Freddie Mac’s ’Omniscient Gnomes’ Led the Company Astray
For me, a magazine advertisement in 1984 explains where it all went wrong. In a bizarre ad in the American Bankers Association journal, the chief financial officer of Freddie Mac, Leland Brendsel, appears to be consulting with gnomes on how to oversee America’s mortgage- backed securities markets.
According to the advertisement, “the gnomes of the secondary market, our omniscient associates” had brought the secret of securitization to Freddie Mac, the government- sponsored housing-finance company. Although clearly the result of an advertiser pulling an all-nighter, the gnomes reflected the supernatural aura of the collateralized mortgage obligation, which seemed to violate the rules of nature. Even to bankers, the system was mysterious. Yet its history was entirely conventional.
Financial markets require invention, and usually help from the federal government. In the Emergency Home Finance Act of 1970, Congress authorized the creation of the Federal Home Loan Mortgage Corporation, or Freddie Mac. Almost immediately, Freddie began to offer mortgage-backed securities, which had only been reauthorized for Fannie Mae, Freddie’s sister company, in 1968. Mortgage-backed securities and their predecessor, the participation certificate, had been absent from American finance since the 1930s, when the market for them collapsed during the Great Depression. State laws forbade the sale of such instruments, but their fate was in any event sealed by their toxic reputation.
Reputations can be revived, however — especially when history is forgotten, as it was by the late 1960s.
Rest here…
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