assume it would seem perverse to the markets that a regulator would agree to allow a regulatee to increase its very high mortgage credit risk leverage (not to mention increasing interest rate risk) without any new capital.” The initial negotiations had the GSEs raising $2 of capital for each $1 of reduction in the surplus. Lockhart wrote in frustration, “We seem to have gone from 2 to 1 right through 1 to 1 to now 0 to 1.”32

Despite Lockhart’s reservations, OFHEO announced the deal, unaltered in any material way, on March 19. OFHEO agreed to ease the capital restraint from 30% to 20%; Fannie and Freddie pledged to “begin the process to raise significant capital,” giving no concrete commitment.33 Paulson told the FCIC that the agreement, which included a promise to raise capital, was “a no-brainer,” and that he had no memory of Lockhart ever having called it “perverse.”34

The market analyst Joshua Rosner panned the deal. “We view any reduction [in capital] as a comment not only on the GSEs but on the burgeoning panic in Washington,” he wrote. “If this action results in the destabilizing of the GSEs, OFHEO will go from being the only regulator that prevented its charges from getting into trouble, to a textbook example of why regulators should be shielded from outside political pressure.”35

Fannie would keep its promise by raising $7.4 billion in preferred stock. Freddie reneged. Executive Vice President Donald Bisenius offered two reasons why, in hindsight, Fannie Mae did not raise additional capital. First was protecting the assets of existing shareholders. “I’m sure [Fannie’s] investors are not very happy,” Bisenius told the FCIC. “Part two is . . . if you actually fundamentally believe you have enough capital to withstand even a fairly significant downturn in house prices, you wouldn’t raise capital.”36

Similarly, CEO Syron spoke of the downside of raising capital on August 6, 2008: “Raising a lot more capital at these kinds of prices could be quite dilutive to our shareholders, so we have to balance the interest of our shareholders.

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