Reckless Endangerment

Undermining the ability of regulatory institutions to function independently may spell financial Armageddon

By Shamindra Kulamannage.

Published on October 25, 2012 with No Comments

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America’s mortgage crisis and the global catastrophe that it sparked offer a number of lessons for emerging markets too. Journalist Gretchen Morgenson and consultant Joshua Rosner’s bestseller ‘Reckless Endangerment’ gives a no holds barred view about the incidents that lead to the breakdown of crucial regulations behind the unchecked growth in predatory lending to people who could not afford to buy houses.

Although not involving mortgages, Sri Lanka is in the middle of a similar crisis, surrounding the stock market and the undermining or breakdown of governing regulations. Reckless Endangerment chronicles how the state-sponsored Federal National Mortgage Association, or Fannie Mae, was set up to expand the secondary mortgage market by securitizing mortgages. Lenders who generate mortgages would essentially package them and sell them to Fannie Mae and grant more home mortgage loans from those receipts. It was a fine model until Fannie’s Chief Executive in the 1990’s James Johnson perverted the cause of home ownership to build the firm’s political influence on the Hill and enrich fellow executives and himself.

The similarities on how Fannie Mae went about undermining the system for its own gain has shocking similarities to the stock market crisis in Sri Lanka. Firstly chief executive Johnson built a nexus of power among legislators by spending over $100 million on lobbying, campaign contributions and arranging sweetheart mortgage deals for lawmakers. A similarly powerful mafia, analysts say, have built a powerful nexus among policymakers and regulators here which is attempting to undermine stock market so that share prices can be manipulated. For instance shares of new market entrant George Stuart Finance PLC rose over 400% percent within days of being listed for no apparent reason. Although GS Finance’s business is small, it is now among the top 20 most valuable listed firms, perhaps indicative according to analysts that its share price is being manipulated.

Fannie Mae, though a publicly traded company since 1968, under CEO Johnson funded charities influencing politicians about housing needs of marginalized communities or ethnic groups, fooling them to urge lawmakers to maintain the implicit guarantee it enjoyed. When the subprime mortgage crisis exploded, taxpayers had to bail Fannie Mae and Freddie Mac, its much smaller cousin, which has so far cost American taxpayers $150 billion and the bill is expected to nearly double when the whole mess is sorted.  When the CSE bubble popped last year, mostly retail investors and some greedy highly leveraged traders lost money. Now analysts say those traders who have expensive loans to settle want to push the market up, so they can sell to some unsuspecting investor.

Secondly Fannie Mae and its backers in a shocking series of events neutralized its regulators, by getting charities and lawmakers to block attempts at greater oversight and raising its minimum capital requirement. Finally Johnson established partnerships with mortgage lenders he knew were predatory to feed the agencies appetite, similar to some brokers and investment advisors here who allow unsophisticated clients to load up on speculative stocks because it brings them high fees; in the short term.

However a decade after Johnson’s exit from the firm the issues that caused the crisis remain unresolved. US Senators Chris Dodd and Barney Franks didn’t even mention the need for better oversight of Fannie Mae when they sponsored a massive financial reform bill passed in 2010. How could they when they had secured sweetheart mortgages and campaign funding from Fannie. But perhaps American tax payers can afford to bail out Fannie Mae for $150 billion, the question is when the final bill arrives, including, lost credibility and savings of investors, can the $55 billion Sri Lankan economy afford it.

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