Why Fannie and Freddie Were Culprits in the Great Recession

Why Fannie and Freddie Were Culprits in the Great Recession

On October 4, 2008, Charles Duhigg in the Sunday edition of the New York Times wrote the following article.

Shortly after he became chief executive, Mr. Mudd traveled to the California offices of Angelo R. Mozilo, the head of Countrywide Financial, then the nation’s largest mortgage lender. Fannie had a longstanding and lucrative relationship with Countrywide, which sold more loans to Fannie than anyone else.

But at that meeting, Mr. Mozilo, a butcher’s son who had almost single-handedly built Countrywide into a financial powerhouse, threatened to upend their partnership unless Fannie started buying Countrywide’s riskier loans.

Investors were also pressuring Mr. Mudd to take greater risks.

On one occasion, a hedge fund manager telephoned a senior Fannie executive to complain that the company was not taking enough gambles in chasing profits.

“Are you stupid or blind?” the investor roared, according to someone who heard the call, but requested anonymity. “Your job is to make me money!”

Capitol Hill bore down on Mr. Mudd as well. The same year he took the top position, regulators sharply increased Fannie’s affordable-housing goals. Democratic lawmakers demanded that the company buy more loans that had been made to low-income and minority homebuyers.

“When homes are doubling in price in every six years and incomes are increasing by a mere one percent per year, Fannie’s mission is of paramount importance,” Senator Jack Reed, a Rhode Island Democrat, lectured Mr. Mudd at a Congressional hearing in 2006. “In fact, Fannie and Freddie can do more, a lot more.”

But Fannie’s computer systems could not fully analyze many of the risky loans that customers, investors and lawmakers wanted Mr. Mudd to buy. Many of them — like balloon-rate mortgages or mortgages that did not require paperwork — were so new that dangerous bets could not be identified, according to company executives.

Even so, Fannie began buying huge numbers of riskier loans.”

Although the press has saddled the investment banking community with much of the blame for the “Great Recession”, I would argue that much of it should be assigned to the federal government.

I have written earlier that the federal government was largely responsible in an article published by the Bond Buyer on February 11th of 2013, but Fannie and Freddie were culprits as well. There is a saying, attributed to  a number of writers, Samuel Johnson being one, that the road to hell is paved with good intentions. From the outset, from the belief that racial discrimination was a factor in red lining, the Congress passed the Community Reinvestment Act.

From Wikipedia we learn:

“The Housing and Community Development Act of 1992 established an affordable housing loan purchase mandate for Fannie Mae and Freddie Mac, and that mandate was to be regulated by HUD. Initially, the 1992 legislation required that 30 percent or more of Fannie's and Freddie's loan purchases be related to affordable housing. However, HUD was given the power to set future requirements. In 1995 HUD mandated that 40 percent of Fannie and Freddie's loan purchases would have to support affordable housing. In 1996, HUD directed Freddie and Fannie to provide at least 42% of their mortgage financing to borrowers with income below the median in their area. This target was increased to 50% in 2000 and 52% in 2005. Under the Bush Administration HUD continued to pressure Fannie and Freddie to increase affordable housing purchases – to as high as 56 percent by the year 2008. In addition, HUD required Freddie and Fannie to provide 12% of their portfolio to "special affordable" loans. Those are loans to borrowers with less than 60% of their area's median income. These targets increased over the years, with a 2008 target of 28%.

To satisfy these mandates, Fannie and Freddie announced low-income and minority loan commitments. In 1994 Fannie pledged $1 trillion of such loans, a pledge it fulfilled in 2000. In that year Fannie pledged to buy (from private lenders) an additional $2 trillion in low-income and minority loans, and Freddie matched that commitment with its own $2 trillion dollar pledge. Thus, these government sponsored entities pledged to buy, from the private market, a total of $5 trillion in affordable housing loans.

I hold the view that the government caused the housing crisis and the above figures from Wikipedia demonstrate that without the aid of Fannie and Freddie, the housing crisis would have been less severe than it was. I rest my case.

 The author spent 36 years in commercial banking and last served as General Manager for Depfa Bank. He currently is teaching at NYU’s School of Continuing Education and is the author of “Handbook of Corporate Lending” with Doctor James Sagner and “Case Studies in Corporate Lending,” both published by Amazon.

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