Financial Crisis: Assertions About Role of Fannie and Freddie Need Checking

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Includes: FMCC, FNMA
by: Rortybomb
So the American Spectator ran a story by Peter Wallison about Fannie (OTCQB:FNMA)/Freddie (OTCQB:FMCC) and the FCIC report, "The True Story of the Financial Crisis," that could have used some fact checking.

Leprechauns, Unicorns

But first, as always, Wallison brings out the same argument that blames the crisis on Fannie and Freddie that he’s been using since 2009. Introduction (my bold):

[G]overnment housing policies…fostered the creation of an unprecedented number of subprime and otherwise risky loans immediately before the financial crisis began….In March 2010, Edward Pinto, a resident fellow (and my colleague) at the American Enterprise Institute who had served as chief credit officer at Fannie Mae, sent the Commission a 70-page, fully sourced memorandum on the number of subprime and other high-risk mortgages in the financial system in 2008. Pinto’s research showed that he had found more than 25 million such mortgages (his later work showed that there were approximately 27 million). Since there are about 55 million mortgages in the U.S., Pinto’s research indicated that, as the financial crisis began, half of all U.S. mortgages were of inferior quality and liable to default when housing prices were no longer rising.

This usually leads to the conservative talking point: half of all subprime and other high-risk mortgages were held by the GSEs! But wait, what’s that “and other high-risk mortgages” doing there?

This zombie argument finally got fully dismembered by Center for American Progress’ David Min in his recent report taking apart Wallison’s FCIC dissent, Faulty Conclusions Based on Shoddy Foundations.

Wallison and Pinto claim that the GSEs were responsible for half of all subprime and subprime-like mortgages. They do this by making up a confusing definition of “subprime-like,” what above is mentioned as their “and other high-risk” mortgages.

The fun part of making up your own definition is that it can be whatever you want it to be. If we define a conventional loan made to a borrower with a FICO credit score between 620 and 660 as a “leprechaun” and a loan with a cash down payment of less than 10 percent as a “unicorn,” we can say that Fannie and Freddie was responsible for half of all leprechauns and unicorns under oath and while serving on the FCIC.

Now instead of a leprechaun they’ve created the definition of “subprime by characteristic” and instead of a unicorn they say “Alt-A by characteristic,” for the numbers mentioned above. This is a definition nobody in the financial markets use.

The three-card monte trick is pretty straightforward once you know where to watch. There’s a lot of statements that go: “Fannie and Freddie made a lot of subprime loans and other high-risk mortgages. And subprime loans had a 25% default rate!” And you naturally assume that the other high-risk loans must also have a gigantic default rate compared with regular mortgages. Except they don’t. From Min’s paper (p. 8):

(Click charts to expand)

That 8.45% and 10% are the “other high-risk loans” that they try to shoe-horn in with subprime. That’s a high default rate, but it’s nowhere near as scary as the nearly 7% default rate on regular mortgage loans. And this trick is even more apparent when you break it down by securitization (see below). These so-called high-risk loans are much closer to regular loans when it comes to defaults, which are high across the board given the housing bubble and subsequent recession and high unemployment.

Min’s document goes through the rest of the claims related to the CRA and securitization as well.

Is there a fact-checker at the American Spectator?

I only ask because they published the following from Wallison (my bold):

After the majority’s report was published, many people lamented that it was not possible to achieve a bipartisan agreement even on the facts….This information, which highlighted the role of government policy in fostering the creation of these low-quality mortgages, raised important questions about whether the mortgage meltdown would have been so destructive if those government policies had not existed. Any objective investigation of the causes of the financial crisis would have looked carefully at Pinto’s research, exposed it to the members of the Commission, taken Pinto’s testimony, and tested the accuracy of his research. But the Commission took none of these steps. Pinto’s memos were never made available to the other members of the FCIC, or even to the commissioners who were members of the subcommittee charged with considering the role of housing policy in the financial crisis.

As an aside, forget bipartisanship – the Wallison dissent didn’t even make partisanship status, as the other three Republicans on the FCIC walked away from it. Keith Hennessey, Bill Thomas and Douglas Holtz-Eakin all voted in favor of removing the phrases “Wall Street” and “shadow banking” and the words “interconnection” and “deregulation” from the final FCIC report. They don’t strike me as the type of people who are going to clutch their pearls and faint at the suggestion that if they fudge some numbers and make up some official sounding definitions ad hoc they can discredit regulation of the financial sector, liberal governance and try to steer some Wall Street friendliness to the GOP. And yet all three put maximum distance between themselves and Wallison’s dissent, writing another dissent separately. So this is hardly a problem of Democrats being mean.

But the actual bolded text above – “looked carefully at Pinto’s research, exposed it to the members of the Commission, taken Pinto’s testimony, and tested the accuracy of his research. But the Commission took none of these steps” – is factually incorrect. Wallison made a very similar argument in a Bloomberg editorial recently, which prompted Leonard Architect at DailyKos to take it apart in his post Why Isn’t FCIC Commissioner Peter Wallison Facing Criminal Prosecution After He Lied To Congress? In this great post, Architect links to the actual FCIC documents and reports, all online, where the FCIC listened to Pinto’s testimony, took his research, reviewed his findings, and addressed them directly in the final FCIC majority report. Architect:

Let’s count the lies:

  1. The FCIC did look carefully at Pinto’s research (pdf);
  2. The FCIC did question Pinto at length and accept all his submissions (pdf);
  3. The FCIC did test the accuracy of Pinto’s research (pdf), and
  4. Pinto’s research was made available to all members of the FCIC.
  5. The FCIC considered and debunked Pinto’s claims, and detailed the process in its report, on page 219 and elsewhere.

In a nutshell, Pinto claimed that there were about 27 million subprime and Alt-A loans, something close to half the national total. he also claimed that about 12 million of those high risk loans were held by Fannie and Freddie. He came up with these numbers by using definitions of “subprime and “Alt-A” that were unique to Pinto alone. The FCIC uncovered a glaring disconnect between actual delinquency rates and Pinto’s categorizations. When it came to actual performance, there was almost no overlap. “High risk” loans held by the GSEs had serious delinquency rates that had only 1/4 the delinquency rates of subprime loans (using everyone else’s definition) and 1/3 the delinquency rate of traditionally defined Alt-A loans. For context, the GSEs’ “high risk” loans had a serious delinquency rate that was below the 6.3% national average at the time (pdf).

The FCIC (pdf) final report writes [p. 219]:

In written analyses reviewed by the FCIC staff and sent to Commissioners as well as in a number of interviews, Pinto has argued that the GSE loans that had FICO scores below 660, a combined loan-to-value ratio greater than 90%, or other mortgage characteristics such as interest-only payments were essentially equivalent to those mortgages in securitizations labeled subprime and Alt-A by issuers… Pinto estimates that as of June 30, 2008, 49% of all mortgages in the country—26.7 million of them—were risky mortgages that he defines as subprime or Alt-A. Of these, Pinto counts 11.9 million, or 49%, that were purchased or guaranteed by the GSEs. In contrast, the GSEs categorize fewer than 3 million of their loans as subprime or Alt-A.

Importantly, as the FCIC review shows, the GSE loans classified as subprime or Alt-A in Pinto’s analysis did not perform nearly as poorly as loans in non-agency subprime or Alt-A securities. These differences suggest that grouping all of these loans together is misleading. In direct contrast to Pinto’s claim, GSE mortgages with some riskier characteristics such as high loan-to-value ratios are not at all equivalent to those mortgages in securitizations labeled subprime and Alt-A by issuers. The performance data assembled and analyzed by the FCIC show that non-GSE securitized loans experienced much higher rates of delinquency than did the GSE loans with similar characteristics.

You can claim that the FCIC didn’t do true justice to these arguments. I’d disagree, but fine, whatever. But the FCIC did review them, they did analyze them (see the link in #3 above) and they did address them in the final report. To print otherwise does a disservice to the reader.