Blaming Fannie Mae
Fannie Mae and Freddie Mac, the so-called Government-Sponsored Entities, really did have some serious problems that have contributed to the current financial crisis. They also really were, politically, generally closer to the Democratic Party. Thus it’s useful for Republicans to act, as John McCain did in his speech this morning, to focus on the tree GSE malfeasance rather than the forest of overall systemic failings. But it doesn’t really make sense. Consider the term “subprime mortgage” that you may have heard. Well, it turns out that what it means for a mortgage to be “subprime” is that it doesn’t meet Fannie or Freddie standards.
Beyond that, it’s impossible to say whether additional regulatory authority over the GSEs would have been necessary or sufficient to reduce the impact of this crisis because the existing regulators weren’t using their existing authority. Arguably, the authority they already had would have been sufficient had they used it. Indisputably, giving additional authority to people unwilling to use their existing authority wouldn’t have changed anything. And that set of regulators wasn’t the only set asleep at the switch — the Fed dragged its feet on the subprime issue despite Fed Governor Ed Gramlich’s warnings about problems here, and the SEC ignored the risks associated with the highly leveraged trades that were being made.
Problems existed with the regulatory oversight across the board. And of course part one crucial common thread here is that all of these agencies were headed up by conservative deregulators. The same people not enforcing environmental regulations and not enforcing civil rights law and not enforcing labor rights were also not doing their job at the financial regulatory agencies. Conservatives believe that the role of agency heads is to avoid using their regulatory authority in constructive ways.
20 Responses to “Blaming Fannie Mae”
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September 19th, 2008 at 10:59 am
If you’re going to post about the real estate/financial meltdown, you should take a day or two and read up on all of Tanta’s ubernerd posts.
September 19th, 2008 at 11:31 am
With every passing day, I feel like I understand this less and less. I am looking for help in understanding the following.
Is it true that Fannie/Freddie did not extend loans to subprime borrowers, but instead invested their revenues in the subprime markets?
- g
September 19th, 2008 at 11:42 am
Greedy mortgage brokers. Do the basics matter? The only solutions are whatever makes “the markets” happy. The government takes over the risk, the markets are happy. We must be paranoid of the schizophrenic markets.
September 19th, 2008 at 11:57 am
I didn’t catch McCain’s speech.
It’s true that in 2005 they were talking about increased oversight of the GSEs, claiming that they were too big and if they failed it’d cost the government a boat load of money. At the time the GSEs had gotten in trouble for understating their profits, and they were using this to make their case, that their accounting was unsound.
Here’s the thing though… (I worked for a subprime lender for 10 years) The real argument was coming from the MBA(mortgage bankers association), and their problem was that the GSEs were too efficient and as a result there was no way to make money in the conforming mortgage market. What the MBA wanted was for the GSEs to be knee-capped. So in 2005 they were talking about placing a limit on their balance sheet. You can only hold so much, that’s it. This would have resulted in the market opening up to non-GSE mortgage offerers. It also meant mortgage rates would go up slightly.
I don’t know if the oversight they were talking about would have made a difference. It may have meant the GSEs weren’t involved, but those problems would still have been there in all the other mortgage companies. Perhaps with the GSEs kneecapped, these other companies would have made more money and been content with that and as such not pushed the limits on non-conforming so hard.
I guess what I’m saying is McCain was perhaps right, but for the wrong reasons. And it’s worth remembering that McCain’s push for this was coming because he was beholden to MBA lobbyists.
September 19th, 2008 at 12:43 pm
Re “Fannie Mae and Freddie Mac, the so-called Government-Sponsored Entities, really did have some serious problems that have contributed to the current financial crisis. They also really were, politically, generally closer to the Democratic Party. ”
—————–
ha ha ha ha. About a week late, Matthew.
Oh ,well, Obama is from Chicago. We were fools to expect a virgin.
September 19th, 2008 at 3:14 pm
The great problem for Fannie Mae is/was not the actual losses they will suffer for holding mortgages or guaranteeing them, and not that they ran out of capital, but after some time the market didn’t just insist on a large surplus of capital but a virtual continuous source of fresh capital as well.
This caused them to take steps to preserve the capital they had, and one of the methods they used was to NOT buy mortgages hand over fist precisely when Paulson needed them to do exactly that. Instead they were buying at a measured pace, and making sure they earned enough to compensate for the risks they took.
You can see today that they are expanding their portfolios quickly (as is the Treasury) now that Paulson is their virtual CEO. Then also have a new capital standard - essentially zero.
Granted that Fannie had a sizable alt-A and subprime portfolios - about 11% of their total, but they also had a large amount of credit protection for them. They had reserved against those losses in full, and still had $49 billion of capital. Many observers still mistakenly think the Treasury put money into them. They absolutely did not! They siezed them to run them their way, which is to be the secondary mortgage market.
A lot of bullsh*t has been thrown against the wall over the years, and now most people think it sticks. When you understand these issues, feel safe to assume that if you read it on the Wall Street Journal Editorial page, it’s still bullsh*t. Fannie Mae didn’t originate the bad mortgages, they didn’t lower interest rates and leave them there to the point where people disregarded all risks. They didn’t create the loans, nor create the illiquidity which caused this crisis.
September 19th, 2008 at 4:32 pm
Fannie Mae didn’t originate the bad mortgages, they didn’t lower interest rates and leave them there to the point where people disregarded all risks. They didn’t create the loans, nor create the illiquid which caused this crisis.
True. They just made widespread “bad mortgages” a possibility for our system (or, more properly, the implicit taxpayer guarantee of Fannie/Freddie make widespread bad mortgages possible).
Remove Fannie/Freddie (or at least their taxpayer guarantee) from the picture, and buyers of mortgage paper will — as shocking as this sounds in the United States of Free Lunches — actually be required to do painstaking risk analysis. And that means it gets a lot harder to lend money to bad risks. Because it makes it a lot harder to sell those loans-to-bad-risks to a sucker further on up the food chain. As a taxpayer I’d be tickled pink to learn that the government has allowed me to get out of the mortgage lending business when this crisis has passed a few years down the line. and that’s mostly because, by forcing the vast majority of mortgage borrowers into loans that pass muster with a free market, it will make a future bailout a lot less likely (it will also make the country a more prosperous place, by curbing the misallocation of (excess) capital into housing).
I want Obama to win, and I want the Democrats to deepen their majorities. But I’d like to have that outcome and still allow the GOP into power for just one day — that day in 2011 when the vote comes up for what to do with Fannie/Freddie. The GOP, I suspect, will quite rightly advocate getting me out of the mortgage lending business. The Democrats will want me to remain.
September 19th, 2008 at 10:10 pm
matthew,
I think your foreign policy realism, is usually right on, but you economic policy needs a lot of work. First off Fannie and Freddoe would issue guidelines on loans that would totally misrepresent the risk that was being taken on in these loans. What was clearly subprime would be upgraded all in the name of getting anyone in the lower middle class (to poor) a home. That’s certainly an admirable thing to do, but unfortunately for everyone today—the gravy train ran out. I agree that this whole thing goes beyond Fannie and Freddie (Sarbanes Oxley is another tragedy as well) but Fannie and Freddie are the foundation of this disaster…as in foreign affairs there’s no such thing as a free lunch.
About McCain though…he is absolutely disingeuous on this issue. He was for proping these two viruses up when they were seized, telling everyone that they serve an important function. Apparently that function for him these days is wrecking the economy.
September 20th, 2008 at 1:16 pm
Jasper - You are very wrong. Fannie and Freddie did not make subprime mortgage possible. It was the securitizations by the big Wall Street i-banks (Lehman, Bear Stearns, Merrill, Morgan Stanley) that made this possible. Without the securitizations, there is no way to off-load the bad mortgages. With the securitizations, you could originate the worst most risky mortgage in the world and still find a ready buyer. This is/was the problem.
G - You are correct. The problem with Fannie and Freddie was that they bought a lot of the bonds issued through the securitization vehicles which made them double-exposed to the mortgage markets. This very bad investment practice and any risk manager with 5 minutes experience knows better than to do this.
September 20th, 2008 at 9:04 pm
Remove Fannie/Freddie (or at least their taxpayer guarantee) from the picture, and buyers of mortgage paper will … actually be required to do painstaking risk analysis. And that means it gets a lot harder to lend money to bad risks. Because it makes it a lot harder to sell those loans-to-bad-risks to a sucker further on up the food chain.
That sounds almost plausible, but flies in the face of the facts. Yes, Fannie and Freddie provide(d) liquidity to the mortgage finance markets, but for the most part, they provided it in the form of defining high quality mortgages with definable ranges of risks. Those who created riskier mortgages, those who financed riskier mortgages, those who judged riskier mortgages - the mortgage brokers, the so-called private-label market, and the ratings agencies were outside of Fannie and Freddie.
Further, because of SFAS 133, an accounting rule which changed hedge accounting, both Fannie and Freddie ran afoul of their regulator in 2004 and 2003 respectively, and while effectively on probation, they stopped growing and then shrunk their participation in the market.
The liquidity flooded in anyway as did the originations and the lack of respect for risk. Throw in sustained negative real interest rates and a feckless Fed Chairman (who actually praised the rise of adjustable rate mortgages at precisely the time borrowers should have been getting into 30-yr fixed) and the lack of market discipline created this perfect storm.
September 21st, 2008 at 10:50 am
Returning to Matt’s original post:
Fannie Mae and Freddie Mac … really did have some serious problems that have contributed to the current financial crisis.
Easily the most serious problem for FNM & FRE was not theirs, but Paulson’s. For the purpose of their regulator and overall confidence, they needed to preserve their capital while taking expected large losses (appropriately net present values of future cash flows, and not mark-to-market). And Paulson needed them not just to aid the mortgage markets, but BE the markets. He needed them to buy bigger mortgages and expand their portfolios. Left to themnselves, they were going to keep the portfolio sizes fairly level, and take less risks by concentrating on higher quality mortgages.
Paulson took them over in the hopes that he could operate them so as to soak up a large enough portion of the spill that the remainder could be contained. His intervention has served to further impair confidence in all our financial institutions, a delicate thing indeed. Now he’s operating them to dramatically expand their portfolios, completely disregard any capital cushion, as well as having the Treasury buy their MBS.
These actions, as dramatic as they are, show why he took over the companies. They were private companies that served a public purpose. Either he could end their relationship with their stockholders, or he could create his own new agency from scratch. It turns out, he pretty much has to do both.
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