Top Scoops

Book Reviews | Gordon Campbell | Scoop News | Wellington Scoop | Community Scoop | Search

 

The Fannie/Freddie Flat Earth Theory

The Fannie/Freddie Flat Earth Theory


by Dean Baker,
t r u t h o u t | Perspective

For the last month, most of the world has been watching the Wall Street gang drowning in their own greed as they threaten to pull the rest of us down with them. However, while we have been distracted, the Flat Earth Society has developed its narrative to explain the crisis.

In the Flat Earth version, the real villains in the story were the public/private mortgage giants Fannie Mae and Freddie Mac. Prominent Congressional Democrats like Senators Charles Schumer and Chris Dodd, and Representative Barney Frank, are cited as accomplices. According to the Flat-Earthers, the problem wasn't sleaze bag bankers pulling down tens of millions a year pushing predatory loans to people who didn't understand them; the real problem was Congressional Democrats, who wanted the government to help the poor and minorities buy homes.

Before addressing the Flat Earth argument, I should be very clear that I have long been a harsh critic of Fannie and Freddie. They committed a colossal mistake by failing to recognize the housing bubble. It is understandable that you could miss an $8 trillion housing bubble if you drive a bus or sell shoes for a living. It's a little harder to accept this sort of mistake from companies that own or guarantee trillions of dollars of mortgage debt.

I first warned that the collapse of the housing bubble would lead to serious problems for Fannie and Freddie in the fall of 2002 , before they began to move into the risky mortgages that were the immediate cause of their collapse. When almost all you own is mortgage debt, and the mortgage default rate rises to several times its normal level, it is virtually guaranteed that you're going to face serious problems. Obviously, Fannie and Freddie's venture into more risky mortgages in the years 2005 to 2007 worsened the problem.

While no one should shed any tears over the collapse of these two giants - the top management and shareholders got what they deserved - it is equally ridiculous to lay the blame for the financial crisis on the shoulders of Fannie and Freddie.

The underlying problem was the housing bubble, which Alan Greenspan allowed to grow unchecked and, arguably, actively promoted. The bubble was accentuated by the willingness of banks to ignore normal prudential standards in issuing mortgages and to make loans that they knew could not be paid off by the borrowers. And, of course, leveraging themselves to the sky guaranteed full-fledged disaster

Banks would issue these loans because they knew they could dump them into the secondary market where securitizers would peddle them off to suckers all round the world. This is where Fannie and Freddie came in. They purchased many of the junk mortgages issued by banks in the years 2005 to 2007. According to the Flat-Earthers, this makes Fannie and Freddie the cause of the current crisis.

There is one basic problem with the Flat Earth story: Fannie and Freddie jumped into the junk mortgage market because they were trying to keep pace with the private issuers of mortgage-backed securities. Fannie and Freddie made a conscious decision to dive into the junk in order to protect their market share, which was being seriously eroded by the aggressive tactics of private giants like Citigroup and Merrill Lynch.

The market share of Fannie and Freddie. in the years 2004 to 2007, never came close to its level before the junk market took off. According to data from the Federal Reserve Board, Fannie and Freddie securitized $315.2 billion worth of mortgages in 2002, accounting for 50.1 percent of the new mortgage debt that year. In 2006, they securitized $276.0 billion in mortgages, giving them a market share of just 34.8 percent.

Fannie and Freddie's conduct was despicable. Their decision to dive into the junk certainly contributed to the further expansion of the bubble and worsened the pain from its eventual collapse. However, they were followers, not leaders. They didn't cause the bubble and the subprime craziness. This train had already left the station. Fannie and Freddie's crime was going along for the ride.

Fannie and Freddie could have instead played a positive role in this crisis. Suppose in 2004 or 2005 one of these mortgage giants issued a statement warning of the dangerous over-valuation in many housing markets across the country. Instead of easing mortgage standards, imagine that Fannie or Freddie announced that it was tightening its rules for mortgages in the most over-valued markets, requiring nonborrowed down payments of 20 percent, or even 30 percent, in order to protect against anticipated price declines.

This action would have produced howls of outrage from builders, realtors, and other big beneficiaries of the housing bubble. It also would have led to headlines and possibly some serious analysis of the evidence for a housing bubble. It may have saved the country from much of the pain it is now suffering.

But this sort of step would have required real courage and leadership, traits rarely found in high positions in Washington, or on Wall Street. Fannie and Freddie should be blamed for following the herd off the cliff. They stand out as especially big sheep. But only the Flat-Earthers could make them the main villains in this story.

*************

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of "The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer" (www.conservativenannystate.org). He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.

© Scoop Media

 
 
 
Top Scoops Headlines

 


Philip Temple: Hang On A Minute, Mate
Peter Dunne quietly omits some salient facts when arguing for retention of MMP’s coat-tailing provision that allows a party to add list seats if it wins one electorate and achieves more than 1% or so of the party vote... More>>


Cheap Grace And Climate Change: Australia And COP26

It was not for everybody, but the shock advertising tactics of the Australian comedian Dan Ilic made an appropriate point. Australia’s Prime Minister Scott Morrison, a famed coal hugger, has vacillated about whether to even go to the climate conference in Glasgow. Having himself turned the country’s prime ministerial office into an extended advertising agency, Ilic was speaking his language... More>>


Binoy Kampmark: Funeral Rites For COVID Zero
It was such a noble public health dream, even if rather hazy to begin with. Run down SARS-CoV-2. Suppress it. Crush it. Or just “flatten the curve”, which could have meant versions of all the above. This created a climate of numerical sensitivity: a few case infections here, a few cases there, would warrant immediate, sharp lockdowns, stay-at-home orders, the closure of all non-vital service outlets... More>>


Dunne Speaks: Labour's High Water Mark
If I were still a member of the Labour Party I would be feeling a little concerned after this week’s Colmar Brunton public opinion poll. Not because the poll suggested Labour is going to lose office any time soon – it did not – nor because it showed other parties doing better – they are not... More>>



Our Man In Washington: Morrison’s Tour Of Deception

It was startling and even shocking. Away from the thrust and cut of domestic politics, not to mention noisy discord within his government’s ranks, Australian Prime Minister Scott Morrison could breathe a sign of relief. Perhaps no one would notice in Washington that Australia remains prehistoric in approaching climate change relative to its counterparts... More>>



Binoy Kampmark: Melbourne Quake: Shaken, Not Stirred

It began just after a news interview. Time: a quarter past nine. Morning of September 22, and yet to take a sip from the brewed Turkish coffee, its light thin surface foam inviting. The Australian city of Melbourne in its sixth lockdown, its residents fatigued and ravaged by regulations. Rising COVID-19 numbers, seemingly inexorable... More>>