Hey, guess what? Two CEOs really are to blame, or so the SEC told us today. Doubtless stung by relentless criticism that no one has been seriously sanctioned for the systemic debacle, the SEC named ousted Fannie and Freddie CEOs in a damning civil enforcement action. If pushed to find someone for the hang-‘em-high treatment, the SEC couldn’t have done better than the GSEs, given the opprobrium now attendant to these behemoths. There’s a lot in the filing that gives one more than pause – Freddie’s CEO said the GSE had essentially no subprime risk even as it mounted to $244 billion. That’s like missing one of the nation’s largest banks in your organization chart – more than a bit of a boo-boo both for the GSE and its ostensible prudential regulator. But, does the SEC case tell us anything about the policy factors that drove the GSEs into the ditch? We think it does, with important implications for forthcoming Congressional action.

Since the GSEs blew up, advocates have asserted that the poison that killed Fannie and Freddie is the government’s mandate that the GSEs meet an affordable-housing mission. This, it is said, forced Fannie and Freddie to do things management would otherwise have foresworn. Thus, it is concluded, the government killed off the GSEs. And, from this, it is further concluded that the government should never regulate financial institutions, at least as far as anything that might smack of a policy goal.

However, the facts asserted by the SEC tell a far different tale. There is only one brief mention of the affordable-housing goals, and it’s just quoting Dan Mudd saying that subprime bookings met them. The SEC’s facts paint a picture in which it wasn’t high-minded government mandates that did the GSEs wrong, but rather the monomaniacal focus of top management on marketshare. With marketshare came bonuses and with bonuses came risk-taking, understood or not.

Did the GSEs in fact know what they were about when they bet the ranch on subprime mortgages? We were skeptical of the GSEs’ claims at the time that neither Fannie nor Freddie had much at risk when they bellied big-time up to the subprime bar. Clients will recall that we questioned the risk-free descriptions of the GSEs’ books of expanded-approval and alt-A loans, starting in 2005. But, this was based on gut instinct, not data. The GSEs and their regulator had or should have had the data and, now revealed by the SEC, they are damning. Instinct was optional, since the GSEs were sitting on big, big books of high, high-risk paper they should have known were there and any examiner should have spotted.

How did this happen? There’s a lot in the SEC filing that speaks to profound failures to take care, let alone exercise fiduciary duty. Case in point: both GSEs abrogated their underwriting responsibilities to Countrywide, buying bigger and bigger books of worse and worse loans to keep the nation’s largest lender happy. The SEC doesn’t say so, but this created a vicious cycle, in which the GSEs bought whatever Countrywide fed them so Countrywide fed them more to get richer and the GSEs bought still more to get still bigger. And, the more Countrywide bought garbage loans to feed Fannie and Freddie, the more mortgage brokers duped the innocent into loans no one could have originated had underwriting standards been held to the laugh test, let alone prudential requirements.

Nothing in the Countrywide findings or any of the others in the SEC’s filing breathes a word about the need to shovel this stuff to keep the regulators at bay. Instead, there is a carefully-drawn case that links sins of omission and commission to the cause of compensation. The courts will decide if the GSE defendants did what they are alleged to have done for the money. However, the SEC has already settled the policy dispute: the GSEs didn’t do it because they cared so much about the affordable-housing goals that, pressed by their regulator, they threw caution to the winds. They threw caution to the winds instead because they got paid better each time a breeze blew by.

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