Setting the stage for a financial crisis with Fannie Mae and Freddie Mac

“Beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low and moderate income borrowers. For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target -- 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.

For 1996, HUD required that 12% of all mortgage purchases by Fannie and Freddie be "special affordable" loans, typically to borrowers with income less than 60% of their area's median income. That number was increased to 20% in 2000 and 22% in 2005. The 2008 goal was to be 28%. Between 2000 and 2005, Fannie and Freddie met those goals every year, funding hundreds of billions of dollars worth of loans, many of them subprime and adjustable-rate loans, and made to borrowers who bought houses with less than 10% down.

.... Without Fannie and Freddie's implicit guarantee of government support (which turned out to be all too real), would the mortgage-backed securities market and the subprime part of it have expanded the way they did?

Perhaps. But before we conclude that markets failed, we need a careful analysis of public policy's role in creating this mess. Greedy investors obviously played a part, but investors have always been greedy, and some inevitably overreach and destroy themselves. Why did they take so many down with them this time?

Part of the answer is a political class greedy to push home-ownership rates to historic highs -- from 64% in 1994 to 69% in 2004. This was mostly the result of loans to low-income, higher-risk borrowers. Both Bill Clinton and George W. Bush, abetted by Congress, trumpeted that rise as it occurred. The consequence? On top of putting the entire financial system at risk, the hidden cost has been hundreds of billions of dollars funneled into the housing market instead of more productive assets.

Beware of trying to do good with other people's money. Unfortunately, that strategy remains at the heart of the political process, and of proposed solutions to this crisis.”

Russell Roberts, "How Government Stoked the Mania", The Wall Street Journal (3 October 2008).

http://online.wsj.com/article/SB122298982558700341.html


Russell Roberts teaches economics at George Mason University and is author of a novel on how markets work, The Price of Everything: A Parable of Possibility and Prosperity (Princeton University Press, 2008).

One should note that in addition to pushing Fannie and Freddie to purchase doggy mortgages, the government for decades by deliberate policy forced commercial banks and saving and loan associations to channel credit artificially to low- and moderate-income neighborhoods and insisted that its mandates regarding credit standards override standard criteria used to identify sound borrowers. These lax government-imposed standards, let me add, were also applied to mortgages in high-income areas with exactly the same results: Defaults and walk-aways.

It is a testament to the strength of the American economy (but not to the wisdom of the American people) that the economy performed as well as it did for so long. In the end, after many years of struggle, poor policies defeated good fundamentals.

Thanks to Larry Willmore for the Tdj.