Controversy continues to swirl regarding the role of Fannie and Freddie in the subprime crisis. My thesis has been that most of those blaming Fannie and Freddie for the crisis (as a major causative element) do so for political reasons (or worse). A sub-thesis has always been that the conservative effort to blame Fannie and Freddie ultimately indicts the Bush Administration.
Let me explain. The argument that Fannie and Freddie acted as bit players is based upon the fact that neither originated nor securitized subprime loans. Further, their investment in subprime, while reckless and foolhardy, simply was not large enough to drive the crisis. Yes, both GSEs were politically co-opted, and yes both parties used them for partisan advantage. But all the data suggest their subprime investments were too modest to lay the cause at the door of the GSEs.
The panel to the left shows the Freddie and Fannie portfolio of private MBS over time. As you can see both Fannie and Freddie cut their subprime exposure by 2007. Even in 2006, however, their portfolio consisted of about half Alt-A or prime, not subprime. This picture is consistent with the data of Professor Alan White as well as a number of media reports. Basically, there is wide agreement that Fannie and Freddie invested in subprime to a significant degree, but they were cutting their investments by 2007, and much of their investment was higher graded product than subprime.
Any objective view of the source of problems shows that the real estate meltdown started in 2006 and 2007 in the subprime market. The panel to the left shows the very high delinquency rates associated with the 2007 and 2006 cohort of subprime mortgages. Those mortgages defaulted at a rate of 40% within months of origination. So there is a timing disconnect. Fannie and Freddie were cutting subprime investment just as it was getting rotten. Moreover they invested in Alt-A to a very significant extent. The numbers of subprime investments are just too small to lay much blame at the feet of the GSEs, and the timing is also out of kilter.
Which brings me to the Bush Administration. Continuing a policy starting in the Clinton Administration, the Bush Administration used the GSEs to further a political goal of expanding affordable housing. So, on November 1, 2004 the Bush Administration announced an expansion of efforts to get the GSEs to invest in subprime. The HUD press release trumpeting these efforts is available here. The effect of this effort was immediate. Whereas in 2001 Freddie bought $18.1 billion in subprime mortgages, the two GSEs bought $434 billion in subprime loans from 2004 to 2006. More specifically, according to the Washington Post: 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." (Note how this data point dovetails with my timing point, above).
Why did the Bush Administration pursue this folly? The Federal Register gives the formal answer: the Bush Administration wanted the GSEs to be market leaders in the cause of affordable housing, expanded home ownership and expanded minority ownership. The GSEs actually objected to this effort.
Experts have castigated the effort:"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."
"For HUD to be indifferent as to whether these loans were hurting people or helping them is really an abject failure to regulate," said Michael Barr, a University of Michigan law professor who is advising Congress. "It was just irresponsible."
Despite its bi-partisan roots, clearly the Bush Administration put the pedal to the metal for GSE purchases of subprime mortgages.
But, for all the blame for the crisis that is out there, this cause continues to strike me as minor. Fannie and Freddie were bit players. As I mentioned in a recent comment post, however, I have no real dispute with those claiming this was a major cause, so long as that line of thinking recognizes that the Fannie and Freddie role was primarily driven by the Bush Administration in terms of numbers, with a hat tip to Andrew Cuomo and the Clinton Administration.
Finally, I am willing to wager that Wall Street lobbyists stood behind both the Clinton and Bush administration efforts for affordable housing. What CEO could resist the easy profits of packaging subprime, even predatory, loans for sale to the GSEs? Any help on this front would be appreciated.