Financial Crisis Not All Fannie And Freddie’s Fault

There is a meme developing that the current financial crisis is all, or at least mostly, attributable to Fannie (FNM) and Freddie (FRE), with a strong supporting role for the Community Reinvestment Act (CRA).  This is simply not true, even if it is repeated in respectable publications, or even in presidential debates.  This is an important point to make, since if a doctor can not make an accurate diagnosis, it is unlikely that he will write the correct prescription.

Let’s review a little bit of history:  Fannie dates from 1938, Freddie from 1968, and the CRA was passed in 1977.  The worst of the bad mortgages were made from 2003 through the first half of 2007.  It sure seems like a very long lead time for Fannie, Freddie or the CRA to be the culprit.

It was the growth of private-label mortgage-backed securities, largely built on mortgages originated by mortgage brokers, not banks, and funded by non-bank financial institutions such as New Century, Ameriquest and Countrywide (late in its life, Countrywide did get a thrift subsidiary) that created the worst paper.

The mortgages that started in these channels were packaged up by Bear Stearns, Lehman Brothers and the rest of the big investment banks and sold bypassing Fannie and Freddie.   Despite a boom in mortgage securitization, the total amount of mortgages securitized by Fannie and Freddie actually fell from $315 billion in 2002 to $276 billion in 2006.  Their market share dropped from 50.1% to 34.8%.  Only in late 2007, when the private label market was imploding, and everyone was afraid that there would be no more mortgages available to anyone, did Fannie and Freddie really start to regain market share, and by the first half of 2008, represented over 70% of new securitizations.

In a debacle like this, there is plenty of blame to go around, and I will not start to claim that Fannie and Freddie were blameless angels in all of this.  However, this focus on Fannie, Freddie and the CRA only serves to distract people from the real culprits.  Yes, Fannie and Freddie ended up drowning in bad mortgage debt.  They did not sacrifice enough market share during the crazy times.  But then again, how many businesses see their market share shrink by over 15% and say we need to give up more?

They yielded to political pressure to pick up the slack in late 2007, but given their charters they were uniquely susceptible to political pressure.  By their charters, they were 100% exposed to residential mortgages.  They were, by design, extremely leveraged.

However, foreclosures have a habit of feeding on each other.  When the house across the street — which was bought with a really bad deceptive mortgage — goes into foreclosure, it lowers the value of your house.  If you have five or six such foreclosures on your block, your house really declines in value.  It’s not that Fannie and Freddie couldn’t swim, but that they were hit with a tsunami, and were all but required to be on the beach.

Subscribe by RSS Subscribe by Email