Monday, November 7, 2011

Fannie, Freddie, Financial Crisis

A party that needn't be named
Made GSEs chiefly to blame
For the mortgage collapse,
Though inquisitive chaps
Say the data don't back up this claim.

Writing in The Big Picture blog, Roosevelt Institute fellow Mike Konczal brings out the data to refute the oft-heard claim that the cause of the mortgage crisis was Congress' pushing Fannie Mae and Freddie Mac to make imprudent loans. Among the key facts:

  • More than 83% of subprime loans issued to 2006 were from private firms, and went into the private label securitization market. 
  • From 2002-2005, the GSEs (government-sponsored enterprises, such as Fannie and Freddie) saw their share of US mortgage originations drop from 50% to 30%. 
  • Before the crash, conservative think tanks such as the American Enterprise Institute were arguing that the GSEs were were blocking the issuance of subprime mortgages, by purchasing too few of them. 


  1. Dr. Goose,

    You concentrate only on retail loan origination, which is only one part of the story. Public vs. Private origination of a retail loan is not nearly as important as GSE's implicit backstop for loans under the "jumbo" limit.

    So-called "conforming loans" were considered to be, and still are considered to be, less risky to a bank, because they know that the government may insure them or buy them. The bank is essentially encouraged to take more risk, offer lower interest rates, etc., because of this backstop. I myself put far more than 20% down on my house, so I could get the dirt-cheap loan for the rest of my house.

    The government is a major player in the housing market, and there is no denying that. The government promotes homeownership because it makes us better-behaved citizens (e.g., you are less of a flight risk if you own a house, care more about your community, etc.). Without the GSE's, the market would look very different indeed. Would there still be fraud? Absolutely. Would bad choices still have been made? Certainly. However, the variables over which the government did have control: effective insurance of conforming loans, and short-term interest-rate targets, completely changed the game, regardless of whether the retail originator was private or public.

  2. Let's be careful to distinguish the role of the Fed from that of Fannie and Freddie. The government had dominated the mortgage market for home ownership promotional purposes for many years before the mortgage bubble. It was Greenspan's low interest rates and resistance to any sort of constraints on derivative instruments that stimulated the explosion in subprime CDOs more than Fannie and Freddie. After all, their AAA ratings were not based on an implicit US government guaranty.

  3. Is there a topic in which those on the Left are ever in err, or those on the Right are ever correct? I'm beginning to think your position is a little one-sided. ;)

    I myself am a little more even-handed. I totally agree with you about the "Greenspan's low interest rates", at least in the latter part of his tenure. Though for a nominally independent central bank, it is difficult to lay political blame there. If we want to lay political blame, one must count even the things you are inclined to support: I blame Bush's "ownership society" daydreams, AND I blame Barney "I want to roll the dice a little bit" Frank.

    My understanding is that derivative instruments certainly contribute to short-term volatility, but not overall long-term direction of markets. I suspect that without them, the bubble would have been smaller, but lasted longer. The area under the curve would have been the same.

  4. So as not to distort my own position, let me say that, while I do not blame Democratic Congressmen for the mortgage crisis generally, I do blame (largely) them for the extent of the financial hole in which the GSEs find themselves. The GSEs themselves were also active participants in their own demise, having lobbied heavily for the enlargement of their "heads I win, tails you lose" business model.


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