Fannie and Freddie Suit: Why the Feds Can't Go for the Jugular

The U.S. government wants its money back, reports the NYT:

The federal agency that oversees the mortgage giants Fannie Mae and Freddie Mac is set to file suits against more than a dozen big banks, accusing them of misrepresenting the quality of mortgage securities they assembled and sold at the height of the housing bubble, and seeking billions of dollars in compensation.

The litigation, expected out next week, isn't coming out of left field. The FHFA has been building the case for at least a year. The agency's first salvo came in July, when it charged UBS with lying about mortgage-backed securities it sold to Fannie and Freddie between 2005 and 2007. The feds are acting now against other banks to beat a statutory deadline for legal action.

Why start with the Swiss? Perhaps because UBS is a softer target than other Wall Street firms, ZeroHedge speculated. The bank earlier this year agreed to pay up to settle government allegations that it rigged bids for municipal bonds, and in 2009 it shelled out $780 million after getting busted helping American clients dodge taxes. It's like a promising boxer who starts with lesser opponents before tangling with the top fighters.

The FHFA's suit against UBS over the mortgage losses now gives the feds a template for going after bigger prey. And while private investors that are suing big banks are demanding that the firms repurchase the original loans, the government wants to be compensated for the financial hit the so-called government-sponsored enterprises took on mortgage-backed securities.

TBTF reflux
There is one eensy-weensy problem: too big to fail. To date, the government has proceeded very gingerly in holding big financial institutions accountable for their part in the housing crash. The Obama administration recently went so far as to squash New York attorney general Eric Schneiderman in his efforts to investigate Wall Street firms over their loan servicing and foreclosure practices.

The White House and U.S. Treasury chief Tim Geithner are worried that aggressive government prosecution could result in huge financial losses for the banks, throwing an already weakened company like B of A into an irreversible slide and, more broadlly, undermining the economic recovery.

The first fear is warranted, the second misplaced. Given that the housing agency is seeking $900 million in damages from UBS, the suits targeting the other banks could run into the tens of billions of dollars, or more, and could well tip vulnerable firms over the edge. Not surprisingly, bank stocks were slammed this morning on news of the FHFA's move (and also because of the crummy job numbers, presumably).

But the White House has it backwards. Troubled "too big to fail" financial institutions like B of A aren't a pillar of the economy -- they're a bomb. The sooner they're defused, the better. Unfortunately, whatever vigor the feds show in pushing big banks to repay taxpayers (we own Fannie and Freddie, let's not forget) for mortgage-related losses will be tempered by the government's urge to keep the banks alive.

Let's hope Obama recalls that the financial reform law he signed last year gives federal regulators the authority and the tools to seize these companies. After all, Fannie and Freddie were also once too big to fail. The government didn't hesitate to seize them.

Image by Ramy Majouji via Wikimedia Commons, CC 2.5
Related:

• Fannie Mae and Freddie Mac: How Politics, Wall Street Could Torch Housing Reform
• Moral Hazard: Why Handing Fannie and Freddie to Wall Street Is a Lousy Idea
• The Sting: How UBS Conned Millions of American Taxpayers
• Smoking Loans Prove Wall Street Committed Fraud
• Three's Company: How Fannie, Freddie and the Feds Stoked the Housing Bubble