Again ... It Wasn't Fannie and Freddie

There are two questions that are being confused in the debate over the source of the financial crisis:

1. What caused Fannie (FNM) and Freddie (FRE) to fail?

2. What caused the financial crisis?

Answering the first question does not necessarily answer the second. Showing that some politician, some policy, some legislation, lack of effective regulation, whatever, caused Fannie and Freddie to fail is important, we need to know why they were vulnerable when the system got in trouble, but Fannie and Freddie did not cause the crisis, they were a consequence of it.

How do we know this?

Fannie and Freddie became fairly large players in the subprime market, and they got that way by following the rest of the market down in lowering lending standards, etc. But they did not lead it down. Their actions came in response to a significant loss of market share, and it is this loss of market share that motivated them to take on more subprime loans.

We need to understand why the overall market - the part outside of Fannie and Freddie's domain - was able to lower lending standards (and increase their risk exposure in other ways as well), and how regulation which had worked up to that point failed to keep Fannie and Freddie from dutifully responding to the market pressures on behalf of shareholders by duplicating the strategy themselves, but again, they were followers, not leaders.

Tanta (via econbrowser) describes the downward plunge of the GSEs:

Fannie and Freddie .... didn't like losing their market share, and they pushed the envelope on credit quality as far as they could inside the constraints of their charter: they got into "near prime" programs (Fannie's "Expanded Approval," Freddie's "A Minus") that, at the bottom tier, were hard to distinguish from regular old "subprime" except--again-- that they were overwhelmingly fixed-rate "non-toxic" loan structures.

They got into "documentation relief" in a big way through their automated underwriting systems, offering "low doc" loans that had a few key differences from the really wretched "stated" and "NINA" crap of the last several years, but occasionally the line between the two was rather thin. Again, though, whatever they bought in the low-doc world was overwhelmingly fixed rate (or at least longer-term hybrid amortizing ARMs), lower-LTV, and, of course, back in the day, of "conforming" loan balance, which kept the worst of the outright fraudulent loans out of the pile.

Lots of people lied about their income (with or without collusion by their lender) in order to borrow $500,000 to buy an overpriced house in a bubble market. They weren't borrowing $500,000 from the GSEs.

Michael Carliner continues, explaining how Fannie and Freddie took on the extra subprime debt:

Fannie and Freddie are ... subject to regulation by HUD, under mandates to serve low- and moderate income households and neighborhoods. As originators and investors with more energy than brains expanded their (subprime) lending to those borrowers and neighborhoods, it was difficult for Fannie and Freddie to increase their shares.

They didn't want to buy or guarantee subprime loans, correctly perceiving them to be insanely risky. Instead they purchased securities created by subprime lenders, taking only the supposedly-safe tranches. Those portfolio purchases were counted toward their obligations to lend to lower-income home buyers, but are now part of the write-downs.

Until Republicans started trying to claim that Fannie and Freddie caused the financial meltdown as a means of tying Obama to the crisis -- a strategy that backfired badly when all of the embarrassing connections to Fannie and Freddie within the McCain campaign were revealed -- nobody was saying Fannie and Freddie caused the crisis. Republicans simply worked backwards -- they found connections between Democrats and Fannie and Freddie (never thinking to ask about their own connections), then tried to blame the crisis on Fannie and Freddie so as to make people think it was the Democrats' fault.  And it's still going on despite the fact that the data doesn't support this story.

There is no excuse for the actions of the management of Fannie and Freddie, and I'm not trying to defend them or their choices, but the idea that Fannie and Freddie caused the general credit crisis is wrong.

Richard Green is dismissive of the whole notion:

Charles Calomiris and Peter Wallison blame Fannie Mae for the Subprime Mess:

Hmmmm. The loan performance on Fannie's book of business is substantially better than the overall mortgage market. And starting in 2002, Fannie Freddie (pink line, click on chart to enlarge) lost market share to ABS (light blue line). [The data underlying the graph is from the Federal Reserve, Table 1173. Mortgage Debt Outstanding by Type of Property and Holder.]

It wasn't Fannie and Freddie.

Comments

[dlaw:]

Thank Goodness!

Finally somebody focuses on this issue.

Fannie and Freddie were largely victims of crooked originators.

And please, can we remember something? No banker was ever under any obligation to lie to the secondary mortgage market about borrower income. They had the means, opportunity, wherewithal and standard business practices to determine borrower income and they chose not to.

It's just plain, old securities fraud.

2008 Sep 25 03:28 AM

[Wefwef:]

'but the idea that Fannie and Freddie caused the general credit crisis is wrong'

There is no such idea. Stop mixing your own politics and finance.

2008 Sep 25 03:30 AM

[pochovilla:]

They didn't cause the problem but were willing participants. Too much money slooshing around paid a lot of people to look the other way. When you get caught with your pants down blame the "shorts"

2008 Sep 25 05:35 AM

[madasiwannabe:]

Wefwef, There is such an idea, it's just not overtly stated. The media has been quick to point out the GSE's grew too big out of greed and that Bush wanted to do something about them years ago. They grew rapidly to bail out the failing S&L's.

Don't forget your history. In the 1980's, the S&L's were in trouble because of mortgage exposure. Sounds very familiar. Remember Silverado's Neal Bush and McCain's involvement in the Keating 5? Also don't forget the original sin that plotted our course to today's crisis, the bailout initiated by President Bush Sr.

With encouragement from Fed Sec Greenspan and the Bush administration, banks went on a lending spree to get the economy rolling after 9/11. The money was so good, no one wanted to stop it from going out of control. If something goes wrong, Uncle Sam will bail us out just like he did with the S&L's.

Why doesn't anyone talk about why Greenspan resigned 2 years into a 5 year appointment, started his own consulting company and has contracts with two of the most vocal companies; PIMCO and Pershing Square. The same two companies that made a total of 10 Billion the day the government took control of the GSE's.

2008 Sep 25 06:38 AM

[turkeyeyes:]

THANKS, EINHORN FOR SPARKING A RUN ON THE BANKS.

You may have to return much of that billion you made on LEH once the FED proves you colluded with other hedgefunds to drive it out of business based on rumors and innuendo ...

Hope you're sleeping soundly until fried.

2008 Sep 25 06:38 AM

[Old Wizard:]

I think one of the arguments in this article sounds like the kind of ratioalization that runs rampart in it wasn't me school. Fannie Mae and Freddie Mac were loosing market share so they start taking marginal loans and questionable derivative securities. Maybe they weren't the ones to start the ball rolling they certainly gave it a push. I find it hard to believe that companies that hold trillions of dollars in mortgages and derivatives aren't a large part of the problem. Why was it necessary to keep market share by taking on questionable securities? Might it have something to do with executive compensation and the increased profit these securities generated? These companies recent history of questionable practices including the 400m fine they paid doesn't actually engender the confidence that these company's management were looking out for main street.

2008 Sep 25 11:57 AM

[David Roskoph:]

243313,

Did you say hedge funds and collusion? Imagine that! Just like the pre-Sec cartels. Say, how many of our politicians are happy clients?

2008 Sep 25 01:20 PM

[txgram:]

i am really shocked to find out barney frank and all those guys that retired with up to 90 million are republicans.. god help us ! remind me to never vote for another republican...

2008 Sep 25 09:13 PM

[Harvybing:]

BILL CLINTON LAYS BLAME FOR FANNIE MAE MELTDOWN ON DEMOCRATS

President Bill Clinton told ABC News That the blame for the Fannie Mae Meltdown Lies squarely at the feet of DEMOCRATS. You have to admire his candor -

See The Jim Angle Report on Fox - www.youtube.com/watch?...= ---- newsbusters.org/blogs/... -

Watch The Interview On ABC News ---
blogs.abcnews.com/poli... --

And The New York Post Agrees -- www.nypost.com/seven/0... --



Hear Barney Frank On Video Stating That There Is No Crisis At Fannie Mae -
mypetjawa.mu.nu/archiv... -


I think there are 2 former CEOs of Fannie Mae, one former assistant CEO, and at least One United States Senator and at least one member of the US House of Representatives who should GO TO JAIL for this!

2008 Sep 25 10:21 PM

[tshk1221:]

I'm a real newbie in stock investment, and recently, I purchased small shares of Fannie Mae just to test drive my money in this market turmoil since the price was so low. When I got the settlement statement of the stock purchase, it said, "Non-negotiable". The other stock I got said, "Good Order". Does this mean that I cannot sell this stock now because the government took over Fannie Mae and Freddie Mac due to the mortgage meltdown? Is this non-negotiable status to be lifted off once the market gets stabilized and once the government makes its final decision as to the future ownership and operation of Fannie Mae just like before as GSE? Can somebody let me know if you purchased Fannie Mae or Freddie Mac recently?

2008 Sep 28 12:46 AM

[caught_cryi...:]

Fannie Mae and Freddie Mac and the Community Reinvestment Act was created to create reinvestment into downtrodden communities.

Here in NYC, in my neighborhood, minorities, artists moved into neighborhoods that were less than desirable. Community Reinvestment Acts, Fannie Mae favors as cronyism by Democrats, and we will not discuss the moves made to move working class minorities who came into clean up neighborhoods received any of these loans.

A name I will not call made sure his friends received a lot of these loans at less than marketable rates, and this stuff has been going on, but many times the minority public was not privy to the give-aways until the last couple of years.

Illegal immigrants have been allowed to purchase homes, the A+ or whatever they are called where credit is not checked were given to illegal, or undocumented immigrants, yet the minorities who started gentrification were many times turned down.. For those of us who have closed businesses when owners would not sell waiting for higher prices and buying up properties for speculative purposes.

Anyone who has taken higher math knows derivatives create less return on investment if not quantified using correct formulas. I've heard young trading trainees discuss the imaginary function, used in derivatives or for creating functions that do not exist. They talk about how they never took Calculus or any higher mathematics, and they are learning this stuff on the fly for quickness.

If you read an article by the infamous N. N. Taleb from NYU Polytech's Mathematics department, you'll find this is a never ending problem that no one will be able to solve. He says its like a disease in a patient, and pills, cures are being tried, but no one knows what's wrong, so of course no one knows how to fix it.

In my opinion, you must trace or drill down the problems to the actual function to determine exactly where the mess came from. Blaming Freddie Mac and Fannie Mae just does not cut it. When I look at it, it seems Freddie Mac and Fannie Mae were the fall guys when the Investment Banks and Securities firms started to see the problems. Since they were allowed to ethically report or not, of course they chose not to report, and executives, traders, even secretaries made tremendous amounts of money.

The people with the bonuses made them using false pretenses, not reporting actual true earnings on their books. Derivatives, Hedge Funds and CDOs, and the exotic products created using Derivatives to create Hedge funds, CDOs must be regulated with great, much more detail if the average taxpayer is investing in this stuff.

2008 Sep 30 02:57 AM

[caught_cryi...:]

Bill Clinton is right, but he was a major benefactor in the Democratic Party that created the mess, and made it larger. His daughter, Chelsea is a Hedge Fund Manager at some securities firm here in NYC.

Blaming Barack Obama when he was not a member of the Senate is about as "crying wolf" as blaming Freddie Mac and Fannie Mae. Drill down the mess to the culprits and you will find the truth. This cannot be done quickly or without serious analysis and investigation, so unfortunately the Congressional members who are afraid of losing their seats were smart by voting no. See the following websites, especially the one with the FOURTH QUADRANT explanation.

The Reality Club: THE FOURTH QUADRANT by Nassim Taleb www.edge.org/discourse...

www.edge.org/3rd_cultu...

www.fooledbyrandomness...

2008 Sep 30 03:08 AM

[User 273010:]

His daughter, Chelsea is a Hedge Fund Manager at some securities firm here in NYC.
========
Not true. She worked for a Hedge Fund Manager in an unknown capacity. Now, however, it is said she attends the Mailman School of Public Health.

2008 Sep 30 09:27 PM