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Fannie and Freddie

December 9, 2008 - John Stack
To hear some tell it (can you say Ann Coulter and her ilk?), the whole current sub-prime problem was caused by president Clinton.
            Lets back up. Freddie Mac and Fannie Mae were created to expand the ‘secondary market’ for mortgages. Simply, they would buy mortgages that had all ready been given, package up a bunch of them, and sell them to investors on the open market. The government (until recently) really had no stake, and didn’t explicitly back any of these mortgages. These 2 mortgage giants though enjoyed many benefits private banks didn’t. They could keep much less cash in reserve for loans that they had bought. For a private bank, this is 3%. These 2 were often under this (and recently, way below it).They also paid no local or state income well as other benefits.  But, this created what it was supposed to, a market for mortgages that might not have existed otherwise, and brought down interest rates, making other loans more affordable. It all went swimmingly for a long time.
            In 1995 President Clinton’s HUD agreed to let these 2 get affordable housing credit for buying subprime securities that included loans to low income borrowers. This also did its job in that many people were now able to afford homes that they otherwise could not afford. HUD assumed Fannie Mae and Freddie Mac would impose their high lending standards on these loans also. But, in 2000, the housing market started to really take off.
            In 2001, Freddie bought $18.6 Bil in subprime loans. Even then, HUD started to see that sub-prime mortgages had very high foreclosure rates (shouldn’t be a surprise). But, move ahead 3 years. HUD revised their lending goals. Freddie and Fannie now were buying hundreds of billions in subprime loans. That year, Bush’s HUD upped the main affordable housing (ie – subprime) goals for Freddie and Fannie, and more loans were bought. This fed upon itself. As these 2 bought more subprime mortgages, it caused more sub prime mortgages to be made. Fannie and Freddie also got very big into the subprime securities market. So, rather than owning the loan and bundling them, they were buying the bundles themselves.
            The subprime loans were doing well, because the market was going out of control. Prices kept on escalating. If someone couldn’t afford the new ARM rate, they could often just refinance at a conventional rate, because they had built up so much equity. But, as always, the party came to an end. Prices dropped. Many owed significantly more than their house was worth. Foreclosures went thru the roof. Now, these sub-prime loan backed bundled mortgage securities were causing huge financial problems.
            So, what do you think these lending giants reacted? Ask for more protection or oversight or regulation? No no no! They spent 11.7 million to outside consultants to kill any regulatory reforms. Most were paid to former Republican lawmakers or staffers: Al D’Amato - $240,000, Re Sue Molinari – $300,000. Even good ole Newt Gingrich couldn’t keep himself away from this pig trough of consulting money, getting $300,000 himself. Freddie even secretly paid a Republican consulting firm , DCI Group to kill legislation drafted by Chuck Hagel and john McCain. This bill would have among other things, created minimum and critical capital levels, a risk based capital test, a check on undercapitalized enterprises, and even golden parachutes.
            My opinion? I don’t think it was a Republican or Democratic made mess. Each may have had an unwitting hand in it, but didn’t direct it. I also don’t blame many of the mortgage borrowers. Yes, many bought homes they shouldn’t have. But, many were also duped into sub-prime mortgages (carrying higher interest rates, ARMs that increased after 3 years) who could have gotten a conventional ). One consumer group puts that number at about 30% of all subprime loans. No, what the Dems and GOP did was create a situation where Freddie Mac and Fannie Mae, through their huge economies of scale and monstrous tax breaks and resources, exploited this program way beyond what anyone could have imagined. Looking back, it seems like this should have easily been foretold. But, when you are raking in billions in profit and bonuses, you don’t care. You’ll be gone when it all eventually came crashing down.


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