Fannie Mae and Freddie Mac

Good article here. Key points:

• The flaw in their business model is that they are owned by private shareholders but backed by the government. As a result, lenders do not care about the risks the companies are taking because they know that the government will eventually step in to protect them against losses on their loans.
• This could all have been prevented if Congress had acted years ago to eliminate the GSE business model. There are three possible models -- privatization, nationalization or liquidation. Congress and the president can decide which it will be, but the worst idea is to reconstitute them as GSEs. Unfortunately, that seems to be the choice Treasury Secretary Paulson made in the plan he announced Sunday

What he neglects to point out though is that there is another flaw that still isn't being addressed: the groups that gives credit ratings to these loans aren't doing their job right.

When Moody's rates a chunk of sub-prime loans as AAA, it isn't so much the LENDER like Freddie Mac who are at fault as it is the RATER and the INVESTOR.

Yes, Freddie Mac's govt backing gave them the ABILITY to buy junk loans for the cheap (and shouldn't have been). But it is the RATER who gave a false rating and enabled Freddie Mac to buy and sell junk loans.

The Rater should have rated the sub-prime loans for what they were--B or C, not AAA because Freddie Mac bought them.

The Investor, looking for a safe investment, will always pick an AAA loan. But they were FOOLS to believe Moody's ratings. And they knew it. People like Warren Buffett knew it--he told everybody that these investments were junk.

The mortgage banks, KNOWING what they were doing, were taking advantage of Freddie Mac to make a quick buck. They knew they can could buy junk loans and hand them off to Freddie Mac. No responsibility, all the profit. And virtually no rules for how bad of a mortgage they can write and still get Freddie Mac to buy it. When anybody can walk off the street and tell a bank that they make $400,000 and the bank just hands them a loan without verifying anything, that's a bank regulatory problem.

The problem is far more systemic than the article suggests. Democrats were always leary of reigning in Freddie Mac because to do so meant that low-income people may not be able to get loans. So that's understandable. Yes, part of the problem is Freddie Mac as a govt-backed entity, but the real problem is how people perceive and take advantage of that and the lack of regulations for how mortgages get written.