Larry C. Johnson is CEO and co-founder of BERG Associates, LLC, an international business-consulting firm with expertise combating terrorism and investigating money laundering. Mr. Johnson works with US military commands in scripting terrorism exercises, briefs on terrorist trends, and conducts undercover investigations on counterfeiting, smuggling and money laundering. Mr. Johnson, who worked previously with the Central Intelligence Agency and U.S. State Department's Office of Counter Terrorism, is a recognized expert in the fields of terrorism, aviation security, crisis and risk management. Mr. Johnson has analyzed terrorist incidents for a variety of media including the Jim Lehrer News Hour, National Public Radio, ABC's Nightline, NBC's Today Show, the New York Times, CNN, Fox News, and the BBC. Mr. Johnson has authored several articles for publications, including Security Management Magazine, the New York Times, and The Los Angeles Times. He has lectured on terrorism and aviation security around the world, including the Center for Research and Strategic Studies at the Ecole Polytechnique in Paris, France. He represented the U.S. Government at the July 1996 OSCE Terrorism Conference in Vienna, Austria. From 1989 until October 1993, Larry Johnson served as a Deputy Director in the U.S. State Department's Office of Counter Terrorism. He managed crisis response operations for terrorist incidents throughout the world and he helped organize and direct the US Government's debriefing of US citizens held in Kuwait and Iraq, which provided vital intelligence on Iraqi operations following the 1990 invasion of Kuwait. Mr. Johnson also participated in the investigation of the terrorist bombing of Pan Am 103. Under Mr. Johnson's leadership the U.S. airlines and pilots agreed to match the US Government's two million-dollar reward. From 1985 through September 1989 Mr. Johnson worked for the Central Intelligence Agency. During his distinguished career, he received training in paramilitary operations, worked in the Directorate of Operations, served in the CIA's Operation's Center, and established himself as a prolific analyst in the Directorate of Intelligence. In his final year with the CIA he received two Exceptional Performance Awards. Mr. Johnson is a member of the American Society for Industrial Security. He taught at The American University's School of International Service (1979-1983) while working on a Ph.D. in political science. He has a M.S. degree in Community Development from the University of Missouri (1978), where he also received his B.S. degree in Sociology, graduating Cum Laude and Phi Beta Kappa in 1976.
There is no doubt that the Republican Party shares a significant portion of the blame for the debacle unfolding in the financial markets. But the hands of many Democrats are stained as well. It is noteworthy that Republican Richard Shelby, who chaired the banking committee, only received $38,000 in contributions from Fannie Mae while newbie Senator Barack Obama raked in $90,549. As I have noted before, what in the hell is going on that a junior Senator gets showered with such largesse? And Obama's take from Freddie Mac and Fannie Mae was only slightly less than the $165,000 that Democrat chair of the Banking Committee, Chris Dodd snagged. Hell, Barack got $50,000 more than Senator Hillary Clinton and she had been in the Senate twice as long as Barack.
The one politician who can hold his head high and say, "I told you so" is John McCain. This is not a partisan talking point. It is an incontrovertible fact.
And if you want to compare the inaction of Barack Obama in 2006 with the prescience of John McCain, go ahead. Make my day.
Here are the facts. Verify them for yourself.
Let's start in November 2004, when it became clear that Franklin Raines was in charge when Fannie Mae was lying about its earnings and convincing investors that it was making more money than the facts supported. Peter Eavis described the situation in a column at Street.com:
He made more than $20 million last year and is highly influential in Washington. But right now, no one in their right mind would want to be Fannie Mae (FNM Quote - Cramer on FNM - Stock Picks) CEO Franklin Raines.
The executive has fought a characteristically tenacious battle to protect his job and defend Fannie as allegations of serious accounting missteps have piled up. Even so, Raines could well be gone from the nation's largest mortgage buyer by the end of this year, with his reputation in tatters. Much rests on what happens Monday. . .
His opponents over the past five years have included both the Bush and Clinton administrations, Federal Reserve Chief Alan Greenspan, rival banks and Fannie's own regulator, the Office of Federal Housing Enterprise Oversight, or OFHEO. And don't forget short-sellers, who have long wagered that losses on Fannie's balance sheet will make the company a danger to the U.S. financial system. . . .
That said, if Raines goes, it will almost certainly go hand in hand with a massive restatement of past financial results. This column has estimated that a critical measure of regulatory capital could have been overstated by billions of dollars, and that as much as $12 billion of derivatives losses were kept out of the income statement.
A restatement of that size would almost certainly open the door to far-reaching reforms of Fannie and rival Freddie (FRE Quote - Cramer on FRE - Stock Picks), both of which operate under advantageous government charters. Those reforms could reduce the profitability of Fannie Mae, which has run its huge mortgage portfolio aggressively and become severely undercapitalized in the process.
Remember. This was written almost four years ago. Another warning came two weeks later (November 21, 2004) from Peter Wallison of the American Enterprise Institute, who wrote:
Investors worried about both interest rate and political risks have driven down the shares of the US mortgage groups Fannie Mae and Freddie Mac close to their 52-week lows. Political risk is probably an insoluble problem, but the companies are voluntarily taking on the serious interest rate risk that investors fear.
Unfortunately for US taxpayers, Fannie and Freddie have done the rational thing for companies that the markets regard as being government-backed, just as the savings and loans organisations did in the late 1980s. They have placed the risk of loss on the government, while keeping the gains. Now investors are worried by the political risk that the government's response will be to weaken its implicit backing for the two institutions. Fannie and Freddie were established to add liquidity to the mortgage markets by purchasing mortgages from lenders, thus allowing them to make more residential mortgage loans. For many years after their creation, they simply purchased and held mortgages. In doing so, they took the interest rate risk associated with holding a fixed income asset–a mortgage–while funding it with variable rate liabilities. The S&Ls were ultimately destroyed by a similar mismatch. . . .
So if Fannie and Freddie are not lowering interest rates by purchasing these securities, why are they doing it? The question answers itself. The taxpayers, through the generosity of Congress, have offered Fannie and Freddie a great deal: heads you win; tails we lose. You can take interest rate risk by repurchasing your own mortgage-backed securities; if you earn substantial profits from your government support, you can keep them; if the market moves against you and you suffer losses, we will cover them.
The way to address this situation is to prohibit Fannie and Freddie from holding mortgages or mortgage-backed securities in their portfolios. That would reduce the risks they are taking on the taxpayers' account, but would not significantly affect mortgage rates. With the concern about the risks being taken by Fannie and Freddie, it is worth considering.
Got it? Problem identified and a solution proffered. That is what you call responsible policy wonkism.
A couple of months later, Robert Blumen weighed in at the Mises Economics Blog. Blumen explains the problem with Government Service Enterprises (i.e. GSEs) as follows:
Fannie is primarily a political creature, not a private sector business firm. The company purchases mortgages from banks and then either resells them as mortgage-backed securities with a form of credit insurance, or holds them on its own books. Their role as an intermediary is to assume credit risk for those institutions that wish to assume interest rate risk only. Fannie along with its slightly less evil twin Freddie Mac, were created during the depression as government to purchase mortgages that were in default extend additional credit to home owners. Over time, their intermediary role has become less important relative to their activity as a mortgage investment portfolio. They currently hold more than $1 trillion in mortgages on their own balance sheet.
They were eventually "privatized", but not really. The default risk that Fannie assumes is probably underwritten by the Fed. Although Fannie denies this, they also rely on the perception of the market that their bonds have a similar default risk to US Treasuries, which will always be paid off in the same nominal amount of dollars so long as the Fed can print money. The Greenspan Fed's policy of "too big to fail", and its reckless expansion of credit whenever a large player started to wobble further reinforced the perception that Fannie was an extension of the US Treasury. This gave Fannie an advantage in competing against private firms who have a higher cost of capital. As a result, they have come to dominate that segment of the mortgage market in which they are allowed to participate. . . .
One of the most destructive side effects of the GSE explosion has been their role in the housing bubble. As the buyer of first and last resort of residential mortgages, they enabled banks to recycle their capital into new mortgages. The risk that piles up on Fannie's balance sheet difficult to quantify, but could become a huge liability when the credit expansion reaches its inherent limits. Their mortgage-backed securities have been a favorite asset class of foreign institutions and central banks in their accumulation of US$-denominated debt.
By funneling domestic and foreign credit into residential real estate, they have created a variant of the mal-investment that Mises first identified in his business cycle theory. Mises noted that the extension of bank credit to producers would result in a form of mal-investment from the creationg of more higher order capital goods than could be afforded given the amout of available savings. The GSEs enable credit expansion to fund the construction of residential real estate, while the socialization of risk defeats the markets' mechanism for containing credit which would occur naturally if private parties were required to bear the risk. The result is an over-consumption of housing, a mal-investment in home building and mortage-brokering, and the creation of the liability associated with the interest-rate and default risk of the mortgage credit.
This problem was clearly identified in early 2005. The Bush Administration did nothing. The Republican controlled Congress did nothing. The Democrats, although in the minority, did nothing. Four Republicans stood up. Most had the reputation for being mavericks and out of step with the Bush Administration. The four? Chuck Hagel, Elizabeth Dole, John Sununu, and John McCain. The bill, was introduced on 26 January 2005:
Federal Housing Enterprise Regulatory Reform Act of 2005 - Amends the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 to establish: (1) in lieu of the Office of Federal Housing Enterprise Oversight of the Department of Housing and Urban Development (HUD), an independent Federal Housing Enterprise Regulatory Agency which shall have authority over the Federal Home Loan Bank Finance Corporation, the Federal Home Loan Banks, the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac); and (2) the Federal Housing Enterprise Board.
Sets forth operating, administrative, and regulatory provisions of the Agency, including provisions respecting: (1) assessment authority; (2) authority to limit nonmission-related assets; (3) minimum and critical capital levels; (4) risk-based capital test; (5) capital classifications and undercapitalized enterprises; (6) enforcement actions and penalties; (7) golden parachutes; and (8) reporting.
Amends the Federal Home Loan Bank Act to establish the Federal Home Loan Bank Finance Corporation. Transfers the functions of the Office of Finance of the Federal Home Loan Banks to such Corporation.
Excludes the Federal Home Loan Banks from certain securities reporting requirements.
Abolishes the Federal Housing Finance Board.
John McCain spoke a year later, 25 May 2006, in favor of this bill. Not a single Democrat added their name to the bill. McCain was out of step with his party and with the Congress, but his words were prophetic:
Mr. President, this week Fannie Mae's regulator reported that the company's quarterly reports of profit growth over the past few years were "illusions deliberately and systematically created" by the company's senior management, which resulted in a $10.6 billion accounting scandal.
The Office of Federal Housing Enterprise Oversight's report goes on to say that Fannie Mae employees deliberately and intentionally manipulated financial reports to hit earnings targets in order to trigger bonuses for senior executives. In the case of Franklin Raines, Fannie Mae's former chief executive officer, OFHEO's report shows that over half of Mr. Raines' compensation for the 6 years through 2003 was directly tied to meeting earnings targets. The report of financial misconduct at Fannie Mae echoes the deeply troubling $5 billion profit restatement at Freddie Mac.
The OFHEO report also states that Fannie Mae used its political power to lobby Congress in an effort to interfere with the regulator's examination of the company's accounting problems. This report comes some weeks after Freddie Mac paid a record $3.8 million fine in a settlement with the Federal Election Commission and restated lobbying disclosure reports from 2004 to 2005. These are entities that have demonstrated over and over again that they are deeply in need of reform.
For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac–known as Government-sponsored entities or GSEs–and the sheer magnitude of these companies and the role they play in the housing market. OFHEO's report this week does nothing to ease these concerns. In fact, the report does quite the contrary. OFHEO's report solidifies my view that the GSEs need to be reformed without delay.
I join as a cosponsor of the Federal Housing Enterprise Regulatory Reform Act of 2005, S. 190, to underscore my support for quick passage of GSE regulatory reform legislation. If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.
I urge my colleagues to support swift action on this GSE reform legislation.
I defy you to find Barack Obama acting with foresight or wisdom on this matter. He was too busy figuring out how to run for President. He could not find the time to reach across the aisle and lend his prestige to this matter. He was not the only Democrat absent on the Senate side.
Fair is fair and right is right. No matter what you might think of John McCain and his politics, on this matter he was a leader, a maverick, and ahead of his time. The same can be said of Chuck Hagel, John Sununu, and Elizabeth Dole. Everyone else, Republican and Democrat in the Senate, asleep at the switch. This is fact, not spin.
Finally, I would recommend you read the report prepared in April 2006 by Robert Eisenbeis, W. Scott Frame, and Larry D. Wall, An Analysis of the Systemic Risks Posed by Fannie Mae and freddie Mac and an Evaluation of the Policy Options for Reducing those Risks. Someone in McCain's office was paying attention. We cannot say we were not warned. We were warned, we just did not want to listen.