June 17, 2011
“Night is day,” “slavery is freedom,” okay David Brooks edited those lines out of his column on Fannie Mae today, but this is pretty much how the rest of it reads. He tells us that the economic crisis was the result of Fannie Mae pushing bad mortgages and buying off everyone who tried to stand in their way.
There’s a small problem in this story. The worst junk mortgages that inflated the housing bubble to extraordinary levels were not bought and securitized by Fannie and Freddie, they were securitized by Citigroup, Merrill Lynch, Goldman Sachs, Lehman and the other private investment banks. These investment banks gobbled up the worst subprime and Alt-A garbage that sleaze operations like Ameriquest and Countrywide pushed on homebuyers.
The trillions of dollars that the geniuses at the private investment banks funneled into the housing market were the force that inflated the bubble to its 2006 peaks. Fannie and Freddie were followers in this story, jumping into the subprime and Alt-A market in 2005 to try to maintain market share. They were not the leaders.
Just to be clear, Fannie and Freddie were serious bad actors. They are both huge companies that do nothing else but deal with housing. It is incredible that they did not recognize the housing bubble and take steps to try to deflate it, and protect themselves, before it grew to such dangerous levels.
Suppose that Fannie and Freddie started demanding appraisals of rental values and refused to buy any mortgage where the ratio of sale price to annual rent was higher than 20. This action by itself likely would have shaken some sense into the housing market. I said this back in 2002, when I first warned of the housing bubble and predicted the collapse of Fannie and Freddie. I also frequently criticized Fannie and Freddie in public forums, including debates with their chief economists. Unlike Brooks, I wasn’t worried about non-issues as economic disaster loomed on the horizon.
As much as Fannie and Freddie deserve blame for incompetence and corruption, no serious person can make them the main culprits in this story. The Wall Street crew made hundreds of billions on pushing fraudulent mortgages. Furthermore, if we had competent economists running the Fed, they would have been shooting at the housing bubble as early as 2002 also. This does not mean raising interest rates in an economy that was struggling to recover from the collapse of the stock bubble. (I’ll say that again, since people have a hard time understanding “do not raise interest rates.” The Fed should not have raised interest rates.)
If Greenspan had paid attention to the economy he would have had the Fed’s staff devoted full-time to documenting the evidence for the housing bubble and he would have used every public appearance (e.g. congressional testimonies, public speeches, international forums) to warn of the risks posed by the housing bubble. He also would have used the Fed’s full regulatory authority to police the mortgage issuing practices of the banks under its supervision. He also would have prodded other regulators to use increased scrutiny for the institutions under their control. (Greenspan was never shy about making suggestions to others.)
My guess is that these actions would have by themselves crashed the bubble and done so long before it grew to such dangerous levels. They would be essentially costless, so it is difficult to see why a vigilant Fed chair would not have followed this route.
It is difficult to believe that these actions would not have been sufficient to deflate the bubble. After all, the David Brooks of the world can ignore Dean Baker warning of the housing bubble, they cannot ignore the Fed chair issuing such warnings, backed up by endless Fed papers documenting the case.
It is incredible, that even after the collapse of the housing bubble has wrecked the economy and wiped out the life’s savings of tens of millions of middle class and moderate income families (this loss of wealth is why people are not spending, it has little to do with “pessimism”), there is still so little effort to re-examine the fixation on homeownership in this country.
Why on earth is President Obama looking to push a renewed Fannie and Freddie type system? Does the public really need to subsidize mortgage interest rates through a government guarantee system, in addition to the mortgage interest deduction?
Brooks might devote some of his fire to these loonie schemes. He might also shoot at the whiners who think no one will issue a mortgage if they have to maintain a 5 percent stake in it. And, he might also call for some criminal investigations of the banks that pushed and securitized fraudulent mortgages. But none of this seems to fit Brooks’ agenda.
Addendum:
I had occasion to quote from this 2006 Moody’s assessment of Freddie Mac. It does a great job of putting Fannie and Freddie’s subprime dealings in context:
Freddie Mac has long played a central role (shared with Fannie Mae) in the secondary mortgage market. In recent years, both housing GSEs have been losing share within the overall market due to the shifting nature of consumer preferences towards adjustable-rate loans and other hybrid products. For the first half of 2006, Fannie Mae and Freddie Mac captured about 44 percent of total origination volume — up from a 41 percent share in 2005, but down from a 59 percent share in 2003. Moody’s would be concerned if Freddie Mac’s market share (i.e., mortgage portfolio plus securities as a percentage of conforming and non-conforming origination), which ranged between 18 and 23 percent between 1999 and the first half of 2006, declined below 15 percent. To buttress its market share, Freddie Mac has increased its purchases of private label securities. Moody’s notes that these purchases contribute to profitability, affordable housing goals, and market share in the short-term, but offer minimal benefit from a franchise building perspective. (p 6)
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