Sunday, April 24, 2011

Betty McCollum Shoots the S&P Messenger

An article from the Strib relates:
April 18, 2011 Debt worries turn up heat on Congress to act
"We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013," Standard & Poor's said in a release. "We believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years."
At least one Minnesota Democrat, U.S. Rep. Collin Peterson, said he believed there was still time to avert that outcome.

"Obviously, we've got a mess," Peterson said of Congress' inability to agree on a fix to the nation's debt crisis. "Whether this is the end of the world? My experience has been that these Wall Street announcements may be more for Wall Street. We're not going to default [on bond and other loan payments]."

Rep. Betty McCollum, a Democrat, met S&P's skepticism with some skepticism of her own.

"S&P is a questionable authority since their AAA ratings of mortgage-backed securities helped bring on the financial crisis," she noted.

But Minnesota Rep. Erik Paulsen, a Republican, called the S&P notice a warning for Congress to do something "sooner rather than later."

"Both parties share responsibility in creating this fiscal mess, and we must work together to find long-term solutions to get our fiscal house in order," Paulsen said.

The other representatives had reasonable responses, acknowledging the problem the debt creates, and that Congress needs to act to lower the debt.  However, the best quote the Strib, a noted supporter of CD4's Betty McCollum, could come up with from Congresswoman McCollum was basically "shoot the messenger"! Sounds a lot like the June 28, 2004 letter she signed telling President Bush
In closing, we reiterate that an exclusive emphasis on safety and soundness, without an appropriate balance in focus on the affordable housing mission of the GSEs, is misplaced. Strong safety and soundness regulation and a vigorous affordable housing mission are not only compatible, but will reinforce each other. We ask you to work with us to craft legislation that achieves the proper balance in both areas.

First, the responsibility for oversight of the GSE's belongs with Congress.  Congresswoman McCollum was appointed to the House Committee on Oversight and Government Reform in January 2007.  She was not on the oversight committee in 2005 when Congress was ignoring the impending crisis, but she certainly should have known of the congressional failings by 2007, and the letter above implies she was more intimately involved in it.  There were also many limitations on Standard & Poor's rating of these GSE's and the mortgage backed securities that they packaged up for resale.  Ratings on AIG were lowered in 2005 and would possibly have been lowered on the GSE's except for their connection to the Government.

Second, S&P defines their credit rating as:
Credit ratings are forward-looking opinions about credit risk. Standard & Poor’s credit ratings express the agency’s opinion about the ability and willingness of an issuer, such as a corporation or state or city government, to meet its financial obligations in full and on time.
It is simply an opinion based on analysis of current and past history that is used by investors to evaluate their future risk of investing in a company.  It does not make policy or endeavor to change behavior of the company.  Although lowering a rating may make it more expensive for that company to borrow. It does not "help bring on the financial crisis", the GSE's and lack of appropriate oversight and control by Congress does that.

In 2005 there was testimony about severe problems found at the GSE's.  How was the testimony received by Congress?
Maxine Waters saying "Through nearly a dozen hearings frankly we were trying to fix something that wasn't broke.  Mr Chairman we do not have a crisis at freddie mac and in particular a fannie mae under the outstanding leadership of Mr. Frank Raines"

So what were the other signs of problems with Fannie Mae and Freddie Mac that Congress was overlooking or ignoring for ideological reasons?  These were indications that Congress should have acted, but the progressive mandate, implemented through HUD, was to increase home ownership by poor and moderate income individuals at all costs.  This was the sub-prime market.

Freddie Mac's S&P Report 2006
For fiscal 2005, net income was $2.1 billion, much below the $2.9 billion in net income for 2004. The decline in profitability is primarily due to net fair value losses on derivative not in qualifying hedge accounting relationships, interest expense related to derivatives, and higher cost of funding. Overall, the restated financial results show a greater volatility of earnings due to the GAAP reporting of derivative losses and losses on the guarantee asset for PCs at fair value. These two items significantly lowered GAAP noninterest income for 2005 and 2004. The reading of GAAP earnings does not portray a comparable analysis of core earnings performance given the nonhedge designation of the vast majority of Freddie Mac's derivatives and the fair value changes in the Guarantee Asset and Guarantee Liability. The large jump in GAAP net income in 2001 was due to the large gains on mark-tomarket derivatives that were previously designated hedges under hedge accounting as prescribed by SFAS 133. Going forward, to the extent interest rates change, the asymmetric mark-to-market of derivatives will lead to significant variability of quarterly GAAP earnings, especially in periods of volatile interest rate changes.

Journal of Economic Perspectives—Volume 19, Number 2—Spring 2005—Pages 159–184
Fussing and Fuming over Fannie and Freddie: How Much Smoke, How Much Fire?
W. Scott Frame and Lawrence J. White

In recent testimony before Congress, Federal Reserve Chairman Greenspan
(2004) suggested that Fannie Mae and Freddie Mac may pose “systemic risks” to the
U.S. economy. That is, if one of the companies became financially distressed,
enough harm to the overall financial system could be caused such that a nontrivial
reduction in general economic activity would result.11
Because of their special status, Fannie Mae and Freddie Mac can issue blanket
credit-loss guarantees on an entire pool of loans as well as avoid the costs of having
their securities rated by rating agencies or registered with the Securities and
Exchange Commission. In contrast, private-label mortgage-backed securities often
have a structure that involves creating different levels of seniority of debt, obtaining
securities ratings from rating agencies like Moody’s or Standard & Poor’s and
registering with the Securities and Exchange Commission—all of which involve
transactions costs.

April 07, 2005|By Kathleen Pender
Last week, scandal-plagued American International Group lost its triple-A credit rating, leaving just seven publicly traded companies in the highest possible categories of Standard & Poor's and Moody's Investors Service, the largest rating agencies. They are Automated Data Processing, Berkshire Hathaway, ExxonMobil, General Electric, Johnson & Johnson, Pfizer and United Parcel Service.

Fannie Mae and Freddie Mac, which guarantee home mortgages, are also rated triple-A, but are in a slightly different category because they owe part of their rating to the perception that the federal government wouldn't allow their debt to go unpaid. If they were to sever their connection with the government, like student loan insurer Sallie Mae did, "I think they would lose their AAA ratings," says Sean Egan, managing director with Egan-Jones Ratings Co.

Jun 20, 2006 FreeRepublic
Sen. Richard Shelby of Alabama, the committee's Republican chairman, will schedule a hearing in the next few weeks to collect testimony on Fannie Mae's $11 billion accounting scandal from credit rating agencies and possibly from Fannie Mae board members, said panel spokesman Andrew Gray.

Standard & Poor's and Fitch Ratings both maintained triple-A senior debt ratings and double-A-minus subordinated debt ratings for Fannie Mae last month after the Office of Federal Housing Enterprise Oversight levied a $400 million penalty against the mortgage giant and issued a report revealing an "arrogant and unethical" culture that led Fannie employees to massage earnings to trigger maximum bonuses

Alt A Loans `Disconcerting,' Jumbos Weaker, S&P Says (Update1)
By Jody Shenn - June 26, 2007
June 26 (Bloomberg) -- U.S. homeowners with good credit are increasingly falling behind on mortgage payments, a sign lenders have been offering ``higher risk'' loans outside the so-called subprime market, Standard & Poor's Corp. said today.

Rising late payments and defaults on so-called Alt A mortgages made last year are ``disconcerting'' and delinquent borrowers appear to be ``finding it increasingly difficult to refinance'' or catch up on their payments, S&P analysts said today in a statement. ``Serious'' delinquencies, foreclosures and seized property among ``prime jumbo'' mortgages in bonds from 2006 reached the highest among loans of less than 13 months since at least before 2000, S&P said in a separate report.

Alt A home loans are granted to borrowers with generally good credit scores who opt for unusual loan terms or underwriting standards, such as reduced proof of their pay, without enough offsetting positive attributes.

Word on the Street November 26, 2007, 12:20PM EST
From Standard & Poor's Equity Research
Analyst Actions: Goldman Cuts HSBC to Sell
Plus: Citigroup downgrades some homebuilders and UBS cuts its opinion on Fannie Mae and Freddie Mac
From Standard & Poor's Equity Research
Fannie Mae (FNM) and Freddie Mac (FRE) fall after UBS Financial downgrades both stocks to neutral from buy. UBS analyst Eric Wasserstrom says the downgrades are based on his outlook for EPS compression, deriving primarily from credit pressures; the likelihood of further book value (BV) and/or fair value of net assets (FVNA) erosion, particularly at Freddie Mac; and the likelihood that BV/FVNA multiples remain compressed in the medium term.
Wasserstrom notes although the GSEs may be relieved from their 30% capital surcharges in 2008, that will not mitigate immediate term pressures, especially at Freddie Mac. He says Fannie Mae's challenge will be building reserve levels, while at Freddie Mac the challenge is rebuilding capital levels.

So with so many signs, was it really the messengers who "caused" the problem?  The problems existed, were being reported by the ratings reports, by the federal auditors, and by Allan Greenspan before Congress, but some members of Congress were ignoring the signs because it didn't fit with their progressive goals.  Betty McCollum was in Congress at the time, sending letters to then President Bush to ignore the problems. She should be stepping up to work on reducing the debt, instead of verbally shooting the messengers pointing out our looming debt crisis now!

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