Saturday, November 7, 2009

Fannie, Freddie and the CRA: A Case of Conservative Mythology

I do not always agree with the Heritage Foundation, but I want to applaud their recent backgrounder Understanding the Great Global Contagion and Recession. It is a balanced, if conservative, overview of the key issues.

Here is their conclusion regarding the role of Fannie and Freddie in the crisis: "While the costs to the taxpayers are inexcusable and those responsible in and out of Congress should be held accountable, the two GSEs played at most secondary roles in the global financial contagion." I could not put it better. Fannie and Freddie did not originate nor securitize subprime loans. There was a bi-partisan effort to encourage the GSEs to invest in affordable loans and after 2004 in the wake of a Bush administration directive the GSEs tripled their purchases of non-prime loans. In 2000, as an example, Freddie bought $18.6 billion in subprime loans. By 2004, the GSE purchases peaked, but only constituted 33% of the market. Thereafter they cut back, and in 2005 their purchases amounted to just 20% of the market.

So, on this point, I concur with the Heritage Foundation: Fannie and Freddie were bit players in the financial crisis or in the exact words of the Heritage Foundation "they were at most incidental."

The Heritage Foundation also found that the Community Reinvestment Act (CRA) was "at most incidental" to the crisis. Here, the Heritage Foundation cites to a now famous Federal Reserve Study that found, according to the Heritage Foundation: "the Federal Reserve Board staff's research of 2006 mortgage originations strongly suggests that the CRA was likely only a minor or incidental factor. As Federal Reserve Governor Elizabeth Duke stated in February 2009, 'only 6 percent of higher-priced loans were made by CRA-covered lenders to borrowers and neighborhoods targeted by CRA.'" The Fed study that proves the irrelevancy of the CRA to the entire financial crisis is available here: Six percent means that 94% of all subprime loans were not CRA loans!

There has long been a steady stream of media analysis demonstrating just how weak the case to pin blame on Freddie, Fannie and the CRA was. In late 2008, two experts stated: "It is not tenable to suggest that the Community Reinvestment Act, which was enacted more than 30 years ago, suddenly caused an explosion in bad subprime loans from 2002 to 2007. During the 1990s, enforcement under the reinvestment act was strong, prime lending to low-income communities increased and it was done safely. In 2000, a Federal Reserve report found that lending under the act was generally profitable and not overly risky."

Another report showed that Fannie and Freddie actually cut their subprime investments in half at the height of the subprime fiasco: "Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding a high of 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent, according to data from Inside Mortgage Finance, a specialty publication."

Over a year ago, Professor of Law Alan White stated: "Fannie and Freddie did play a role, albeit a minor one. As of 12/31/07, Freddie held $234 billion and Fannie held $112 billion in subprime securities, out of a total market of $2,116 billion (i.e. $2.1 trillion). Most of these purchases took place in 2005 and 2006. A significant chunk to be sure (about 15%) but if you took out the GSE purchases, there would still have been a huge subprime market, and there is no way to know whether other buyers might have purchased those same securities if Fannie and Freddie had not (i.e. their presence was probably not vital to the growth of subprime lending and securitization.) Other purchasers of subprime securities included banks and thrifts, foreign investors including sovereign wealth funds, mutual funds, hedge funds, insurance companies, state and local governments, private pension funds, and wealthy institutions and individuals. It is also worth noting that Fannie and Freddie started buying subprime securities late in the game, years after the subprime mortgage market had been launched and its dangerous products deployed."

So why do right wing extremists and other conservatives continue to circulate this myth that the crisis was caused by Fannie, Freddie and the CRA? I think the purveyors of this myth fall into three camps.

First, there is the principled laissez faire enthusiast. Basically these folks are against government involvement in the economy. Even the idea of a central bank is anathema. Fine, I disagree; but I respect the principled and consistent position.

Second, are the party ideologues. Here principle gives way to intellectual dishonesty. The point is to try to blame everything on the Democratic party. Even in the face of a manifestly bi-partisan crisis, generated by bi-partisan policies, the idea here is policy as boxing match. You pick a fighter and then root for him to bash the brains out of the other fellow. Truth is irrelevant as is the best interest of the country. I will call this the Krugman position, after the well-known Noble laureate in Economics, who is similarly dismayed by efforts to pin the blame on Fannie, Freddie and the CRA.

Finally, there are the hard core racists. Constituting perhaps 10-12% of the population, this group simply wants to blame the crisis on people of color. Ann Coulter's theories on the crisis have great appeal to this group because she casts her points in an overtly racial way. Obviously, there is no sign of intelligent life here, there is no point trying to reason with these extremists, and facts and numbers will not hold sway with this portion of body politic.

So, there is a conservative myth that the crisis was caused totally by Fannie, Freddie and the CRA. It is embraced by the 30% of the population that is more conservative than the Heritage Foundation. They tend to substitute heat for light in their arguments, so they make a lot of noise. Their main choice of argument is to hurl insults at those who disagree.

Thinking conservatives, like those at the Heritage Foundation have evolved to a point that their analysis is driven by fact rather than myth.


  1. Ah, yes, those right-wing extremists. Those evil racists at City Journal and The Village Voice. Why you've found the conclusive, irrefutable explanation over at the Heritage Foundation website. How do I know that this is true? Because they agree with you.

    And everyone knows that disagreeing with you makes a person unreasonable, un-evolved, an extremist and worst of all - a racist!

    Here's that pesky Peter Wallison again writing in Commentary:

    IN 1992, AN AFFORDABLE housing mission was added to the charters of Fannie and Freddie, which--like the CRA--permitted Congress to subsidize LMI housing without appropriating any funds. A 1997 Urban Institute report found that local and regional lenders seemed more willing than the GSEs to serve creditworthy low- to moderate-income and minority applicants. After this, Fannie and Freddie modified their automated underwriting systems to accept loans with characteristics that they had previously rejected. This opened the way for large numbers of nontraditional and sub-prime mortgages. These did not necessarily come from traditional banks, lending under the CRA, but from lenders like Countrywide Financial, the nation’s largest sub-prime and nontraditional mortgage lender and a firm that would become infamous for consistently pushing the envelope on acceptable underwriting standards.

    Hmmm, Countrywide Financial, where have we heard that name before?

  2. Continuing ....

    Fannie and Freddie used their affordable housing mission to avoid additional regulation by Congress, especially restrictions on the accumulation of mortgage portfolios (today totaling approximately $1.6 trillion) that accounted for most of their profits. The GSEs argued that if Congress constrained the size of their mortgage portfolios, they could not afford to adequately subsidize affordable housing. By 1997, Fannie was offering a 97 percent loan-to-value mortgage. By 2001, it was offering mortgages with no down payment at all. By 2007, Fannie and Freddie were required to show that 55 percent of their mortgage purchases were LMI loans and, within that goal, 38 percent of all purchases were to come from underserved areas (usually inner cities) and 25 percent were to be loans to low-income and very-low-income borrowers. Meeting these goals almost certainly required Fannie and Freddie to purchase loans with low down payments and other deficiencies that would mark them as sub-prime or Alt-A.

    The decline in underwriting standards is clear in the financial disclosures of Fannie and Freddie. From 2005 to 2007, Fannie and Freddie bought approximately $1 trillion in sub-prime and Alt-A loans. This amounted to about 40 percent of their mortgage purchases during that period. Moreover, Freddie purchased an ever-increasing percentage of Alt-A and sub-prime loans for each year between 2004 and 2007. It is impossible to forecast the total losses the GSEs will realize from a $1.6 trillion portfolio of junk loans, but if default rates on these loans continue at the unprecedented levels they are showing today, the number will be staggering. The losses could make the $150 billion S&L bailout in the late 1980s and early 1990s look small by comparison.

    $1.6 TRILLION. Losses that could make "the savings and loan crisis look small by comparison". You're right, they were "bit players".

    The GSEs’ purchases of sub-prime and Alt-A loans affected the rest of the market for these mortgages in two ways. First, it increased the competition for these loans with private-label issuers. Before 2004, private-label issuers--generally investment and commercial banks--specialized in subprime and Alt-A loans because GSEs’ financial advantages, especially their access to cheaper financing, enabled them to box private-label competition out of the conventional market. When the GSEs decided to ramp up their purchases of sub-prime and Alt-A loans to fulfill their affordable housing mission, they began to take market share from the private-label issuers while simultaneously creating greater demand for sub-prime and Alt-A loans among members of the originator community.

    What, their reckless behavior distorted the market? Hasn't he received "the one true explanation" over at the Heritage website? This guy must be a racist.

  3. And then there is that font of reason Paul Krugman. No "party ideologue" is he:

    …Fannie/Freddie did some bad things, and did, it turns out, get to some extent into subprime. But thanks to the accounting scandals, they were actually withdrawing from the market during the height of the housing bubble — the vast majority of the loans now going bad came from the private sector.

    But, perhaps, Mr. Krugman just needs to read his own paper:

    Fannie Mae and Freddie Mac engaged in “an orgy of junk mortgage development” that turned the two mortgage-finance giants into vast repositories of subprime and similarly risky loans, a former Fannie executive testified on Tuesday

    The former executive, Edward J. Pinto, who was chief credit officer at Fannie Mae, [said] that the mortgage giants now guarantee or hold 10.5 million nonprime loans worth $1.6 trillion — one in three of all subprime loans, and nearly two in three of all so-called Alt-A loans, often called “liar loans.”

    Such loans now make up 34 percent of the total single-family mortgage portfolios at Fannie Mae and Freddie Mac, a level that will link them to eight million foreclosures, or one in six, in coming years.

    The New York Times

    " in three of all subprime loans, and nearly two in three of all so-called Alt-A loans, often called "liar loans." Yeah, they were at most incidental.

  4. Your comments were entirely predictable.

    So, here are my questions:

    You do agree that it was bi-partisan, right?

    And, you certainly agree that Fannie, Freddie and the CRA were not the sole cause, right?

    And, I know we agree that Fannie and Freddie did not originate nor securitize any loans, right?

    So all of you invective comes down to this: I think Fannie and Freddie were minor causes and the CRA played virtually no role and you think Fannie and Freddie were major causes?

    Fine whatever.

    Then, you have to agree that in 2004 the Bush administration ordered the GSEs to invest more in subprime? Bad idea. It was probably a bad idea in the 1990s when Clinton did the same thing on a smaller scale,but it was horrible on the scale of 2004-2005.

    So what are we are arguing about?

    You will never convince me that this was all the Democrats. You do not need to convince me that Fannie and Freddie was a political mess.

    But, even a normal Fannie and Freddie, like in 1992, would not have stopped this mess.

    On that point the Heritage Foundation is dead on.

  5. BTW, Peter Wallinson is a really good, guy.

    Very principled.

    You should read my post, rather than just assume it says what you want it to say.

  6. I never claimed that the CRA or Fannie and Freddies involvement were responsible for the entirety of the crisis, only that they were major contributing factors. Fannie and Freddie were not "bit players" whose involvement was "at most incidental". Like so many utopian social schemes, the CRA's intent was noble - provide access to credit for underserved communities - it's reinterpretation and implementation by the Clinton administration, however, was a travesty.

    You continually refer to Bush ordering the GSE's to invest more in subprime, where is the evidence for this? While not blameless, the fact is that the Bush administration did, on numerous occasions, attempt to rein in Fannie and Freddie. His subordinates routinely testified about the inherent dangers at Fannie and Freddie. Of course, all the while he was taking credit for increased homeownership. I would agree that that behavior was pathetic.

    I first came across this site following a link from a site I read routinely. Reading the posts, I could see that your perspectives were not in line with mine, but interesting. I checked back now and again to get your take on things and left a comment or two. I tried to make those comments forceful and thoughtful, yet civil. If I've failed in that, sorry. I found your initial response to my comments to be condescending in their tone and responded in kind. I do not believe I have all the answers, but I do try to read widely about issues that interest me. Perhaps in the future our exchanges can be more back and forth and less confrontational.

  7. anonymous and professor ramirez:

    i appreciate your recognition of believing differently on this topic and your both "agreeing to disagree" evidenced with some conciliation at the end of the last few posts. the back and forth has been fascinating and enlightenting.

    still anonymous, i am curious as to your take on my long post in the last thread (comment #14). by my way of thinking, if fannie, freddie and the c.r.a. were "major contributing factors" in the subprime debacle, then private sector CEOs and bank executives would have to have followed the lead of government regulators and employees that they so quickly and readily dismiss as economically illiterate and inept.

    why would bright CEOs and bank executives follow the government's lead "off the precipice" if you will, if they are so much more economically schooled so as to be capable of seeing through the morass that this subprime lending could lead to? i personally do not believe that CEOs and bank executives were "forced" to write subprime loans, do you? so if not irresponsibly chasing profit, why overleverage their books so heavily with subprime, even if a sucker was standing at the ready to buy (fannie and freddie)?

    i am no seeing it. any insights?

  8. I do hope to have future exchanges with you. And, I will strive to be less condescending.

    Sitting next to my desk downtown is the order from HUD in 2004.

    I'll post it here very soon.

    BTW, there is probably much that I have written that you would disagree with.

    Here is my SSRN page:

    Steve R.

  9. I found this link:

    It suggests that in 2004 HUD (i.e., the Bush Administration) imposed quotas on the GSEs to invest in subprime.

    I think it just expanded the policy that started with Clinton Administration.