Thread by @Ny1david

1. Why have Fannie & Freddie been kept in conservatorship for 15 yrs? Because of demand for GSE "reform" based on an anti-GSE narrative used to distract away from the fatal flaws & institutionalized fraud of private label residential mortgage securitizations. An explainer 🧵

2. First, the business models of GSE securitizations and private label securitizations are antithetical. The GSEs retain and diversify all credit risk; the private label industry does the opposite.

3. The private label industry sells off credit risk, which is *not* diversified in their securitizations, but is instead reallocated and concentrated in the subordinate tranches.

4. This clear dichotomy shows that anyone who conflates GSE securitizations with private label securitizations is ignorant. A lot of Phd economists with highfalutin credentials conflate both business models.

5. Because the private label industry sells off credit risk, it is incentivized to overlook signs of fraud. Half of all private label mortgages had false documentation. papers.ssrn.com/sol3/papers.cf…

6. The GSEs can enforce effective remedies against fraud. They successfully sued 18 banks that sold triple-A private label bonds, all tainted by fraud.

7. Whereas few investors in private label deals, who suffered 10x the losses of the GSEs, have the ability to seek similar redress. The vast majority culpable of fraud got away with it.

8. None of the risks tied to market timing (home prices, interest rates) are diversified in private label deals; the opposite is true of the GSEs' ongoing business operations.

9. Private label deals were never structured to consider the combined impact of both the interest rate cycle and the housing cycle.

10. Private label deals may see interest income wiped out by faster-than-expected refinancings, a non-issue for the GSEs, which keep booking new loans.

11. Lewis Ranieri identified a fatal flaw in private label deals--unfettered refinancings result in unpredictable interest income--in his famous 1994 lecture at Northwestern.

12. Private label deals don't really diversify location risk, because the credit losses are always concentrated in whichever housing market is slumping at the time, & the credit losses are always concentrated in the subordinate tranches.

13. Consequently, a portfolio of different deeply subordinated private label bonds doesn't really diversify risk, which is why we know the premise of all CDOs was bogus, as proved by results.

14. The clear precedent to the 9/2008 meltdown was the subprime collapse in the late 1990s, when *all* the holders of the bottom tranches, different mortgage originators who arranged different deals, saw their equity wiped out.

15. The 1990s subprime collapse occurred when the economy was booming and home prices were rising everywhere. So it was easy to extrapolate the impact when the end housing boom came to an end.

16. Simple math: A 1% tranche (rated BBB) subordinate to 95% of total debt in a 100%-debt capital structure has scant margin for error.

17. Why was there a Wall Street meltdown in September 2008? Because *investment banks* had bulked up on deeply subordinated private label bonds stuffed into CDOs.

18. Best executive summary of the entire September 2008 meltdown? Financiers did not think they would lose money on CDO bonds with bogus triple-A ratings.

19. Again, the 9/2008 meltdown was never about mortgage loans, but about deeply subordinated mortgage *bonds.*

20. Virtually ALL subordinated private label bonds (those originally rated below triple-A) recovered ZERO principal. You can't lose 100% principal in a single mortgage loan.

21. Why did these bonds lose 100% principal? Not because of a market tsunami, but because NONE of these deeply subordinate tranches could withstand a moderate cyclical downturn.

22. The Big Short breakeven proposition was simple: flat home prices wipe out investment grade (BBB) subprime bonds. Since every housing boom had been followed by a multi-year slump, The Big Short was always a sure thing.

23. Losses from subordinated private label bonds, a tiny 2% sliver of the total market, dwarfed the credit losses from all GSE mortgages, which represented almost half the market.

24. An immutable rule: With financial companies, if you don't focus on risk concentrations and diversification and subordination, you are clueless.

25. Which is why those who contend that the GSEs must have been at the center of the crisis, because they financed half of all mortgages, have an overly superficial grasp of the data. (More to come)

26. In every big business scandal, a central cause is not what the crooks did, but what the gatekeepers *didn't* do. Everybody piggybacked off of everybody else's due diligence, which was never done properly in the first place.

27. It requires a *long* explainer (maybe later), but private label bonds were never actively traded. So investors relied on the rating agencies for signals of value.

28. Derivatives are valued according to prices of assets that are both *fungible* & *actively traded*, which are *not* private label bonds (never actively traded) and every tranche of every securitization is unique.

29. It requires a *much longer* explainer, but two inventions--ISDA's pay as you go swaps and the ABX indices--were designed to create an illusory hologram of a private label market.

30. The Markit ABX hologram supported an elaborate pump and dump scheme used to for The Big Short, to temporarily prop up triple-B bonds and synthetic CDOs designed to fail.

31. The rating agencies slow-walked private label downgrades until Hank Paulson forced the issue in 9/2008, which allowed him to pick winners and losers before the November 2008 election.

32. Three 9/2008 events: a) the GSE gov't takeover, b) the Lehman bankruptcy & c) the AIG liquidity crisis/bailout didn't just happen, but were instigated by Hank Paulson & his proxies.

33. From his 9/15/08 press conference onward, Paulson impugned the GSEs, which distracted away from his role at Goldman in selling fatal CDO risk concentrations, especially to AIG, which caused the meltdown.

34. Other apologists for private label fraud mimicked and amplified Paulson's false insinuations about the GSEs.

35. To reiterate: GSE operations had nothing to do with the September 2008 meltdown, which was about the long overdue recognition that CDO bonds were wiped out.

36. Why exempt the GSEs? Because they never had liquidity problems and their bonds always traded close to par. Anyone who says otherwise is misleading.

37. GSE loan performance has always been exponentially superior than the rest of the market. Anyone who says otherwise is a liar.

38. Again, the GSE non-cash accounting "losses" that triggered the government bailout were reversed.

39. Which raises an obvious question to those insist on GSE reform: Reform what? No one can show how to improve upon GSE (pre-takeover) loan performance or liquidity.

40. For over 20 years, GSE regulators have rejected a basic practice, which reconciles original estimates with eventual results, and then adjusts accordingly.

41. To go back and reevaluate the GSE regulators' false claims about an "accounting scandal," or "massive accounting losses," or the justification for the net worth sweep would open a can of worms pointing to malfeasance that implicates many.

42. The 2012 GSE net worth sweep, designed to keep GSE equity at zero, was the regulators' penultimate effort to prevent a reconciliation of original estimates with eventual results.

43. No one has ever given a credible reason for a company in conservatorship to out pay cash dividends. All of the excuses have pandered to financial illiteracy.

44. Though Congress is too polarized to do anything, leaders of the "GSE reform" agenda have tried to resuscitate private label deals by using GSE infrastructure and/or a government guarantee.

45. All of the foregoing requires detailed explainers, (see Brandolini's Law) but the gestalt is necessary for framing the unanswered questions about the 15-year GSE conservatorship.
en.wikipedia.org/wiki/Brandolin…

46.For 16 yrs, the GSEs & most Americans have been victimized by The Big Lie, that affordable housing policy caused the 2008 meltdown. So housing affordability is a now a central concern of most Americans.Freeing the GSEs from a dishonest conservatorship is a good place to start