Byline: Rob Garver
In 1974, fresh out of law school, Edward Pinto joined a Michigan affordable housing agency. By 1989 he was a top executive at Fannie Mae. Today Pinto is the go-to housing finance pundit - from the pro-privatization set.
Since December 2008, he has testified before congressional committees seven times about the role his former employers Fannie and Freddie Mac played in causing the financial crisis, as well as the risks posed by the astronomical growth of the Federal Housing Administration. Over the same period, Pinto has been quoted as an expert on, and critic of, these agencies dozens of times inThe Washington Post, The Wall Street Journal, The New York Times and other major media outlets. This year Pinto, a resident fellow at the American Enterprise Institute, co-wrote a report calling for the government's future role in the mortgage market to be tightly circumscribed.
For someone who says he once believed that, done right, government-run affordable housing programs "could have tremendous success," Pinto appears to have traveled a long ideological journey - perhaps akin to that taken by onetime Democrat Ronald Reagan or former conservative Arianna Huffington. Indeed, much of Pinto's worldview was shaped by the hard lessons about lending, and politics (both the national and corporate kinds) that he learned at governmental and quasi-governmental entities.
But he says it was only the summer of 2008 when he began wondering whether the government-sponsored enterprise model was inherently flawed.
Fannie and Freddie had not yet been taken over by the government at that point, but they were in a death spiral as worries about mortgage credit pushed their stock prices into free fall. One morning Pinto picked up the Journal and saw an op-ed piece by Franklin D. Raines, the former chief executive of Fannie. (They never worked together; Raines first joined the company in 1991, two years after Pinto's departure.)
The essay, "Truce Time in the Fan-Fred Wars," challenged the idea that the GSEs had contributed significantly to the mortgage meltdown. Raines - who had been forced out of Fannie in 2004 by an accounting scandal - claimed among other things that "the toxic waste in this financial meltdown is the product of 'purely private' financial institutions, not the GSEs."
Pinto said the Raines article did not reflect "the history as I knew it," and it inspired him to do further research on the history of the GSEs - history that, he says, eventually changed his thinking about GSEs entirely.
'BOOTS ON THE GROUND'
Pinto, 62, with glasses and slightly tousled gray hair, has the mien of an academic. He allows conversations to lapse into silence for minutes at a time while he thumbs through a book or searches the Internet for evidence to support a point he is making. Alex Pollock, an AEI colleague, describes Pinto as "very intense - he digs into data in a very impressive way."
Pollock, a former president of the Federal Home Loan Bank of Chicago, was an ardent critic of Fannie and Freddie long before he joined the AEI in 2004, so he sees Pinto's evolution as natural. "He, of course worked in credit and understands the credit issues in residential mortgage finance very well," Pollock said. "So he was well placed to see how far Fannie and Freddie [had] strayed from the 'true' way over the years."
Pinto works in an AEI office in Washington that is as cluttered as his thoughts on the collapse of the GSEs are ordered. Clearing a chair for a visitor sends a teetering pile of papers and folders cascading to the floor. Pinto acknowledges this minor disaster with a shrug as he circles around to his desk chair and begins to talk about his days in the government mortgage finance business.
At the Michigan State Housing Development Authority, Pinto rose to the position of general counsel in 1977. At the time, state housing authorities were relatively new. Michigan, Pinto said, got its affordable housing program off the ground by buying a package of loans to housing development projects underwritten by the FHA, all of which promptly defaulted.
"I learned three things at Michigan," said Pinto, who has a habit of enumerating lessons and rules in groups of three. "One is that FHA is a problem." The federal agency, in an attempt to finance affordable housing on a national scale, was unable to do the sort of detailed underwriting necessary to assure success, Pinto said. In Michigan, he said, housing development officials made the decision to bring underwriting in-house, and not to touch any more FHA-guaranteed projects.
"We saw that you could do this the right way, or you could do it the wrong way," he said. "If you did it the right way, you could have tremendous success. If you did it the wrong way you could have tremendous failure, and people's lives were impacted."
The second lesson from this period, Pinto said, "was that even though we were a state agency and there was an executive director who was a political appointee, it was very important to refuse to allow politics to get involved in the lending process." Third, "the way you do affordable housing successfully and sustainably is through a well-designed program with lots of boots on the ground." He described a system where housing authority architects and inspectors monitored every step of construction, approving plans and visiting building sites, creating a level of oversight that, he said, assured that "fraud was squeezed out of the process."
Pinto left Michigan in 1982 to join Mortgage Guaranty Insurance Corp., and two years later was hired away by onetime MGIC colleague Michael A. Smilow to come to Fannie Mae as vice president of negotiated transactions.
'CASH FOR TRASH'
Pinto said that it quickly became apparent to him that there were serious problems in the way Fannie was doing business.
At one point during a discussion with his new subordinates, Pinto said, it was explained to him that Fannie ran a "cash for trash" operation. The company bought mortgages of all descriptions, booked a fee as immediate income and then paid out the losses it ran on its portfolio. At the time, Fannie was operating at a loss, and Pinto said it quickly became apparent that he had been hired specifically to wind down the "cash for trash" side of the company. He began by examining the standards on individual bundles of loans and tightening them as he saw fit, but he said it soon became clear that bigger steps were necessary.
"After about eight months I went to my boss, and I said: 'We need to do more than just one-offs. We need to actually change our underwriting and get it back to some reasonable standard.' "
According to Pinto, the effort, undertaken with the full support of then-chairman David Maxwell, dramatically improved the quality of the loans that Fannie purchased and set the company on a path to profitability. It also pushed the company toward the establishment of a formal credit department - something Fannie lacked for the first five decades of its existence.
"That gave me a reputation for credit," he said. "So when it was decided to set up a credit department, I was named as the chief credit officer."
Maxwell, who is now retired and serves on several corporate and philanthropic boards, has a different recollection of the situation Fannie found itself in during the mid-'80s.
"I don't recall that Fannie's credit standards needed tightening," the former chairman and CEO said. "We were committed to the mission of Fannie Mae, which a lot of people lose sight of these days, which was standardization and sound mortgage lending. The reason we would have had a chief credit officer was to make sure we were consistently doing that."
In the years that followed, Pinto said, there was constant pressure for Fannie Mae, whose main job was to ensure liquidity for middle-class mortgages, to get involved in affordable housing finance - a digression he adamantly opposed, given what he observed in Michigan. "Fannie Mae was a wholesale operation," he said. "Doing affordable housing was retail."
At one point, he remembers, hundreds of activists with the fair lending group National People's Action descended on Fannie Mae's offices. Pinto was deputized to speak with the legendary organizer Gale Cincotta, the group's leader.
Pinto says that during the meeting with Cincotta (who died in 2001), he outlined his concerns about Fannie Mae getting involved in affordable housing. "I said: 'Gale, let me tell you three things. If you expect us to run a nationwide program at Fannie Mae, you are sorely mistaken. We will be no better at it than HUD. We will fail miserably. Number two, we can't do anything dumb from an underwriting perspective. And number three, the lender has to be on the hook.' "
The discussion with Cincotta is significant, Pinto said, because in it he laid out the three rules that Fannie would ultimately break - assuring, in his view, the GSE's eventual collapse.
'PROTECT THE CHARTER'
At the tail end of the Reagan presidency and into the tenure of George H.W. Bush, mortgage markets were roiled by the savings and loan crisis, and there was a strong campaign to privatize functions that had long been in the hands of the government. According to Pinto, Maxwell briefly flirted with the idea of lobbying Congress to allow Fannie to go private, but then decided to embrace the company's status as a government-chartered enterprise and, in Pinto's words, to "protect the charter" and the preferred treatment it assured the company's bonds in the market.
The company brought in Lehman Brothers managing director Jim Johnson as a consultant, to make surethe company's GSE status would not be challenged by Congress, the only entity with the power to alter or revoke the charter. Johnson, who would later serve as chairman and CEO at Fannie, advised the company that by financing affordable housing on a nationwide basis, it would assure continued favorable treatment on Capitol Hill.
Maxwell denied that he asked Johnson to find ways to shield Fannie from political interference. "We actually hired Lehman Brothers to explore whether there was a practical way in which Fannie Mae could become a completely private entity. That is to say, to sever the government ties, which obviously was something that was important to explore," he said.
"The problem always was, and still is today, that there is a tremendous amount of Fannie Mae debt and a tremendous amount of guarantees. How do you honor those and start over? We really went into it thoroughly, generating great big thick reports," Maxwell said. "The conclusion was that as an economic matter there was no way to get from here to there, and therefore the charter was the charter and Fannie Mae had to continue to operate under it."
In any case, in the late 1980s and early 1990s Fannie Mae began to push more into the affordable housing finance arena.
ON THE SIDELINES
Pinto said he was fired in 1989. Though he says he was never given an explanation - and as an at-will employee was not due one - he clearly thinks his resistance to a loosening credit culture was a major factor.
As chief credit officer, he said: "I had to say no to a lot of things. And saying no gets you some people who aren't happy with you."
Pinto worked as a consultant after his departure from Fannie, and founded Courtesy Settlement Services in 1994. The company provided loan closing services to banks and credit unions. Mellon Bank and Chevy Chase Bank were customers. In 2004, Courtesy joined the Independent Community Bankers of America's SmartLender program, which provides bulk pricing on mortgage-related services to the trade group's member banks; Pinto took over as president and CEO of SmartLender.
At the end of 2010, Pinto said, Courtesy changed its focus to providing "mortgage processing software services." Pinto is no longer a SmartLender executive, having left his position with the company last fall, around the time he joined the AEI as a resident scholar in October.
Pinto said that he watched with increasing concern as Fannie waded deeper into affordable housing finance.
The Federal Housing Enterprises Financial Safety and Soundness Act of 1992, he said, contained three "Trojan horses" that were "the seeds of Fannie and Freddie's ultimate collapse." The law, which created the now-defunct Office of Federal Housing Enterprise Oversight to monitor the GSEs, established affordable housing goals for the enterprises, required them to help banks achieve their own goals under the Community Reinvestment Act, and, in Pinto's view, effectively mandated the loosening of underwriting standards.
Under Johnson, Fannie Mae jumped into affordable housing with gusto, eventually announcing in 1994 a plan to purchase $1 trillion in loans to low-income homebuyers. Fannie stock soared, and a mortgage market boom carried the economy well into the new century, as easy access to mortgage credit pumped up consumer spending.
The eventual crash may have taken longer than expected, Pinto said, but by attempting to run a nationwide affordable housing program, drastically lowering underwriting standards and allowing banks to make mortgages without retaining significant risk, Fannie and Freddie set themselves, and the mortgage market as a whole, on a course that led inexorably to their collapse in 2007 and 2008.
Other GSE veterans disagree with his diagnosis. Thomas A. Lawler, who joined Fannie Mae the same year as Pinto and retired as senior vice president for risk policy in 2006, called Pinto's analysis of Fannie's role in the mortgage crisis "completely off base."
"I think he places way too much blame on government policy and not nearly enough on the fact that fully private folks in the private-label market made egregious mistakes by failing to account for the crazy lending and fraud that was going on," said Lawler, who is semi-retired and runs Lawler Economic & Housing Consulting LLC in Leesburg, Va.
EPIPHANY
After reading the 2008 Raines op-ed piece, Pinto threw himself into researching the progress of Fannie through the 1990s, poring over the legislative record as well as firsthand accounts of the development of crucial laws affecting the GSEs. The more he learned, he said, the more he realized that the public-private hybrid model was fatally flawed.
"As I have now thought about it," he said, "the original sins were right there from the beginning." There are, of course, three.
Original sin No. 1 was separating Fannie from the government without thoroughly severing the connection between its debt and a perceived government guarantee. (Fannie was a federal agency from its inception in 1938 until 1954, when it became a mixed-ownership company, with the federal government holding preferred shares and private investors holding common stock; in 1968, the original Fannie Mae was split into the Government National Mortgage Association, which remained part of the government, and the current Fannie Mae, which became a public company with a government charter.)
"The moral hazard of the implicit guarantee ... is there right from the beginning," Pinto said. "They are no longer selling government debt, but the market is assuming the debt is guaranteed by the government, and that's a problem."
Original sin No. 2: "No matter what limitations you put on them, Fannie and Freddie will want to have mission creep. It's just natural with any government-type entity. What did Fannie eventually view its share of the conventional conforming market to be? One hundred percent."
No. 3: "The quid pro quo that Congress always has when it gives somebody something for nothing. That was the affordable housing mission. We gave you these charter advantages, and you are beholden to us, and you have to give back. Rather than charging them a fee for it, they said, you will give it back to us in kind, in the form of affordable housing loans."
To Pinto, the first sin is, perhaps, the most damning.
"Government market interventions have led to large-scale taxpayer bailouts twice in the last generation," the AEI said in the white paper published in March, which Pinto wrote with colleagues Peter Wallison (a former official in the Reagan administration and a longtime GSE critic) and Pollock. After Fannie and Freddie are wound down, the trio argued, the government's role in the market should be relegated to narrowly targeted programs like a reined-in FHA. Effectively, they endorsed the first of the three post-GSE options the Treasury had laid out in its February report. The other two involved maintaining some sort of federal backstop.
For Pinto, the key to rebuilding housing finance is replacing government guarantees with insurance sold by private companies. In this, he says, the taint of government involvement can finally be expunged from the mortgage market. "In my opinion," he said, "moral hazard is just endemic in Congress' creating a guarantee of anything."
Rob Garver is a freelance writer in Springfield, Va.
