Saturday, November 19, 2011

Freddie and Fannie: a revision

Some financial commentators and several readers of this blog have claimed that the quasi-federal mortgage entities Fannie Mae and Freddie Mac were the real culprits responsible for the 2008 financial collapse. This view was rejected by 9 of 10 members of the congressional Financial Crisis Inquiry Commission appointed to determine the causes of the crash (3 of the 9 were Republicans). Only one commissioner wrote a separate report blaming Mae and Mac: Peter J. Wallison; the separate Republican dissent is not, in fact, much different from the full report, and does not place the blame on Mae and Mac: see analysis here. Also, see this fact check for further summary of the Commissions findings and rebuttal of the Chamber of Commerce's distortions. However, the idea of blaming Mae and Mac persists for several reasons.

1. Mae and Mac did, in fact, invest heavily in subprime and near-subprime motgages, beginning around 2000 and peaking around 2007.

2. Mae and Mac were under some federal pressure -- mostly during the Clinton administration -- to originate and deal in home mortgages (and mortgage backed securities) in a way that would make housing loans more available to low and moderate-income people -- part of their charge as GSEs (Government Sponsored Entities).

3. Mae and Mac supposedly had a leg up in this game because they were assumed to be protected in their investments (and speculations) by the federal government itself.

4. Besides being involved in an accounting scandal, their officers also had their bonuses tied to their performance in buying and selling securities.

 From what I read, these statements are largely factual. You can read an account with some facts and charts in a report prepared by the Cato Institute.

To be fair, the Cato report has its own definition of what constitutes a subprime mortgage; it also doesn't go as far as saying that Mae and Mac actually caused the crisis, although it does claim they played a major role and were responsible for nearly half of the market for subprimes during the height of the frenzy. This estimate has been contested.

But, of course, there is another side to the story. A recent article in the New York Review of Books gives a different take on the role of the GSEs:


Among other things, the authors (J. Madrick &  F. Portnoy) point out that Mae and Mac bought much less risky securities: few CDOs and few really low-rated bonds; they also had a much lower rate of default than other Wall Street speculators.Here's a brief quote:

"In fact, the rate of delinquencies for all GSE securities in 2004 was 4.3 percent, compared to a delinquency rate in private industry of 15.1 percent of mortgages. In 2005, the GSE rate was 7.8 percent compared to 28.7 percent, and in 2006 and 2007, the rates reached 13.2 and 14.9 percent in the GSEs and 45.1 and 42.3 percent in the private market ... [also] losses as a proportion of mortgages guaranteed or bought by the GSEs were far lower than in private industry."

Mae and Mac, as far as I could determine, did no trading in CDOs (derivatives based on, e.g., mortgage backed-securities -- and worse). CDOs -- and especially so-called "synthetic" CDOs --  were the most dangerous of the lot. These were the instruments that were fraudulently mis-rated by supposedly reputable rating agencies. GSEs also had nothing to do with credit default swaps -- the "insurance" policies on CDOs whose sale did in AIG.

All in all, I think it is fair to say that the GSEs behaved irresponsibly during the recent fiscal crisis. However, those whose ideology is anti-government -- especially when government regulates business or aids the less fortunate -- have used the transgressions of Mae and Mac to attack the role of government in housing (see the Cato statement below), and, further, to let major private-capital culprits off the hook. While Mae and Mac definitely need stronger regulation, this goes double for the the rest of Wall Street, and blaming Mae and Mac for the crash is simply revisionist history.


Finally, I think the underlying ideological position of conservatives and libertarians is well summed up by this quote, also from the Cato report mentioned above.

"Ultimately taxpayers and the broader economy will only be protected from future bailouts by a full withdrawal of the federal government from housing policy. Policy interventions, such as those by the Federal Housing Administration and the Federal Home Loan Banks, continue to distort capital toward the housing market, while our commercial banking system remains vulnerable to downturns in the housing market. Our financial system would become considerably more stable were Washington to abandon its attempts to direct capital to politically favored segments of the economy."

There is simply no evidence for the claim in the last sentence -- it is merely an item of conservative belief. When left to its own devices, without government intervention, the "free (capital) market" has historically created one unstable disaster after another. However, there is a larger principle. The preamble to our Constitution asserts that one of the essential tasks of our government is to "promote the general Welfare". There is no mention of free markets or the superiority or desirability of what is now our capitalist system. Our government, in order to promote the general welfare has intervened repeatedly to ensure that all of our citizens have the opportunity to lead decent and productive lives. Many times this intervention is necessary to prevent the wealthy and powerful from taking unfair advantage of the less powerful.  Although I have doubts about the desirability of home ownership for all, I have no doubt about the desirability of dignified shelter for all. Sometimes attaining this involves directing capital to certain segments of the economy -- not because they are "favored" but because they simply have been dealt a raw deal and need help from their fellow citizens to insure their welfare.

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