A very good description of Fannie/Freddie, via Doug Diamond and Anil Kashyap, posting at the Freakonomics blog:
"The Fannie and Freddie situation was a result of their unique roles
in the economy. They had been set up to support the housing market.
They helped guarantee mortgages (provided they met certain standards),
and were able to fund these guarantees by issuing their own debt, which
was in turn tacitly backed by the government. The government guarantees
allowed Fannie and Freddie to take on far more debt than a normal
company. In principle, they were also supposed to use the government
guarantee to reduce the mortgage cost to the homeowners, but the Fed
and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits
and squeeze the private sector out of the “conforming” mortgage market.
Regardless, many firms and foreign governments considered the debt of
Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly.Fannie and Freddie were weakly supervised and strayed from the core
mission. They began using their subsidized financing to buy
mortgage-backed securities which were backed by pools of mortgages that
did not meet their usual standards. Over the last year, it became clear
that their thin capital was not enough to cover the losses on these subprime
mortgages. The massive amount of diffusely held debt would have caused
collapses everywhere if it was defaulted upon; so the Treasury
announced that it would explicitly guarantee the debt.But once the debt was guaranteed to be secure (and the government
would wipe out shareholders if it carried through with the guarantee),
no self-interested investor was willing to supply more equity to help
buffer the losses. Hence, the Treasury ended up taking them over."
That’s about as cogent an explanation as I have come across . . .
And to repeat what I have written ad nauseum, Fannie/Freddie were cogs in the great housing mess, but they were not the proximate cause of either the boom or bust, or the eventual credit collapse.
>
Source:
Diamond and Kashyap on the Recent Financial Upheavals
Steven D. Levitt
Freakonomics, September 18, 2008, 10:04 am
http://freakonomics.blogs.nytimes.com/2008/09/18/diamond-and-kashyap-on-the-recent-financial-upheavals/
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