Tuesday, September 23, 2008

Blame Fannie Mae and Congress For Credit Mess

How the political obsession with "affordable housing" and "home ownership" backfired:

The vast accumulation of toxic mortgage debt that poisoned the global financial system was driven by the aggressive buying of subprime and Alt-A mortgages, and mortgage-backed securities, by Fannie Mae and Freddie Mac. The poor choices of these two government-sponsored enterprises (GSEs) -- and their sponsors in Washington -- are largely to blame for our current mess.

In order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie Mae and Freddie Mac committed to increased financing of "affordable housing." They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.

Beginning in 2004, their portfolios of subprime and Alt-A loans and securities began to grow. Subprime and Alt-A originations in the U.S. rose from less than 8% of all mortgages in 2003 to over 20% in 2006. During this period the quality of subprime loans also declined, going from fixed rate, long-term amortizing loans to loans with low down payments and low (but adjustable) initial rates. The hint to Fannie and Freddie was obvious: Concentrate on affordable housing and, despite your problems, your congressional support is secure.

Now the Democrats are blaming the financial crisis on "deregulation." This is a canard. There has indeed been deregulation in our economy -- in long-distance telephone rates, airline fares, securities brokerage and trucking, to name just a few -- and this has produced much innovation and lower consumer prices. But the primary "deregulation" in the financial world in the last 30 years permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable in this storm.

As a result, U.S. commercial banks have been able to attract more than $100 billion of new capital in the past year to replace most of their subprime-related write-downs. Deregulation of branching restrictions and limitations on bank product offerings also made possible bank acquisition of Bear Stearns and Merrill Lynch, saving billions in likely resolution costs for taxpayers.

~Charles Calomiris and Peter Wallison in today's WSJ

See related CD post below


At 9/23/2008 9:12 AM, Blogger K T Cat said...

My fiancee, a devoted Democrat and Hillary supporter, would second this article, but only after it addressed the compensation portion of the problem. Management was biased towards risk because there was no penalty to them for failure.

At 9/23/2008 11:45 AM, Blogger Dave Narby said...

Clearly, this was a big part of the problem.

Combine that with fiat currency, fractional banking, and CEO's willing to swap debt like crazy to make $$$, and you've got your BOOM...

Followed by BUST.

Followed by BAILOUT.

At 9/25/2008 10:36 AM, Anonymous Anonymous said...

If only the Banking Committee Repubs could have clipped Fannie and Freddie's wings back in '05. We could have moved all those mortgages over to the 'investment banks' and counter-party insurers, like AIG, and got REAL he-man leverage (along with huge commissions). Today, we wouldn't have that $25B bailout of Freddie and Fannie!!! Of course, we'd be bailing the banks out at $1.5 Trillion instead of a measly $700 billion. What a missed opportunity for the American taxpayer!

At 9/26/2008 6:19 PM, Anonymous Anonymous said...

with what is going on, this is your economic insight? What a shame.


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