How Much Are Fannie and Freddie to Blame?

Peter Wallison at AEI has out an attempted take-down of economist Paul Krugman ("Fannie, Freddie and You", 7/14/2008), and pretty much anyone else who thinks Freddie and Fannie's role in this crisis during the 2005-2007 period was irrelevant compared to private actors. It's provocative stuff, and reasonably nuanced.

At the same time, Wallison introduces a theory for why the two firms acted so destructively: While they were fighting for share, they were mostly trying to impress Democratic overseers post-account scandals. Call it the tail-wagging model of mortgage market implosion.

 Why did the GSEs follow this disastrous course? One explanation -- advanced by Lockhart -- is that Fannie and Freddie were competing for market share with the private label securitizers and had to purchase substantial amounts of subprime mortgages in order to retain their position in a growing market. Fannie and Freddie's explanation is that they were the victims of excessively stringent HUD affordable housing goals. Neither of these explanations is plausible. For many years before 2004, Fannie and Freddie had followed relatively prudent investment strategies, even with respect to affordable housing, but they suddenly changed their approach in 2005. Freddie Mac's report, for example, shows that the percentage of mortgages in its portfolio with subprime characteristics rose rapidly after 2004. In addition, Freddie Mac's disclosures indicate that of the loans added to its portfolio of single-family loans between 2005 and 2007, 97 percent were interest-only mortgages, 85 percent were Alt-A, 72 percent were negative amortization loans, 67 percent had FICO scores lower than 620, and 68 percent had original loan-to-value ratios greater than 90 percent. It seems unlikely that competing for market share or complying with HUD regulations--which contained no enforcement mechanism other than disclosure and delay in approving requests for mission expansions--could be the reason for such an obviously destructive course.

Instead, it seems likely that the event responsible for the GSEs' change in direction and culture was the accounting scandal that each of them encountered in 2003 and 2004. In both cases, they lost their reputation as well-managed companies and began to encounter questions about their contribution to reducing mortgage rates and their safety and soundness. Serious observers questioned whether they should be allowed to continue to hold mortgages and MBS in their portfolios--by far their most profitable activity--and Senate Republicans moved a bill out of committee that would have prohibited this activity.

Under these circumstances, the need to manage their political risk became paramount, and this required them to prove to their supporters in Congress that they still served a useful purpose. In 2003, as noted above, Frank had cited an arrangement in which the GSEs' congressional benefits were linked to their investments in affordable housing. In this context, substantially increasing their support for affordable housing--through the purchase of the subprime loans permitted by HUD--seems a logical and even necessary tactic.

More here.

Comments

[turkeyeyes:]

Franklin Raines also got a tidy sum as well.

Let's not forget his bonus.

Couldn't that have been a tiny factor in all this?

Hopefully, the FBI can get some of that money in a nice clawback of sorts.

2008 Oct 02 11:54 AM

[The Realist:]

Paul Krugman might be an economist but he is not a very good one. Marx was an economist too. Krugman is first and foremost a political hack, so anything he writes is subject to intellectual question.

Fannie and Freddie are actually the central point of this entire fiasco and Krugman needs to be dishonest about this intentionally or else he would be forced to lay blame on his lords the Democrats.

The list of Democrat big wigs that made tens of millions in salary and bonuses at these companies is endless. They were pets of the Democrats and basically a slush fund.

How sad is the net result that the Democrats are responsible for so much of this crisis and it is they who have framed the debate in the media and are forcing us to spend a trillion dollars to cover up their semi-illegal activities.

2008 Oct 02 12:24 PM

[dlaw:]

Fannie and Freddie were CUSTOMERS of the fraudster-bankers who put out this junk. The NONSENSE out of AEI is a politically-motivated canard and the author does himself and all his readers a disservice by taking it seriously.

Because of poor management, Fannie and Freddie became BUYERS of the bad paper - just like hundreds of other institutions. They were duped by the fraudsters who issued this private-label junk and their capital base was too small ever to have taken that kind of risk.

But that in no way "contributes" to the bad paper. They issued no bad paper, they did not make markets in this paper, this is about McCain being able to run ads with Barack Obama's face next to Harold Raines's face.

Hmm, what's similar about those two guys?

2008 Oct 02 12:28 PM

[AlexS:]

Trillions of dollars is a small price to pay for the approval of Barney Frank and Chris Dodd, especially now that they're members of the party in power in Congress.

2008 Oct 02 12:29 PM

[dlaw:]

Realist, you're either a dupe or a liar.

The numbers aren't there. This is a ridiculous attempt to scapegoat Fannie and Freddie to cover up for massive fraud by the American banking system.

The private institutions that issued this paper are to blame and all your anti-government talk will do you no good now.

2008 Oct 02 12:30 PM

[AlexS:]

Essentially, originators would be laundering mortgages through Fannie and Freddie. Junk mortgages in. Implicit government guaranteed mortgages out. What a scam.

2008 Oct 02 12:35 PM

[dlaw:]

AlexS, that is a complete and total lie.

Fannie and Freddie DID NOT EVER turn subprime mortgages into agency securities.

That is a ridiculous Limbaugh talking point.

2008 Oct 02 12:40 PM

[The Realist:]

dlaw, perhaps an economic course would do you well. You put the cart before the horse and can not let go of your cognitive dissonance about politics to take one second to see what you are staring at. Nothing the democrats can do is wrong for you. As long as your fascist Democratic leaders get power anything is fair to say regardless of how inane it is. I on the other hand hate all politicians, I can bad mouth Republicans just as well as Democrats.

The bankers did not stick the paper on Fannie and Freddie. Without those two institutions the banks could never have made this paper. How simple can this concept be and you still can't get it. Duh.

The CDOs were predicated on the fact that Fannie and Freddie could borrow at below market rates. If Fannie and Freddie did not exist these CDOs would never have been created.

Get a life dlaw, learn to look at reality instead of through your partisan prism. Your name reminds me of all our Democratic congressman who are lawyers and no absolutely nothing about economics.

2008 Oct 02 12:54 PM

[DCBill:]

Peter Wallison has made plenty of money and earned his Right Wing "eagle badge" peeing on Fannie and Freddie, but in his zeal to score "McCain points"--which likely will be a losing effort come Nov. 4--Wallison overlooks many crucial facts.

--The Bush campaign machine called for the "ownerhsip society" and enlisted Fannie and Freddie in that effort, at times taking direct credit for the companies' efforts.

--All of the major D's (Johnson, Raines, Gorleick, et al) were long gone when the company stepped in deep caca, through purchases of Alt A and subprime securities. They refused to originate the stuff, but Dan Mudd (a life long Republcian and McCain contributor) wanted it on the Fannie Mae books and his mistake cost him his job and the company it's structure and private ownership.

Mudd made the same mistake as the managers of Bear, Merrill, WAMU, Wachovia, AIG and dozens more. There was nothing unique in the greed that drove subprime security purchases

Don't forget, when Fannie was atken over, it had cleaned up its books and was SEC compliant. It also had OFHEO officals in its operational offices 24-7, blessing every significant business action and deal, so
who was responsible for what? It was hardly Barney Frank and Chris Dodd.

Fannie's major errors came in 2005-2007, when no Democrats were in authority. Sorry Peter.

2008 Oct 02 01:26 PM

[whtamess:]

Dear Realist,
Did you ever hear of Mark to Market accounting... the gov't doesn't have to abide by it Fannie and Freddie did. You want the culprit to this fiasco look at the Financial Accounting Standards Board site and review the rules and if you have any idea at all about accounting rules you will begin to understand a portion of what happened here. I found it interesting to hear a Senator mention on the news that the govt doesn't have to abide by these rules and therefore they will be in a position to make money and protect the taxpayers for this rescue plan.
And yet another reason for the mess. From an article..." Andrew Cuomo and Fannie and Freddie
How the youngest Housing and Urban Development secretary in history gave birth to the mortgage crisis
By Wayne Barrett"
published: August 05, 2008
and I quote "Andrew Cuomo, the youngest Housing and Urban Development secretary in history, made a series of decisions between 1997 and 2001 that gave birth to the country's current crisis. He took actions that—in combination with many other factors—helped plunge Fannie and Freddie into the subprime markets without putting in place the means to monitor their increasingly risky investments. He turned the Federal Housing Administration mortgage program into a sweetheart lender with sky-high loan ceilings and no money down, and he legalized what a federal judge has branded "kickbacks" to brokers that have fueled the sale of overpriced and unsupportable loans. Three to four million families are now facing foreclosure, and Cuomo is one of the reasons why." here is the link for the article www.villagevoice.com/c...

2008 Oct 02 01:57 PM

[madasiwannabe:]

Your forgetting your history. In 2003/2004, the GSE's were flooded with lawsuits for racism. People were complaining that they were denied loans for no reason so it must be ratial profiling. Their disadvantaged numbers were not consistant with their competitors so it looked bad on paper for Fannie and Freddie. When you look at the first case, a single black female, her FICO was 560.

To get the dogs off, Congress had OFEHO mandated that both Fannie and Freddie lower the bar. They did and now look where they are at.

In 2004 the CEO of Freddie ignored the Chief Risk Officer when he came forward with concerns. On an interview his explination was "I understood the risk, but I work for many masters". Yes the GSE's took on too much risk, but not for greed or to keep up with the Jones's.

Look up speeches by Bush and Greenspan in 2004. They were preaching owning a piece of the American dream was as a right and urged banks to come up with ways to make loans available to all Americans. They did.

Time for the media to talk with OFEHO and Congress to get the real story.

2008 Oct 02 05:06 PM

[jdfarrell45:]

hey Realist; know, not no. What a gaff for a person using words like dissonance and inane. I hate almost all politicians as well, as well as most of the morons they represent, who allow them to be our representatives. It's a vicious circle called the human condition. If we could just fast forward about10,000 years to a new "star trek" like era where truth and rationality prevail.

2008 Oct 03 11:40 AM

[mediapro:]

Read Naomi Klein's "The Shock Doctrine" for the clearest explanation of The Mess.

For all you Milton Friedman addicts, der Fuhrer has been stripped of his clothing.

2008 Oct 03 08:49 PM

[mediapro:]

Ay, ya, yai!

Just look at all the swinging gates in this post. How can I be right when everybody's wrong?

To pin this mess on any one party or any one thing is foolish. But we can look at one key event that facilitated the whore mongers. The Mess in fact did start with the 1999 repeal of a depression-era law (Glass-Steagall) that served to keep a check on commercial lending and re-packaging financial products into incomprehnsible paper that was constantly re-sold. Sound familiar? If we want to pin the blame, McCain chief financial advisor, Phil Gramm, literally inserted in the middle of the night the key provision that allowed the financial industry waters to be muddied with no distinctions between insurance, banking and investing.

Do you really believe the lie that Fannie and Freddie CAUSED this crisis? If you really want to look at who was repackaging the clean mortgage paper into CSE's look no further than the same investment company that was the key reason for the passage of Glass-Steagall -- JP Morgan and the rest of the Investment Banking community. They were doing exactly the same thing they did in 1932 -- re-packaging debt into complex instruments and re-selling.

Though I agree with the premise of this article, there's enough blame to go around. This FIX does not solve the problem until we look at how the accounting rules, lax regulation and religious devotion to unfettered capitalism got us into this mess.

My one regret about the structure of the fix, as far as I can tell, is that the taxpayer still has no skin in the game. Let's just look at this logically: If Warren Buffet offered to invest his entire wealth to help solve this problem by purchasing paper of unknown real value, do you thin that he would exact majority control over the business operations of these companies in which he is literally investing?

We are simply left with the hope that someday about twenty years down the road, most of the honest borrowers will adhere to their debt obligations.

For now, the bankers get their money up front, and it's business as usual.

2008 Oct 03 09:00 PM

[Axetogrind:]

Can FRE and FNM climb out of the bad paper when the goverment buys it and become profitable again?

2008 Oct 04 06:48 PM

[DCBill:]

The minor name-calling and putdowns aside, please draw a distinction between Fannie Mae's "community lendign activity"--basically what they did to get to and over the statutory requirement that "55% of their annual business serve low, moderate and middle income families and those living in central cities and other underserved areas" (Quote is from the law.)--and the yield driven subprime purchases in 2006 and 2007, which severely wounded the company. (Fannie had $40 billion in capital on their books when put into "conservatorship," suggesting to me politics not market concerns as the cause for Paulson's move.)

Hosuing Goals:Fannie regularly took in enough quality business in most of their standard acquisitions which helped them get to about 50% of the needed 55%. It was the last slug which relied on their community lending pproducts and all of the flexible underwriting emouluments, they added.

However, most of those loans perofmred only slightly worse than their very solid standard business. In fact, ALL OF THOSE COMMUNITY LENDING LOANS could have gone belly up, which they never did, and Fannie's losses would have been tiny and overwhelmed by their other positive earnings.

But the purchase of high yielding subprime securities--orignated otuside the F&F systems, by Wall Street with direct delievry from mortagge brokers---is what took the GSEs down.

Again, all the "legendary" Fannie D's were gone by that time and the congressional Democrats, who indeed were GSEs cheerleaders, but mostly becausee the GOP had decided, in the Reagan era, to come after the Rossevelt created Fannie for ideological reasons.

Back to the word combat!

2008 Oct 07 10:52 AM