Fannie and Freddie were at heart of crisis
Much of the analysis of the housing crash and ensuing credit panic has focused on the manic activities of Wall Street, where most of the headlines of the debacle were made.
That’s a critical part of the story, but last week’s lawsuit against six former top executives of Fannie Mae and Freddie Mac rightly moves the spotlight toward the government’s role in generating the crisis.
In the suit, the Securities and Exchange Commission accuses the executives — including former Fannie CEO Daniel Mudd and former Freddie CEO Richard Syron — of misleading the markets about their companies’ exposure to high-risk loans.
As SEC Enforcement Director Robert Khuzami put it, “Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was,” giving analysts and rating agencies a skewed picture of the level of risk in the market.
Fannie and Freddie, odd hybrids, were at the heart of the crisis. Supposedly, they were private, stock-issuing corporations. But their government charter let them borrow at rates lower than competitors because markets assumed, rightly as it turned out, that if they failed the taxpayers would back them up. The “subprime exposure” mentioned by Khuzami was also taxpayer risk.
A bailout is exactly what happened in 2008. The government seized control of Fannie and Freddie and bailed them out at a cost, so far, of $150 billion.
Fannie and Freddie don’t make loans. They buy loans from those who do, and then keep them on their books or package them into bonds for sale to investors. This was a great way to raise money for housing finance, but politicians pushed it too far.
As Gretchen Morgenson of The New York Times and Joshua Rosner wrote in “Reckless Endangerment,” the Fannie-and-Freddie debacle shows what happens “when Washington decides, in its infinite wisdom, that every living breathing citizen should own a home.”
Beginning in 1992, the government began pushing for more allocation of credit to lower-income borrowers. To meet affordable-housing goals set by Congress, the two mortgage giants steadily lowered their credit standards and began buying subprime loans or no-document mortgages — those for which verification of key data like income was absent. Subprime originators seized the opportunity to reap profits with dubious mortgages while shifting the risk to Fannie and Freddie — and the Treasury.
Whenever concern was raised about the increased risk, reforms would be blocked by powerful Fannie-and-Freddie backers in Congress, like Massachusetts Rep. Barney Frank.
“I want to roll the dice a little bit more in this situation toward subsidized housing,” Frank said in 2003. He argued that the same “safety and soundness” standards for banks shouldn’t apply to Fannie and Freddie. In Washington, he was hardly alone. Fannie and Freddie rewarded their friends well.
The SEC allegations against the former executives of Fannie and Freddie may well be tough to prove because of the lack of an agreed-upon legal definition of “subprime.” But it’s appropriate that more light shines on the role of the two mortgage giants, which did so much to encourage the subprime mania.
As Charles W. Calomiris of the Columbia Business School wrote, “The decisions by Fannie and Freddie to embrace no-doc lending in 2004 opened the floodgates of bad credit.” After that, loans to people with lousy credit or those offering little documentation exploded, rising to more than $1 trillion in 2006.
In some ways, Washington still hasn’t absorbed the lessons. The massive Dodd-Frank financial-reform bill did little to resolve the status of Fannie and Freddie — an issue that remains for the future.
Kent Mueller
1 year, 5 months agoWell, well, well,KC Star. Welcome to the party. A bit late, but welcome never the less. The conservatives have been saying this for years. The government played a very key role in the entire mess. McCain and many other Republicans wanted to tighten the GSE’s up. They wanted to increase capital requirements. They wanted to reform the credit practices. What happened? They got steamrolled by the Democrats. I recall one Democrat upbraiding a government auditor for fingering the bad practices of the GSE’s. The auditor was testifying and the Democrat Rep absolutely ridiculed him. Barney Frank very pointedly professed the soundness of Fannie and Freddie just weeks before the collapse. Either he didn’t know they were weak, which is scary, or he did know they were weak, which is much worse.
What I find astounding, and it is right here in your editorial. You mention one person at the heart of the problem, Barney Frank. Chris Dodd was right there with him. There were many others, almost entirely Democrats. Then you refer to the “massive Dodd-Frank financial-reform bill”. How crazy is it to allow those two who were so complicit with the problem, to write industry reform? Think about that for a minute. That’s crazy.
But thanks for finally recognizing how it all got started. Keep at it and expose those responsible. And don’t be afraid to note their party membership.
Kevin O'Brien
1 year, 5 months agoThere was no subprime mortgage market if Freddie and Fannie didn’t exist. Someone should tell that the the fleabggers protesting in the wrong location.
Mark Hastert
1 year, 5 months agoWhile they’re at it go after Angelo Mozillo and the principals at WaMu and it should be criminal not civil charges. If Fannie and Freddie had behaved the the real government loan programs VA, FHA, and FMHA they wouldn’t have gotten into this mess. Instead they played like the big boys making sketchy loans and selling even sketchier securitized investments. At least there’s been some pittance of restitution from Countrywide this past week.
This is what happens when you trust the foxes to guard the chicken coop. I’d like to hear what Alan Greenspan has to say about self regulating markets now.
JR Beillenhouser
1 year, 5 months agoI’m assuming that everyone on the Star’s editorial board is on vacation and Thomas Mc wrote this piece. It is 100% on track so that has to be what happened.
Oh, and we told you so 3 years ago.
Mark Hastert
1 year, 5 months ago“You fail to mention that Dodd-Frank,”
Read more here: http://voices.kansascity.com/entries/fannie-and-freddie-were-heart-crisis/#storylink=cpy
.. and lets not forget the legislation that enabled the whole mess, Graham, Leach, Bliley (all Republicans). I know you guys don’t want to think that conservatives have any culpability but your memories can’t be that bad. If you’re really interested in assuring that this never happens again then be honest about who and what caused it. Legislators of both parties participated in the deregulation/self regulation fairy tale, bought and paid for by the big banks, monied elite, and Wall St. They write the legislation, buy the politicians, and their lobbyists sheperd it through at local, state, and the federal levels. He who makes the rules wins…. the middle and lower classes lose.
Kevin O'Brien
1 year, 5 months agoTrying to blame Graham, Leach, Bliley is just a laughable diversion from uninformed liberals who will defend anything. That’s like saying it’s the auto manufacturers fault you drove your car at 100 miles an hour into a concrete wall. Keep on trying to deflect Marky Mark, the truth has come out and you have been exposed.
Kevin O'Brien
1 year, 5 months agoPappy, you need to get your facts straight, Bush tried 3 times to reign in Fannie and Freddie, he was blocked by guess who, Frank in the house and Dodd in the senate.
Mark Hastert
1 year, 5 months agoTrying to blame Graham, Leach, Bliley is just a laughable diversion from uninformed liberals who will defend anything. That’s like saying it’s the auto manufacturers fault you drove your car at 100 miles an hour into a concrete wall.
Read more here: http://voices.kansascity.com/entries/fannie-and-freddie-were-heart-crisis/#storylink=cpy
Not as uninformed and you think. Graham Leach Bliley repealled the Glass Steagall Act opening the doors to the risky (some would say fraudulent) banking activity that brought us low. To take your analogy a step further it was like repealing speed limits. Sometimes you have to stop people from being stupid for everyone’s safety.
Kevin O'Brien
1 year, 5 months agoI know what it did dim one. The backing of Fannie and Freddie were the sole cause of this behavior. Without that gurantee banks would have never taken the risk. You lose move on!
JR Beillenhouser
1 year, 5 months agoYou STILL need to read reckless endangerment Mark……
Read more here: http://voices.kansascity.com/entries/fannie-and-freddie-were-heart-crisis/#storylink=cpy
No, he gets everything he needs to know from the Daily Kos.
Kent Mueller
1 year, 5 months agoMark….Graham Leach Bliley had nothing to do with Fannie and Freddie, the topic if this string. They didn’t buy a bank, insurance company or and investment house. They did this with the help of their friends in congress. Please stay on topic.
Mark Hastert
1 year, 5 months ago….Graham Leach Bliley had nothing to do with Fannie and Freddie
Read more here: http://voices.kansascity.com/entries/fannie-and-freddie-were-heart-crisis/#storylink=cpy
I think if you’ll look a little harder it has everything to do with the risky banking/lending practices that were facilitated by the repeal of Glass Steagall. Fannie & Freddie jumped in with both feet along with big Wall St investment banks, BOA, etc. Had Glass Steagall remained intact we would not be in the mess we’re in now.
Glass Steagall ensured that there were clear boundaries between commercial and investment banks. The year before the repeal, sub-prime loans were just five percent of all mortgage lending and were confined to the riskiest borrowers, by the end of 2008 they were approaching 30 percent with qualified borrowers being shunted into them. Why? because the investment makers (people who lent on homes purchases for the value of the portfolio) were replaced by risk takers from the investment banks and sound lending practices were replaced by front loaded loans thus eliminating concerns about long term risks.
In keeping with the Season watch “It’s a Wonderful Life”
Kent Mueller
1 year, 5 months agoMark, Fannie and Freddie are neither commercial nor investment banks. Glass Steagall had nothing to do with the GSE’s. Yes, I know the difference, having worked for both types of banks. You make an observation that sub prime loans grew once Glass Steagall had been altered. What you failed to do was to make a connection. Yes, I know you said investment makers (what on earth are those? I’ve spent decades in the business and have never known a lender as an investment maker)were replaced by risk takers from the investment banks. And yes, I know that sounds good. The only problem is is that it isn’t so. Investment bankers weren’t transferred to the mortgage origination department. Plain and simple.
Indeed there were many problems in the mortgage debacle, just not those your referenced.
Mark Hastert
1 year, 5 months agoYou guys can’t seem to follow the money trail nor are you willing to acknowledge the mutation in the mortgage market since deregulation. It’s a process that began in the 1980’s and continues today.
The dishonest and illegal loan practices that resulted in a swollen market share for sub-prime loans was all a for profit scheme. The hybrid securities, AAA security ratings, credit default swaps that brought down? Not Fannie & Freddie I assure you.
If the lending instituion get’s paid up front in fees, dumps the loan into a portfolio and sells it within short while they simply stop caring about the quality of the loans. It turns into a quantity over quality game. Maybe investment bankers weren’t transferred into mortgage origination but I know first hand that mortgage origination became a wreckless game of yield spread premiums, deception, and closing volume based purely on bonuses.
This appears in today’s NY Times.An Op/Ed entitled The Big Lie
“…Thus has Peter Wallison, a resident scholar at the American Enterprise Institute, and a former member of the Financial Crisis Inquiry Commission, almost single-handedly created the myth that Fannie Mae and Freddie Mac caused the financial crisis. His partner in crime is another A.E.I. scholar, Edward Pinto, who a very long time ago was Fannie’s chief credit officer. Pinto claims that as of June 2008, 27 million “risky” mortgages had been issued — “and a lion’s share was on Fannie and Freddie’s books,” as Wallison wrote recently. Never mind that his definition of “risky” is so all-encompassing that it includes mortgages with extremely low default rates as well as those with default rates nearing 30 percent. These latter mortgages were the ones created by the unholy alliance between subprime lenders and Wall Street. Pinto’s numbers are the Big Lie’s primary data point. Repetition is all-important to spreading a Big Lie.
In Wallison’s article, he claimed that the charges brought by the Securities and Exchange Commission against six former Fannie and Freddie executives last week prove him. Rarely, however, has his intellectual dishonesty been on such vivid display. In fact, what the S.E.C.’s allegations show is that the Big Lie is, well, a lie. The S.E.C. complaint makes almost no mention of affordable housing mandates. As Karen Petrou, a well-regarded bank analyst, puts it: “The S.E.C.’s facts paint a picture in which it wasn’t high-minded government mandates that did [Fannie and Freddie] wrong, but rather the monomaniacal focus of top management on market share.” ….”
I’ve encounter Ed Pinto before and he’s spreading BS for hire. He’s been quoted in a number of real estate publications. Both he and Wilkinson’s false conclusions have been rejected by the other members of the Financial Crisis Inquiry Commission. They were as bad as many of the Wall St malefactors but certainly no worse.
Kent Mueller
1 year, 5 months agoFirst of all, Mark. The NYT Opinion Page is a pretty sorry place to look for solid analysis. There wouldn’t have been any significant deterioration of credit quality without Frank, Dodd, et al buying votes with mortgages for everyone. Wall Street certainly played a big role, but it was Democrats in Washington who set the stage.
Kent Mueller
1 year, 5 months agoMark, perhaps you aren’t checking the Diuguid blog on which we were commenting anymore. But, I asked a question of you, perhaps after you stopped reading it. I’d like to get your answer to it, ok?