Sense on Cents

Chris Cox’s tenure as chair of the SEC was not highly regarded. From the debacle with the Bernie Madoff situation, to the failure of Lehman Bros., to the fraud encompassing Auction Rate Securities, the SEC under Cox was reduced to a kangaroo court. Knowing full well that he and his regime at the SEC would largely be held in contempt, it appears that Cox attempted to salvage some degree of respect as he prepared to depart. How so? Bloomberg reports Cox Questioned Fannie, Freddie Oversight While At SEC:

Christopher Cox, in one of his last acts as Securities and Exchange Commission chairman, took Fannie Mae and Freddie Mac’s regulator to task in a letter questioning whether the agency was upholding its legal duty to “preserve and conserve” the mortgage companies’ assets.

Cox asked in the Jan. 16 letter to Federal Housing Finance Agency Director James Lockhart whether the government-sponsored enterprises were being pressed too hard to bolster U.S. housing markets at the expense of profits. As a member of an oversight board advising Lockhart, Cox urged Lockhart to develop an “exit strategy” from government conservatorship that would restore the companies’ finances.

Cox’s questioning of the motivation and practices of the FHFA eerily reminds us of the pressures applied to Freddie Mac CFO David Kellerman prior to his taking his life. Clearly, Cox and Kellerman were uncomfortable in the approach and practices promoted by Uncle Sam. As The New York Times reported on April 22, 2009, Reported Suicide is Latest Shock at Freddie Mac:

Mr. Kellermann was also working in a poisonous political atmosphere. In addition to taking criticism over the bonuses, he was recently involved in tense conversations with the company’s federal regulator over its routine financial disclosures, according to people close to those discussions who also spoke on condition of anonymity. Freddie Mac executives wanted to emphasize to investors that they believed the company was being run to benefit the government, rather than shareholders. The company’s regulator, the Federal Housing Finance Authority, had pushed to play down that language. Freddie Mac reported to the Securities and Exchange Commission that changes it had made in practices to help the government “have increased our expenses or caused us to forgo revenue opportunities.”

In a very similar fashion, Bloomberg today reports:

The letter from Cox, which hasn’t been made public, underscores the tension between Fannie Mae and Freddie Mac’s responsibilities to investors and government demands that they help end the worst housing crisis since the Great Depression. The issues facing the companies, saddled with seven consecutive quarters of losses totaling $150 billion, will be examined by a House panel tomorrow.

Certainly both Cox and Kellerman felt seriously troubled and conflicted between their roles and responsibilities and the goals of the government programs. The government programs have amounted to a massive redistribution of wealth to select American homeowners from investors, with the ultimate burden being assumed by American taxpayers.

Cox is trying to defend what is left of his reputation by shedding light on the magnitude of the “red sea” of embedded losses at Freddie and Fannie. Over and above that, the systemic risk posed by Freddie and Fannie has very real risk for other quasi-government agencies. Bloomberg addresses all of the possible consequences:

Failure to make Fannie Mae and Freddie Mac financially sound would impose expanded burdens on the Treasury and private debt markets because their $1.7 trillion in unsecured debt and $4 trillion in mortgage bonds are so widely held, he said. The government would bear responsibility even though the companies’ liabilities aren’t technically backed by its full faith and credit, he wrote.

The U.S. may be forced to assume the companies’ liabilities, increasing the $11.3 trillion in outstanding U.S. debt by about 50 percent and hampering the Treasury’s ability to borrow, Cox said.

If the government chose not to back Fannie Mae and Freddie Mac’s debt and they defaulted, Cox said there may be “significant impact on both the Treasury market as well as the agency market, including the Federal Home Loan Banks, the Farm Credit System and the Tennessee Valley Authority.

While Chris Cox has now been relegated to a punching bag in the pursuit of regulatory reform, he should be commended for drawing attention to the ugly underside of our financial system embodied by Freddie, Fannie, and their cousins FHLB, FCS, and TVA.

LD