How Washington Failed to Rein In Fannie, Freddie

Huge WaPo article on Fannie & Freddie that’s (mostly) worth reading:

"Blessed with the advantages of a government agency and a private company at the same time, Fannie Mae and Freddie Mac used their windfall profits to co-opt the politicians who were supposed to control them. The companies fought successfully against increased regulation by cultivating their friends and hounding their enemies.

The agencies that regulated the companies were outmatched: They lacked the money, the staff, the sophistication and the political support to serve as an effective check.

But most of all, the companies were protected by the belief widespread in Washington — and aggressively promoted by Fannie Mae and Freddie Mac — that their success was inseparable from the expansion of homeownership in America. That conviction was so strong that many lawmakers and regulators ignored the peril posed to that ideal by the failure of either company…

Fannie Mae, and to a lesser extent Freddie Mac, became enmeshed in the fabric of political Washington. They were places former government officials went to get wealthy — and to wait for new federal appointments. At Fannie Mae, chief executives had clauses written into their contracts spelling out the severance benefits they would receive if they left for a government post."

One significant omission: Freddie Mac overstated its capital base, and that was pretty much the last straw for the GSEs. The rest of the article emphasizes the attempts to expand home ownership in the 1990s (Clinton) and the 2000s (Bush) via the two GSEs.

While there is some merit to the argument that this movement impacted the housing market, it is for the most part significantly overstated, given what we now know about abdication of lending standards and the issuance of mortgages over the past 6 years. These are the vintage mortgages that are resetting, becoming delinquent, and going into defaults — not the circa 1990s trasnactions. And, the bad RMBS/CDO paper that is the root cause of the present credit crunch also date from the post 1% Fed funds rate. 

The proximate cause of current Housing situation (and eventual Credit crunch) stem primarily from 3 significant errors of the 2000:

1) Grenspan’s FOMC: Took Interest Rates taken to 1%, and kept their for over a year;
2) Banks and Mortgage Underwriters: Abdication traditional lending standards, and ignored the traditional principle that loans should only be made to those who can reasonably repay them;
3) Federal Reserve: Failed to adequately supervise banks; I consider this to be Greenspan’s Nonfeasance.

There have been numerous attempts to paint various government agencies and acts (HUD, CRA, and others) as the proximate cause of the current Housing problems. These are misguided, and primarily political, attempts that misstate well known facts about lending, mortgages and the Fed.

Indeed, government policies of the 1990s hardly managed to expand Home
ownership by any significant amount.

What did help out housing dramatically was the economic boom of the 1990s — huge wealth creation and robust income gains led to the end of the housing downturn that had tamped down home price appreciation from the late eighties til 1996. That’s the date of where Home price appreciation began in earnest.

From 2003 forward, however, prices went vertical, thanks to low interest rates, and all but non existent credit standards. If you could fog a mirror, you could get a mortgage. So much for lending standards. Indeed, the vast majority of irresponsible lending was (sua sponte) the idea of the major mortgage lenders. The loans presently defaulting, and the foreclosures now roiling both
the Housing and Credit markets primary stem from poor private sector
decision-making and weak bank policies.

Consider this February 2003 speech by Countrywide CEO Angelo Mozlilo at the American Bankers National Real Estate Conference, was typical of the era:

Sources:
How Washington Failed to Rein In Fannie, Freddie
As Profits Grew, Firms Used Their Power to Mask Peril
Binyamin Appelbaum, Carol D. Leonnig and David S. Hilzenrath
Washington Post, Sunday, September 14, 2008; Page A01
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/13/AR2008091302638.html

The Ongoing Impact of the Housing Sector   
Barry Ritholtz
Investor Insight, Aug 27 2007, 11:50 AM
http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2007/08/27/the-ongoing-impact-of-the-housing-sector.aspx

Download National Mortgage News February 13, 2003.pdf