Causes and Instruments
George Will asks rhetorical questions:
Suppose there had never been implicit government backing of Fannie Mae and Freddie Mac. Better yet, suppose those two had never existed — there was homeownership before them, just not at a level that the government thought proper. Absent Fannie and Freddie — absent government manipulation of the housing market — would there have developed the excessive diversion of capital into the housing stock?
I completely agree that spinning Fannie and Freddie off as private firms with a hazily public mission and implicit government guarantee was a mistake. But that said, while I understand conservatives’ desire to push the “real” blame for the present crisis far enough into the past so as to exculpate the Bush administration but as with the Community Reinvestment Act you have to think about the timeline. The financial panic is happening in 2008. The housing bubble burst in 2006. And it only really came into existence in the 21st century after the bursting of the tech stock bubble. Fannie and Freddie were spun off in 1968. So it hardly makes sense to say that their mere existence is responsible for our current predicament. Rather, because Fannie and Freddie exist an unsustainable housing bubble brought them down. But it’s bringing other firms down, too, and if they didn’t exist there would just have been some other firms taking on these bad loans. They were the instruments through which some portion of these problems occurred, but not the root of the problem.
What’s more, in terms of the housing bubble the policy error (if any) was much more plausibly a sin of omission than one of commission. Perhaps policymakers — most plausibly those in the Bush administration, but in theory congressional Democrats as well — could have done something to try to end the bubble psychology back in 2003 or 2004 or 2005, but they didn’t. But for various reasons they chose not to do so.
50 Responses to “Causes and Instruments”
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October 1st, 2008 at 1:29 pm
Fannie and Freddie… Important Swing Voters in 2008.
But do you know the Top 50 Swing Voters in 2008?
#50 - Hockey Moms
#47 - People with STDs
#44 - Women with Unfortunate Muffin Top Tattoos
#41 - Predatory Lenders
#40 - ???
October 1st, 2008 at 1:32 pm
We could extend George Will’s argument,
- without the creation of the Gutenberg press contracts and loan documents would have been too expensive to produce, so you see the real cause of the subprime crisis is the… Bible, or at least printing it.
October 1st, 2008 at 1:34 pm
You’re forgetting that in conservative America, Fannie and Freddie weren’t victims of the bubble; their existence was the cause of the bubble. If only we’d regulated them in 2006 (or, as Will says, if they’d never existed) everything would be fine!
October 1st, 2008 at 1:34 pm
Yeah, these arguments are pretty weak. There were plenty of factors that led to the housing market bubble. And there were plenty of simple measures the federal government could have taken to deflate it or soften the landing once it began developing. If the existence of Fannie Mae and Freddie Mac prevent the Bush administration from addressing this problem up front that would be one thing. But that’s not the case. The fact remains that this problem developed on their watch and they did nothing to address it.
October 1st, 2008 at 1:36 pm
We could extend George Will’s argument…
You’re a piker. How’s this: Suppose mankind had never developed agriculture. Absent the reliable presence of vegetable food, we’d still have a self-reliant society of strong nomadic hunter-gatherers, not the limp and ineffectual degenerates of the present day.
October 1st, 2008 at 1:39 pm
Matt, if I recall correctly, Fannie and Freddie bought 44% of the sub-prime mortgages. Indeed, in the last decade they were subject to political pressure to buy a lot more of them. So inanely repeating that they and CRA were both set up a long time ago doesn’t do you any good if their behavior has changed recently in a manner that facilitated the crisis. (There’s also some argument that the Clinton administration enforced CRA a lot more vigorously than the previous administrations had).
Moreover, you can’t just assert a counter-factual that other firms would have bought up the loans. Maybe they would have. But you need evidence for that claim. Fannie and Freddie were the most aggressive purchasers of the sub-prime loans. Other firms bought them too. But maybe, without Frannie, net less loans would have been bought up. Then, the crisis would not have been nearly as bad. It’s a matter of degrees (which is something you seem perfectly capable of understanding when it comes to international cooperation). Moreover, it’s not like nothing was done to try to regulate Fannie. The Bush and Clinton administration both tried to reign in Fannie’s lending powers. In both cases, they were thwarted by Congressional Democrats. Clinton has said as much.
October 1st, 2008 at 1:40 pm
Matthew, if you have a minute, you should look at the comments to Tyler Cowen’s blog post on this topic and rebut those as well, as they add another layer to the analysis.
The gist is that there were some Congressional reforms ~ 2004 that allowed Freddie and Fannie to buy Alt-A and subprime mortgage-backed securities and theoretically that could have driven up the volume of those types of mortgages.
It seems implausible, as F&F were hardly the only players out there buying MBS.
October 1st, 2008 at 1:44 pm
Maybe I’m completely wrong here, but from this layman’s perspective it seems like blaming Frannie and Freddie for the whole crisis is like this:
There’s a domino chain where domino A knocks over domino B, which in turn knock over domino C, and so on, and eventually goes down different paths where D knocks over E1 and E2 and E3 and E4. All dominoes are red, except for E2 and E3, which are blue. After they’ve all fallen, someone shows up and surveys the scene and says “Well, this is obviously the fault of the blue dominoes.”
October 1st, 2008 at 1:56 pm
Jamie, you do not recall correctly. In 2006 and 2007, Fannie and Freddie bought 18% of subprime securities issued. Also, the idea that they made these purchases wholly or mainly because of political pressures is questionable–they, like a lot of other buyers, thought they would make a lot of money by holding subprime MBS.
For some reason, a lot of people seem very invested in trying to find some cause for this crisis that’s not market failure. That dog won’t hunt.
October 1st, 2008 at 2:05 pm
Or you could say it’s like blaming the World Trade Center for 9/11.
October 1st, 2008 at 2:10 pm
The conservatives like to posture that defeat of a McCain cosponsored bill in 2005 (s.190) was a missed opportunity to avoid the mortgage crisis. McCain likes to tout this bill as his push to regulate the housing GSEs and his great effort to thwart the sub-prime meltdown.
But what the bill actually called for was regulation to force Fannie/Freddie to buy only securitized mortgages, disallowing them to own individual mortgages. The AEI was a primary cheerleader of this reform (google AEI + Peter Wallison + s.190). Their argument was that this legislation would abandon interest rate risk in exchange for doubling down on the less systemic (read: safer) credit risk.
Well, as we know now, the mortgage meltdown is a result of miscalculating credit risk (not interest rate risk), much of which was made possible by the popularity of securitized mortgages.
I’m no expert, but I believe that the Republicans’ silver bullet for “McCain is a mortgage reformer” - The Federal Housing Enterprise Regulatory Reform Act of 2005 - would have actually accelerated the downfalls of Fannie/Freddie, had it been successful.
October 1st, 2008 at 2:21 pm
Mike in MI:
Well, as we know now, the mortgage meltdown is a result of miscalculating credit risk (not interest rate risk), much of which was made possible by the popularity of securitized mortgages.
As Matt has pointed out before, financial firms weren’t forced to invest in profitable securitized mortgages. It was the magic of the market. As he said, all of the money from tech bubble flowed into real estate.
Conservatives want to blame it on government, when it was obviously a massive market failure. These firms were in stiff competition which forced them to make risky bets. Of course there was a lack of regulation and transparency on what was going on, which was an intended government failure. Because these firms lobbied not to be regulated.
October 1st, 2008 at 2:33 pm
Sean,
Fannie and Freddie are carrying 44% of the foreclosed homes.
http://www.all-foreclosure.com/2008/uncategorized/fannie-and-freddie-carrying-44-percent-of-foreclosed-homes
They also bought 44% of the subprime loans in 2004.
http://www.washingtonpost.com/wp-dyn/content/article/2008/06/09/AR2008060902626_pf.html
I may have been conflating these two numbers. Anyways, it’s clear that they were pushed by politicians to take on risky loans-I don’t think that’s really in dispute. What is in dispute is the degree to which they should be blamed for the crisis. I’m not saying they should take on all of the blame, or even the majority of it. The markets also clearly failed. But in a matter of degrees, the crisis would not be as bad if the purchaser of 40% of the foreclosed loans had not been a single GSE.
October 1st, 2008 at 2:37 pm
Perhaps there are two quite separate issues here.
One, a set of policies that pushes up the equilibrium price of homes and equilibrium percentage of families enjoying “home ownership”.
Shifting the equilibrium point does not make a bubble.
Second, a set of policies that bump the prices and the supply yet higher. And the higher they fly above equilibrium, the steeper the drop.
I think that on the most macro level, central banks of USA, China and several other countries decided that it is OK to have a global savings imbalance, with USA absorbing several trillions of the saving surplus of other countries. Barnanke is on record lecturing about the benefits of such arrangement.
One level lower, there was mechanism of risk management that was allowed to thrive, and allowed to mask an enormous amount of market risk, ostensibly insured by entities without means to cover the losses. This is rather central to the concept of securitization of sub-prime mortgages. If you lend to people who put 20% down on their purchases, you have basically AAA paper. If you borrow to people who put down less, the risk of default prevents you from selling this loan to others unless a third party agrees to bear that risk. Now, for a mere 0.1% per year I could be the third party, say, for a billion worth of mortgages, so I would get each year a cool million dollars. Worst come to worse, I would liquidate all my possessions, minus the salaries and bonuses I paid to my stuff, which would yield, say, a million, but the holders of the paper are in a hole worth, say, 200 million. Clearly, I got money for nothing. So how much should I risk? Suppose 200 million. But I could get 10 million of almost risk free interest, would I have that much money! So the price should be higher that 1% per year, perhaps, 2%. At this point, honestly structured loans cannot compete with dishonest, unless the buyers of the securities can tell the difference.
Subprime loans were always possible in principle, but there were hard to insure and trade, and the interest difference was big. Moreover, there existed a recognition that when the downpayment is below, say, 10%, we are entering sub- sub territory, making the loans so expensive that hardly anyone could afford them. After all, the fact that you could not come up with even 10% down does not make it more possible for you to pay 2% extra each year, if not 3% extra.
Once the price of insurance became much lower than honest, honest competition was very difficult. This is where regulation should intervene, but it did not.
Recap: when we compare the period of 1990-2000 and 2000-2008, there is hardly any difference in any aspect of the housing market except for risk management, and the changes were either enabled by the regulatory changes, or at the very least, not prevented by regulators who could figure out that old principles were still valid, and that old principles were being violated.
October 1st, 2008 at 2:38 pm
Fannie and Freddie directly contributed toward overinvestment in housing stock due to subsidized interest rates for the housing market in general. So the scale of the problem can partially be attributed to them.
Furthermore, their participation contributed to *stability* in the housing market that market participants mistook as equating housing with sure bet. This stability in prices made participants think that the market could sustain a lot of leverage and loan quality wasn’t terribly important. This change in the attitudes of the market occurred over *time* due to derivative pricing models that use historical data. It takes lots of data for these models to generate adequate confidence intervals.
In summary: Fannie and Freddie weren’t sufficient causes, but they were probably necessary causes. It’s certain that we wouldn’t have the scale of the problem that we do if they hadn’t existed.
October 1st, 2008 at 2:43 pm
Matthew,
Because Fannie and Freddie were not permitted to make so-called jumbo loans, they only affected a portion of the market. And I recall seeing several academic studies which estimated the effect of Fannie and Freddie on interest rates for non-jumbo loans. Effects were pretty small to my memory. A quick trip to google scholar can give you exact estimates, but I think you’re talking about less than 25 basis points, at most. The fact that their presence exerted seemingly little force on loan interest rates seems consistent with the idea that the market would have been largely the same without them.
Michael
October 1st, 2008 at 2:45 pm
Will is doing the old conservative dodge, that the difficulty of properly regulating and managing institutions could be avoided if we just eliminated the institutions. We’ve seen how this works in practice: it fails. The way to properly regulate and manage institutions is to appoint competent people whose mission is to properly regulate and manage those institutions, and pay them well. At age 70-geezer, Will is finally becoming a grownup, but he still has some silly Reagan youth in him.
October 1st, 2008 at 2:49 pm
Fannie and Freddie are carrying 44% of the foreclosed homes.
I like how the all-foreclosue link pulls 44% out of nowhere(or, maybe some secret place they don’t want to tell us). There is only one link in the post. The link goes to a Chicago Tribune article which also does not say 44%.
October 1st, 2008 at 2:52 pm
Anyways, it’s clear that they were pushed by politicians to take on risky loans-I don’t think that’s really in dispute
My goodness. You have no evidence, no one in the world is agreeing with you, and you fall back on “I don’t think that’s really in dispute.”
Are you realy Sarah Palin’s sock puppet?
October 1st, 2008 at 2:56 pm
Sure Matt. No actions in the past led us to the present. So the terrorism against Israel is a mystery, since we can’t ponder 1948, 1968, 1973, or any of the actions of Arab or Israeli governments in the interim.
Likewise, the 2003 war against Iraq is a mystery, because we can’t consider the 1991 Gulf War, or the post Versailles creation of Iraq itself - those are in the past, and thus irrelevant. Heck, how could any of the events from the Paris Peace conference possibly affect us now, anyway?
Jeez Matt, do you put your stupid hat on when you talk about economic policy? Just as with foreign affairs, it’s all additive from past impacts. We can argue over relative weights, but claiming that the initial and modified structure of the US housing market is irrelevant is, well, stupid.
October 1st, 2008 at 2:59 pm
One man is to blame for the housing meltdown: Alan Greenspan.
October 1st, 2008 at 3:13 pm
Re mars says “One man is to blame for the housing meltdown: Alan Greenspan.”
————
I wouldn’t object if Alan was publicly flogged on the National Mall, but I consider Rep Jim Saxton and Senator Robert Bennett also greatly at fault.
Which is why I suspect the 2005 Joint Economic Report has gone missing off of Thomas.gov.
Unlike the Executive Branch and the Fed, Congress doesn’t have to EXECUTE anything — Congress has the time for –and is supposed to — exercise oversight, look at the bigger picture, and intervene to prevent problems.
But you get distracted when you spend half your day calling up campaign donors and giving them phone sex.
October 1st, 2008 at 3:16 pm
Unlike the news media, Reason has put up a relatively coherent description of who screwed the pooch. Democrats en masse played a role, according to them.
See
Has anyone gotten a look at Danny Schechter’s book “
October 1st, 2008 at 3:19 pm
And maybe you grab a Home Equity Line Of Credit because your wages are stagnating.
And maybe with wages stagnating, banks shouldn’t push HELOCs.
And maybe under Democrats our economy grows far better, and shares growth evenly, allowing working people to have jobs and to pay their mortgages.
October 1st, 2008 at 3:19 pm
Sorry –hit the wrong button.
Has anyone gotten a look at Danny Schechter’s book
“Plunder: Investigating Our Economic Calamity and the Subprime Scandal” ?
Reason’s timeline on subprime mess is at
http://www.reason.com/news/show/129158.html .
May be a pack of lies –haven’t double checked it yet.
October 1st, 2008 at 4:03 pm
Dear Mr. Will,
Can I stomp on your big toe every time you confuse necessary and sufficient causes?
Thanks for your attention in this matter.
October 1st, 2008 at 4:25 pm
To pile on, Rush Limbaugh went even FURTHER back for blame on today’s show! This is reparations, people! So go back to the 1800s and blame the promise of 2 acres and a mule!
I wish I were kidding, but I heard the bloviating gasbag say this on his show.
October 1st, 2008 at 5:17 pm
Matt,
You’re starting to do a good job of channeling my stuff into acceptable form.
As you say, more sins of omission than commission (although one could argue that the commission system of compensating mortgage brokers was a big part of the problem). Essentially, this was a regulatory failure, a failure to prevent excessive leverage both at the high end (Wall Street) and in the bottom two-thirds or so of American society, who, especially in California, Arizona, Nevada, and Florida, where half the foreclosures and probably 2/3rd or 3/4ths of the dollar value of defaults are found, took on excessive risk in homebuying.
The single simplest regulation would have been to insist upon minimum down payments for mortgages, of, say, merely 5%. But President Bush had spent a lot of 2002 and 2003 on the warpath against down payments, denouncing them as the primary barrier to minorities getting their fair share of the American Dream:
President George W. Bush addresses the White House Conference on Increasing Minority Homeownership at The George Washington University Tuesday, Oct. 15, 2002
THE PRESIDENT: …. I appreciate your attendance to this very important conference. You see, we want everybody in America to own their own home. That’s what we want. This is — an ownership society is a compassionate society.
More and more people own their homes in America today. Two-thirds of all Americans own their homes, yet we have a problem here in America because few than half of the Hispanics and half the African Americans own the home. That’s a homeownership gap. It’s a — it’s a gap that we’ve got to work together to close for the good of our country, for the sake of a more hopeful future.
We’ve got to work to knock down the barriers that have created a homeownership gap.
I set an ambitious goal. It’s one that I believe we can achieve. It’s a clear goal, that by the end of this decade we’ll increase the number of minority homeowners by at least 5.5 million families. (Applause.) … And it’s going to require a strong commitment from those of you involved in the housing industry. …
… To open up the doors of homeownership there are some barriers, and I want to talk about four that need to be overcome. First, down payments. A lot of folks can’t make a down payment. They may be qualified. They may desire to buy a home, but they don’t have the money to make a down payment. I think if you were to talk to a lot of families that are desirous to have a home, they would tell you that the down payment is the hurdle that they can’t cross.
http://vdare.com/sailer/080928_rove.htm
October 1st, 2008 at 5:42 pm
Will and the other conservatives are going to focus on the past trends that they objected to, and blame the failures on those. Just as you all focus on the past trends that you objected to, and blame the failures on those.
It is a fact that Fannie and Freddie were pressured to increase the loans to higher-risk individuals. http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
It is also a fact that apparently the managers of the large I-banks are morons who would rather stick their heads in the sand than actually manage the risk in their portfolio. It’s pretty clear that they found ways to ’skirt’ regulatory restrictions on risk. And everyone else on Wall Street had to run along with them, or risk getting smaller bonuses.
Of course, if you agree with that previous statement, then you should also agree that if Fannie Mae started loaning large amounts to higher risk people, other organizations were going to follow along, for the same reasons (risk of smaller bonsues)
So you can say ‘It is the fault of the greedy investment bankers’ and I would say ‘Yes, it is, at least partially’. You can also say ‘It is the fault of Fannie Mae for making bad loans’ and this is also true, at least partially.
As jamie noted earlier, Democrats are remarkably nuanced in their willingness to apportion blame and responsibility for international issues. However on domestic issues, y’all seem to always find a way to make it the fault of Republicans. (And Republicans always seem to conveniently break the other way).
October 2nd, 2008 at 10:25 am
I actually went to the Washington Post article that Jaimie (and I guess George “I am the living definition of a stuff shirt” Will) relied on to blame the whole thing on FDR’s creation of Fannie in 1938. Funny, but I don’t think FDR (or Clinton) was president in 2004 and I somehow think this party called the Republicans ran the Congress. And there was an election involving that President in 2004, was their not?
“But by 2004, when HUD next revised the goals, Freddie and Fannie’s purchases of subprime-backed securities had risen tenfold. Foreclosure rates also were rising.
That year, President Bush’s HUD ratcheted up the main affordable-housing goal over the next four years, from 50 percent to 56 percent. John C. Weicher, then an assistant HUD secretary, said the institutions lagged behind even the private market and “must do more.”
For Wall Street, high profits could be made from securities backed by subprime loans. Fannie and Freddie targeted the least-risky loans. Still, their purchases provided more cash for a larger subprime market.
“That was a huge, huge mistake,” said Patricia McCoy, who teaches securities law at the University of Connecticut. “That just pumped more capital into a very unregulated market that has turned out to be a disaster.”
In 2003, the two bought $81 billion in subprime securities. In 2004, they purchased $175 billion — 44 percent of the market. In 2005, they bought $169 billion, or 33 percent. In 2006, they cut back to $90 billion, or 20 percent. Generally, Freddie purchased more than Fannie and relied more heavily on the securities to meet goals.”
I guess what we non-socialist liberals are arguing is that this was a combined failure of the market and regulation, an example of crony capitalism, and if there is a very fundamental causes, it was the stagnation of median income growth in the U.S. along with a deregulation credit with risk management becoming primarily a job of passing “risk” along to a final stuckee the last thrity years. rrisuthe last . The best criticism of the current bailout is that it continues the policy of Government intervention for the benefit of the select and politically connected few (connected to both Republicans and Democrats -(I think an example of this are Senators Dodd & Schumer for whom the investment bankers and the hedge fund managers are needy constituents, not “the malefactors of great wealth.” Hence, no real limits on executive compensation and very little equity ownership for the Government in the banks which will receive public funds for their “shit,” which I think is the best technical term for the CDOS, SIVS, and related garbage.
There is still so much denial (I keep hearing talk about “a housing recovery” from Paulson, Bernanke, and the media echo chamber, but the bubble is still deflating, with at least another 20% decline coming. Paper based on bubble housing prices is therefore fundmentally of little value, and at most will recover only 50% of its value, because of this price decline.)
October 2nd, 2008 at 1:44 pm
Fannie and Freddie went into the high risk mortgage market for political reasons. As “government sponsored entities,” they had to strike a balance between making money and supporting low income housing. It wasn’t sensible for other companies to copy Fannie and Freddie’s behavior because other companies weren’t subject to the same political constraints.
Furthermore, many companies didn’t actually copy Fannie and Freddie’s strategies. As the numbers given by rickstersherpa in #30 show, after 2004 they responded to the problems in the market by scaling back on high risk securities. They also tried to minimize their risk by concentrating on “Alt A” mortgages, which are higher quality than much of the subprime market. Some companies did precisely the opposite, increasing their exposure even as the problems with the market became more apparent.
Blaming Fannie and Freddie for the broader subprime mortgage crisis (as opposed to the losses on their own portfolios) is only possible if you use a double standard. It is basicly a way of saying that executives at Fannie and Freddie are not only responsible for their own actions, but for the actions of every executive at every company in the industry.
October 2nd, 2008 at 2:21 pm
James Robertson, sitting in his crappy white-flight house with its painted lawn, will wave around foreign policy examples, but curiously won’t talk about pasty piss-stains like himself who barricaded themselves up in their suburban enclaves to get away from Those People.
And Sailer’s just a Klansman in a suit who talks purty.
October 2nd, 2008 at 7:43 pm
1999 New York Times article
Fannie Mae Eases Credit To Aid Mortgage Lending
This was printed/published in 1999
George W Bush assumed presidency on January 20, 2001
Bill Clinton was President from January 20, 1993 to January 20, 2001
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