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: http://www.federalreserve.gov/newsevents/speech/20081203_analysis.pdf. 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.