As soon as the 2008 financial crisis hit, Republicans and their radio and TV doppelgangers propagated the narrative that the whole crisis was due to the excesses of Fannie Mae and Freddie Mac and liberal do-gooders, like Barney Frank, who pushed too many poor and unreliable borrowers (read minorities) into the housing market. The NY Times reports (February 12, 2011) that the Obama administration in the person of Treasury Secretary, Timothy Geithner, has apparently accepted this narrative.
On Friday (February 11), Treasury published a report on “redesigning the government’s role in housing finance,” which according to the NY Times will not only dissolve Fannie Mae and Freddie Mac, but cut back the federal government’s “broadly popular, long running campaign to help Americans own homes.” The effect of the report would be to “raise the cost of mortgage loans and push homeownership beyond the reach,” of many families.
When you read that “business interests and advocates of smaller government,” are “pleased” with the ideas put forward by Mr. Geithner, you know where all this is headed. While the Obama administration says that it wants to help all Americans have “access to quality housing … they can afford,” the old American dream of homeownership is being tossed into the dustbin of history. Better to let some people rent than “sustain its commitment to minting homeowners.”
Fannie Mae and Freddie Mac, no doubt, deserve their share of blame for the housing debacle, but the story is far more complicated and we are going to need some help sorting it out. If you want to delve into all the grimy details, I suggest a very readable book by Bethany McLean and Joe Nocera, “ All the Devils are Here , The Hidden History of the Financial Crisis.” I rely on them for much of what follows.
It is true that the Fannie Mae was the first to securitize mortgages beginning in the 1970’s by guaranteeing the payment of principle and interest on FHA and VA loans. Freddie Mac issued the first mortgage-backed securities using conventional mortgages.
“From a standing start in the late 1970’s, bonds created from mortgages on single-family homes grew to more than 350 billion by 1981 …” and to 3.3 trillion by the end of 2001.
It must be remembered however that in the initial stages, at least, these bonds were issued against conventional, 30 year fixed term mortgages at current market interest rates.
Fannie Mae and Freddie Mac are hybrid creatures. They are private enterprises with shareholders, a board of directors and the “structure of a typical corporation.” Their public relations stressed that they were ‘private taxpaying corporations that operate at no cost to taxpayers.’ However, they had a “vaguely defined social mandate from Congress to make housing more available to low- and middle- income Americans.” This latter characteristic gave Fannie and Freddie a leg up with investors and the banking industry because it was assumed that these GSEs (government-sponsored enterprises) would always be backed by the federal government due to their key role “in making thirty-year mortgages possible for middle-class Americans.” However, this special status created animosity both in Congress and on Wall Street. Congressional conservatives and Wall Street types believed that “the private sector was perfectly capable of issuing mortgage-backed securities without Fannie and Freddie.”
Things changed in 1984 when the Reagan administration passed the Secondary Mortgage Market Enhancement Act, which “removed the restrictions against institutions like state-charted financial institutions, pension funds and insurance companies from investing in mortgage-backed securities issued by Wall Street.” From there, the mortgage-backed securities market really took off.
All kinds of new mortgage companies came into existence using securitization as a source of mortgage funding. There were basically two brands. One set of companies, “originated fairly standard loans to people with good credit,” which they sold to Fannie Mae and Freddie Mac. The second brand grew out of what was known as “hard-money lending,” primarily the exploitation of poor people by “imposing onerous terms” and “extracting high fees.”
“These new companies moved hard-money lending into the mortgage market, making loans that would eventually become known as subprime.”
“This influx of new lenders created exactly what Wall Street had been searching for: mortgage products that it could securitize without Fannie and Freddie.”
The new business of bonds backed by subprime mortgages and what were called ‘credit enhancements’ created a “trifecta of opportunity” for Wall Street.
“Street firms could make money selling and trading the mortgage-backed securities. But they could also make money by providing a warehouse line of credit so that the mortgage companies could make the loans in the first place. And you could make money by taking subprime specialists public.” The problem is that “securitization severed that critical link between borrower and lender. Once a lender sold a mortgage to Wall Street, repayment became someone else’s problem. The potential consequences of this shift were profound,” because sound loans are essential to a sound banking system.
Two key culprits in letting subprime lending get out of hand were Alan Greenspan at the Federal Reserve and Phil Gramm, Chairman of the Senate banking committee. Greenspan and the Federal Reserve had the authority to reign in subprime lending had it deigned to do so. The Home Ownership and Equity Protection Act, or HOEPA, gave the Federal Reserve, “the power to flatly prohibit mortgage lending practices that it concluded were unfair or deceptive.” Greenspan as an acolyte of Ayn Rand, and blind faith in free market ideology, believed “that the market would not produce, and investment banks would not buy, loans that did not make sense.” Apparently, he was wrong.
Phil Gramm, for his part,
“opposed any move to regulate subprime lending. His staff at the Senate banking committee issued a report saying that it made no sense to regulate predatory lending practices because it was impossible even to say what predatory lending was. To do otherwise, the report said, ‘threatens to subject those regulated to the abuses of arbitrary and capricious governmental action at worst’.”
First Alliance Mortgage Company, otherwise known as Famco, was one of the early stars of the subprime movement and provides a good case study in subprime abuses. The company went public in 1996, “allowing its founder and his wife to take $135 million out of the company.” Within two years, its abuses were so widespread that several states sued the company. In Massachusetts, “an incredible 35% of Famco mortgages had fees over 20%. In 1995, a Lehman Brothers executive wrote a memo “describing Famco as a ‘sweat shop’ specializing in ‘high pressure sales for people who are in a weak state’.” But did that stop Lehman Brothers from doing business with the company?
“Of course not. Starting in 1998 – the same year the states filed suit – Lehman gave Famco a warehouse line of $150 million and helped it sell $400 million in mortgage backed securities.” A jury later found the company had systematically defrauded borrowers. Lehman was found guilty of ‘aiding and abetting the fraudulent scheme,’ but got a slap on the wrist.
Fannie Mae and Freddie Mac moved gradually into the subprime market, but initially confined their purchases to the “safest” subprime securities: the “triple A rated tranches of residential mortgage backed securities.” And, “overtime Fannie and Freddie became two of the world’s largest purchasers of triple A tranches.” This was aided by pressure from both President Clinton with his National Homeownership Strategy to create 8 million new homeowners and George W. Bush’s “Blueprint for the American Dream,” which promoted homeownership for minorities.
But it would be wrong to say, as many on the right do that “Fannie and Freddie caused the crisis – by leading the charge into subprime mortgages to meet their housing goals. This is completely upside down; Fannie and Freddie raced to get into subprime mortgages because they feared being left behind by their nongovernment (private sector) competitors,” on Wall Street.
One of the startling realizations to come out of the subprime crisis is that it wasn’t really about “minting new homeowners.” It “had nothing to do with getting people into homes, since the vast majority of subprime loans were refinancing.” It was “calculated that the dollar volume of refinancings during the 1990s was $3.4 trillion, more than the entire volume of mortgage origination in the 1980s.” One study showed that “more than 75% of homeowners who refinanced in the last three months of 2000 had taken out mortgages at least 5% higher than the ones they retired. They were using their homes as piggy banks.”
Clearly Fannie Mae and Freddie Mac were two of the “devils” in the mix, but not the only ones and perhaps not the worst, but bailing them out cost the American taxpayer over $135 billion. The larger question, aside from the fate of Fannie Mae and Freddie Mac, is the one asked by Representative Dennis Cardoza of California: ‘How is Joe Six-Pack ever going to be able to afford a home?’ Indeed, the question boils down to what role the government should play in guaranteeing mortgages for lower-income families, veterans and farmers. If conservatives and the Wall Street crowd have their way – it will be none. The Obama administration’s approach is to shut Fannie and Freddie down rather than reform them. They are ‘eradicating a proven system that worked very well for most of its history.’ For Joe Six-Pack, he may awake into the cold dark night and find that, yes; it was all just a dream.