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Why Freddie Mac let down its guard, let us down

By STEVEN PEARLSTEIN, Washington Post
Published December 12, 2007


It will take years to determine who bears primary responsibility for the mortgage mess. But a piece of the puzzle fell into place last week with a story by the Washington Post's David Hilzenrath about Freddie Mac's decision in 2005 to begin dealing in a significant way with "piggyback" loans that effectively allowed homeowners to borrow more than 80 percent of a property's value - the limit set by Freddie's congressional charter.

The reason for the 80 percent rule was to limit the risk of the government-chartered corporation by ensuring it would have enough collateral in the property in the event that home prices fell. But that approach apparently went out the window when Freddie's private-sector competitors began selling packages of loans up to 100 percent of a property's value.

"I think that what happened over time is we found that our own caution was making us less and less relevant, and we weren't sure, quite frankly, that our competitors (on Wall Street) were being crazy," explained Anthony "Buddy" Piszel, Freddie's chief financial officer. "Could we have run for the hills and said we're not going to do any of that? What if things didn't go down? We would basically be just taking our whole future and giving it away."

Given the continuing concern of regulators and Congress about Freddie's safety and soundness, you would think the chief financial officer could come up with a better excuse than "all the other kids were doing it." It reflects not only an appalling lack of business judgment but a misunderstanding of Freddie's mission as a government-sponsored, privately owned housing finance enterprise - a mission that does not include protecting market share at any cost.

Equally disturbing is the fact that Freddie's regulator, the Office of Federal Housing Enterprise Oversight, apparently sat on its hands when competitors in the mortgage insurance business brought all this to its attention.

There's now a dandy debate on Wall Street about whether an investment bank should continue creating and selling mortgage-backed securities after its trading desk has begun to advise hedge funds and other big clients to stay away from them or begun placing big bets of its own that the market is headed for a fall.

That's what happened last year and this year at Goldman Sachs, Deutsche Bank and Lehman Brothers.

In its defense, the industry argues that banks were merely responding to the demand of sophisticated investors for mortgage products whose risks were fully disclosed. It makes sense in a weird, Wall Street sort of way.

But unless I'm missing something, it means when you see the name Goldman Sachs or Lehman Brothers, it may not be the financial seal of approval that investors and issuers have always assumed, and for which they have always been willing to pay those premium fees.