Nocera vs. Wallison: A GSE Debate Skirmish

During the Christmas-New Year holiday weeks a little throw down between the NYT’s Joe Nocera and AEI’s Peter Wallison ensued. I have been neglect in blogging about it until now, but late is better than never.

Privately, Wallison and Nocera have exchanged different points of view for a while now on the role of Fannie and Freddie in the housing bubble and financial crisis stories, but that spilled out onto the pages of the New York Times and AEI’s web publication The American after the SEC brought suit against six former GSE executives. We first covered the lawsuits a month ago, and did a follow up the week after Christmas.

It all started when Nocera took on the SEC case against the GSEs in his December 19th NYT column. He argued that while there are many reasons to dislike Fannie and Freddie—their dual mission that privatized profits and socialized losses, their unforgiving bully mentality to anyone who tried to cross them politically (under the leadership of Jim Johnson), their manipulation of legislation regulating them to be effectively meaningless, and their malinvestments that have cost taxpayers $150 billion and counting—”these real sins have been largely overlooked in favor of imagined ones.” And then he throws down:

Over at the conservative American Enterprise Institute, two resident scholars, Peter Wallison and Edward Pinto, have concocted what has since become a Republican meme: namely, that Fannie Mae and Freddie Mac were ground zero for the entire crisis, leading the private sector off the cliff with their affordable housing mandates and massive subprime holdings.

The truth is the opposite: Fannie and Freddie got into subprime mortgages, with great trepidation, only in 2005 and 2006, and only because they were losing so much market share to Wall Street. Among other things, the Wallison-Pinto case relies on inflated data — Pinto classifies just about anything that is not a 30-year-fixed mortgage as “subprime.” The reality is that Fannie and Freddie followed the private sector off the cliff instead of the other way around.

Nevertheless, Wallison, who was a member of the Financial Crisis Inquiry Commission — charged with investigating the root causes of the crisis — wrote a 99-page dissent when the F.C.I.C. issued its final report, claiming it was all Fannie and Freddie’s fault. In a column I wrote at the time, I described Wallison’s dissent as a “lonely, loony cri de coeur.” He’s been trying to get me to take it back ever since.

On Friday, the Securities and Exchange Commission waded into the Fannie/Freddie wars by filing a lawsuit against three executives from each company. The complaint charges them with making “materially false” disclosures about the size of the companies’ subprime portfolios. […]

The complaint is extraordinarily weak. Taking its cues from the Wallison/Pinto school of inflated data, it claims that Fannie and Freddie failed to reveal to investors the true extent of their subprime portfolios. To make this claim, however, the S.E.C. has included categories of loans, such as so-called Alt-A loans, that may have had a subprime characteristic, such as low documentation, but which were often made to borrowers with high credit scores.

The Nocera column continues to critique the SEC lawsuits, concluding with: “I now concede that [Wallison] is half-right. Loony though his theory may be, he’s sure not lonely anymore.” Wallison then took up the challenge and responded to the Nocera op-ed on The American blog the next day, writing:

But Nocera’s column is full of errors that show he has not—as he claimed—read the complaints. For example, he states that there are “no damning e-mails in the complaint, with executives contradicting their public statements.” No. No e-mails, but the complaint against Freddie has something worse—that, over many years, the firm coded hundreds of billions of dollars in mortgages it was acquiring as “subprime” or “subprime-like,” even though its executives were reporting to the public and investors that their exposure to subprime loans was “less than 1 percent.” As to e-mails, those have already been published in an article by Charles Calomiris in the Wall Street Journal several weeks ago. He quoted from the chief risk officer of Freddie telling the chairman that the loans they were buying were poor quality and would cause losses. But the risk officer was ignored.

Even more seriously, he notes that the complaints didn’t have any “default data.” Leaving aside the question of whether that was necessary to show material misstatements about their subprime exposures, the complaints cite high rates of “serious delinquency,” which is of course a mortgage that is virtually in default, but not yet foreclosed. Since Fannie and Freddie are now insolvent, and have already cost the taxpayers about $150 billion, one would think there would be little argument about whether the loans they held were in fact subprime. But Nocera manages to do so, largely by following the absurd argument—another product of the left-wing echo-chamber—that Fannie and Freddie’s loans were not subprime because others were worse.

Now, in Noceraworld, even the SEC is part of the Wallison/Pinto cabal.

The debate had really just scratched the surface. Four days later, on December 23, Nocera picked up where he left off in his Monday column, and taking on the push back from Wallison. He wrote:

Peter Wallison, a resident scholar at the American Enterprise Institute, and a former member of the Financial Crisis Inquiry Commission, almost single-handedly created the myth that Fannie Mae and Freddie Mac caused the financial crisis. His partner in crime is another A.E.I. scholar, Edward Pinto, who a very long time ago was Fannie’s chief credit officer. Pinto claims that as of June 2008, 27 million “risky” mortgages had been issued — “and a lion’s share was on Fannie and Freddie’s books,” as Wallison wrote recently. Never mind that his definition of “risky” is so all-encompassing that it includes mortgages with extremely low default rates as well as those with default rates nearing 30 percent. These latter mortgages were the ones created by the unholy alliance between subprime lenders and Wall Street. Pinto’s numbers are the Big Lie’s primary data point.

We at Reason would like to think that we’ve helped build the narrative that Fannie and Freddie were core combatants in the financial crisis melee. But Wallison and Pinto have been leaders on the front lines to be sure, and so we wouldn’t want to take away from the Nocera spotlight. After all the nature of Ed Pinto’s research (frequently cited by Wallison) does create a hinge point: the definition of subprime characteristics can be gamed to make a balance sheet look safer than it really is, or to show that losses related to particular mortgages are lower or higher than other classes in order to win a public relations game. Any time I hear the Center for American Progress talk about this, they bring that up. It was even brought up in a Congressional hearing in late-2011 that Ed was not even at. Nocera continued though:

Central to Wallison’s argument is that the government’s effort to encourage homeownership among low- and moderate-income Americans is what led to the crisis. Fannie and Freddie, which were required by law to meet certain “affordable housing mandates,” were the primary instruments of that government policy; their need to meet those mandates, says Wallison, is what caused them to dive so heavily into those “risky” mortgages. And because they were powerful forces in the housing market, their entry into subprime dragged along the rest of the mortgage industry.

But the S.E.C. complaint makes almost no mention of affordable housing mandates. Instead, it charges that the executives were motivated to begin buying subprime mortgages — belatedly, contrary to the Big Lie — because they were trying to reclaim lost market share, and thus maximize their bonuses.

As Karen Petrou, a well-regarded bank analyst, puts it: “The S.E.C.’s facts paint a picture in which it wasn’t high-minded government mandates that did [Fannie and Freddie] wrong, but rather the monomaniacal focus of top management on market share.” As I wrote on Tuesday, Fannie and Freddie, rather than leading the housing industry astray, got into riskier mortgages only after the horse was out of the barn. They were becoming irrelevant in the most profitable segment of the market — subprime. And that they couldn’t abide.

After enjoying a Christmas holiday, Wallison came back with a response at The American, this time sharing a byline with Pinto, and retorted that:

It’s somewhat implausible that two guys at a Washington think-tank, arguing that the financial crisis was caused by government housing policy, could create a widely accepted alternative to the conventional liberal narrative that the financial crisis was caused by the greed and lack of regulation of Wall Street. After all, the conventional narrative was created by the government, propagated by the New York Times, and accepted without question by just about every other major newspaper and electronic mass media outlet, foreign and domestic. Apparently, however, in Noceraworld, threats to the accepted narrative can never be fully suppressed.

After having their fun, Wallison and Pinto went straight to the core of the matter, the data in dispute, and provided a summary of the numbers that have been published in many other places before, but apparently not very well read by Nocera:

Summarized below are the original numbers we relied on, taken from Fannie and Freddie’s own data and from the views of bank regulators—and now supplemented with additional data from the Securities and Exchange Commission’s recent complaints against certain officers of Fannie and Freddie. Of particular interest are Fannie and Freddie’s non-prosecution agreements with the SEC, in which they agree with facts that confirm—and in many cases go beyond—our original research concerning the scope of the GSEs’ subprime and Alt-A exposure. These are facts, and Nocera and others who might wish it otherwise should become familiar with them.

For example, in its non-prosecution agreement Freddie agreed that as of June 30, 2008, it had $244 billion in subprime loans, comprising 14 percent of its credit guaranty portfolio, rather than the $6 billion it had previously disclosed. Freddie also agreed that it had $541 billion in reduced documentation loans alone, vastly more than the $190 billion in previously disclosed Alt-A loans which Freddie had said included loans with reduced documentation.

While the SEC documents about $1.03 trillion in previously undisclosed subprime and Alt-A loans in Fannie and Freddie’s credit guaranty portfolios, an estimated $812.8 billion, or about 80 percent, were already accounted for in the totals of Fannie and Freddie subprime and Alt-A exposures included in Pinto’s Forensic Study and Wallison’s Dissent from the majority report of the Financial Crisis Inquiry Commission.

The SEC findings add $219 billion and 1.43 million loans to our original Fannie and Freddie subprime and Alt-A totals, bringing the combined subprime and Alt-A total to $2.041 trillion and 13.37 million loans.

All told, after adding the SEC’s new data to our original estimates, there were approximately 28 million subprime and Alt-A loans outstanding on June 30, 2008, before the financial crisis, with a value of approximately $4.8 trillion. This was half of all mortgages in the United States. Of these loans, over 74 percent were on the books of U.S. government agencies and firms subject to government housing finance policies. This shows where the demand for these low quality loans came from. Fannie and Freddie were themselves exposed to more than 13 million subprime or Alt-A loans, or 65 percent of the government total.

Wallion and Pinto then add a table showing the values of the subprime and Alt-A loans originally included their published research, supplemented by the data included in the SEC’s complaints and the non-prosecution agreements.

The war is far from settled, but this skirmish certainly helps to frame up where the debate will move in 2012. And the outcome of the SEC case could be a deciding factor in what arguments continue to stand and what falls by the wayside.

(In full disclosure Peter and Ed are friends, and I also liked Nocera’s book All the Devils Are Here—though I think Peter doesn’t give enough credit to non-GSE contributors to the financial crisis and I think Nocera’s book lacked the proper conclusions to the many correct facts he and Bethany McLean pointed out.)

See here for the timeline of events in this skirmish: