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.
The answer to Mr. Waxman's question about their role [the GSE's] in the crisis, in other words, is that they were central players, if not the central players, in the creation of the housing boom and the credit bust.
ReplyDelete"Whitewashing Fannie Mae", WSJ
While Fannie and Freddie [GSE's] were theoretically independent corporations they did not have to adhere to the same rules regarding capitalization and oversight that governed most other financial institutions. They had much lower capitalization requirements and a less demanding regulatory regime. Changes made by the Clinton administration in 1995 allowed them to invest up to 40 times their capital in mortgages. By contrast, banks were limited to 10 times their capital. In an effort to increase the number of mortgages that the GSE's could underwrite the government allowed them to become grossly undercapitalized.
The GSE's were also very political, drawing their management and board of directors from the political world and not the business world. As a result, they lobbied heavily and sometimes illegally. In 2006, Freddie was fined millions of dollars for improper election activity. Their management and board of directors read like a who's who of the Democrat party. Franklin Raines, Jamie Gorelick, Rahm Emanuel, etc.. Not surprisingly, most of the money went to Democrats, but is should be pointed out that almost everyone in Congress got something.
The web of corruption widened to include mortgage originators, like Countrywide. Countrywide was the single largest originator of subprime loans and the number one customer of the GSE's. As the WSJ pointed out, "Countrywide wasn't their competitor, it was their partner". Countrywide made billions selling garbage loans to the GSE's and expressed it's gratitude, in part, by writing sweetheart loans to top Democrats. Chris Dodd, Jamie Gorelick, Franklin Raines, Kent Conrad, etc. were all "friends of Angelo".
The impetus for all this was "affordable housing" and the end of discrimination in lending, both noble goals, but as this article points out there was also something else at work:
Clinton Administration regulations in the ‘90s added teeth to CRA, requiring banks to show compliance with meeting low-income loan targets or face civil actions that could assess a 500,000 penalty for each violation. Banks were “encouraged” to comply by hiring community groups (including ACORN) who contracted with financiers to steer low-income applicants to their institutions.
As the Manhattan Institute’s Howard Husock wrote in 2000: “The Senate Banking Committee has estimated that, as a result of CRA, $9.5 billion so far has gone to pay for services and salaries of the nonprofit groups involved.” The left created the system that paid its community organizers very handsomely, thanks to the regulations on the financial community.
Human Events
Before we proceed, it's important to understand that Alt-A loans, sometimes called "liar loans", while not technically subprime, are still just another level of the same garbage and as you admit, "they [the GSE's] invested in Alt-A to a very significant extent."
ReplyDeleteThe argument that Fannie and Freddie acted as bit players is based upon the fact that neither originated nor securitized subprime loans.
This really is immaterial, and misleading. The GSE's mission was to provide a market for these loans, to purchase them from the originators, like Countrywide, providing the liquidity to write more and more loans. Fannie and Freddie both issued securities tied indirectly to the subprime and Alt-A mortgages they purchased. Worse, investors were led to believe that these securities carried an implied government guarantee. This is the reason that many sovereign wealth funds, pension funds and banks purchased these securities.
I really do not understand why you fail to recognize this point, made by Peter Wallison, unless it's just willful blindness. Since it destroys the "GSE's were incidental" narrative, and is logically irrefutable, it bears repeating:
Mortgage brokers had to be able to sell their mortgages to someone. They could only produce what those above them in the distribution chain wanted to buy. In other words, they could only respond to demand, not create it themselves. Who wanted these dicey loans? The data shows that the principal buyers were insured banks, government sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac, and the FHA—all government agencies or private companies forced to comply with government mandates about mortgage lending.
WSJ
Even in 2006, however, their portfolio consisted of about half Alt-A or prime, not subprime ... Fannie and Freddie invested in subprime to a significant degree, but they were cutting their investments by 2007 ...
Half of their portfolio was trillions and trillions of dollars! Further, they were cutting back on purchases not because of some new found sense of responsibility, but because they had been caught cooking the books and the Bush administration was pushing hard for reform.
Even if your argument were true and the GSE's were moving their enormous purchases up the food chain, that would not absolve them of responsibility. If they were to buy more high quality mortgages, that would only force their competitors into lower quality purchases. Purchases that they would not have made otherwise. The fact that they could borrow at lower rates because of their quasi-governmental status and that they did not have to shoulder the same regulatory burden as private firms created a huge distortion in the market.
... 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."
ReplyDeleteMost of this money was appropriated to meet explicit targets laid down by Congress as far back as 1996 during the Clinton administration:
According to George Mason University’s Russell Roberts, the CRA was buttressed by other new regulations during the Clinton Administration. As Roberts writes, “For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target -- 42 percent of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50 percent in 2000 and 52 percent in 2005.
For 1996, HUD required that 12 percent of all mortgage purchases by Fannie and Freddie be “special affordable” loans, typically to borrowers with income less than 60 percent of their area’s median income. That number was increased to 20 percent in 2000 and 22 percent in 2005. The 2008 goal was to be 28 percent.”
The banks were kept from rebelling by using Fannie Mae and Freddie Mac’s deep pockets to buy these poor-quality loans and take them off the banks’ books.
Under-regulation of the GSEs -- Fannie Mae and Freddie Mac -- allowed the money stream to widen and keep flowing. There has always been an implicit understanding that taxpayers would cover GSE losses and this enabled them to attract money and pour it into the CRA-induced sub-prime market. The Bush Administration had warned about this for years. Fannie and Freddie, however, could skim enough to pay for political protection, plus pay sky-high executive salaries and bonuses to well-connected political figures.
Over the past decade, Fannie and Freddie combined to spend a reported $200 million on lobbying and campaign contributions.
Human Events
Leaving aside, for the moment, that the lending targets were already set and that Bush did not specifically request this money, the amount of money involved, $434 billion, is chump change compared to the amounts already pumped into the GSE's during the Clinton administration. Here is just one example:
ReplyDeleteIn November 2000, President Clinton's Housing and Urban Development Department would trumpet "new regulations to provide $2.4 trillion in mortgages for affordable housing for 28.1 million families." The vehicles for this were Fannie and Freddie. It was the largest expansion in housing aid ever.
Let The Inquisition Start With Frank, IBD
There is something else that doesn't quite fit with this narrative, during this time - 2004 to 2006 - the Bush administration was pushing hard for reform of the GSE's, including tighter lending standards, increased capitalization, stronger regulatory oversight and the elimination of political appointment to the GSE's management and board of directors:
Bush's first budget, written in 2001 — seven years ago — called runaway subprime lending by the government-sponsored enterprises Fannie Mae and Freddie Mac "a potential problem" and warned of "strong repercussions in financial markets."
In 2003, Bush's Treasury secretary, John Snow, proposed what the New York Times called "the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago." Did Democrats in Congress welcome it? Hardly.
"I do not think we are facing any kind of a crisis," declared Rep. Barney Frank, D-Mass., in a response typical of those who viewed Fannie and Freddie as a party patronage machine that the GOP was trying to dismantle. "If it ain't broke, don't fix it," added Sen. Thomas Carper, D-Del.
Unfortunately, it was broke.
In November 2003, just two months after Frank's remarks, Bush's top economist, Gregory Mankiw, warned: "The enormous size of the mortgage-backed securities market means that any problems at the GSEs matter for the financial system as a whole." He too proposed reforms, and they too went nowhere.
In the next two years, a parade of White House officials traipsed to Capitol Hill, calling repeatedly for GSE reform. They were ignored. Even after several multibillion-dollar accounting errors by Fannie and Freddie, Congress put off reforms.
In 2005, Fed chief Alan Greenspan sounded the most serious warning of all: "We are placing the total financial system of the future at a substantial risk" by doing nothing, he said. When a bill later that year emerged from the Senate Banking Committee, it looked like something might finally be done.
Unfortunately, as economist Kevin Hassett of the American Enterprise Institute has noted, "the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter."
Don't Blame Bush For Subprime Mess, IBD
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.
ReplyDeleteThis statement comes very close to confirming your thesis, that there are "political reasons" for the way some evaluate this crisis and the GSE's role in it.
Finally, I am willing to wager that Wall Street lobbyists stood behind both the Clinton and Bush administration efforts for affordable housing.
By "Wall Street Lobbyists", you must mean those who were not already on Fannie and Freddie's payroll.
What CEO could resist the easy profits of packaging subprime, even predatory, loans for sale to the GSEs?
Certainly not Countrywide Financial.
It is a fact that the greatest volume of subprime investment came on Bush's watch.
ReplyDeleteYou keep saying it was all Democrats. I keep saying it was bipartisan.
Fannie and Freddie paid McCain's campaign manager $2 million:
"Fannie and Freddie paid Senator John McCain’s campaign manager was paid more than $30,000 a month for five years as president of an advocacy group set up by the mortgage giants Fannie Mae and Freddie Mac to defend them against stricter regulations, current and former officials say."
http://www.nytimes.com/2008/09/22/us/politics/22mccain.html
I really think you need to modify this approach you have of dredging up every analysis you can find blaming just the Democrats and start thinking about the key causes of this catastrophe. Once you lose the partisanship you can see the real causes.
Clinton bears responsibility. He botched derivatives regulation and too-big-to-fail with the repeal of Glass Steagall. He probably should not have reappointed Greenspan.
But it is a tribute to the power of cognitive dissonance for you to pin it all on the Dems and assign zero blame to the GOP who controlled Congress for 12 of the last 13 years before the crisis and the White House for the last eight years before 2009.
So just answer me one question. Is it you position that this crisis was 100% the fault of the Dems? If so, that explains much about your obsession with Freddie and Fannie.