The Big Lie Annotated: An AEI History Of The Financial Crisis

The Big Lie Annotated: An AEI History Of The Financial Crisis
David Fiderer
February 26, 2013





“There was never any significant debate about the causes of the 2008 financial crisis,” argues Peter Wallison, who must believe that his stint on  the Financial Crisis Inquiry Commission was a complete waste of time. Two years ago, he blamed the other nine FCIC commissioners, for “ignoring” the research of Edward Pinto, who proclaimed that the crisis was caused by Fannie, Freddie and affordable housing goals.

Now Wallison blames the media.  “Although there were two narratives about why it happened, only one of them was accepted and propagated by the media,” he says. “And in effect  the necessary competition in ideas never occurred.” For $72 you can read all about it in his new book, Bad History, Worse Policy: How a False Narrative about the Financial Crisis Led to the Dodd-Frank Act.

The irony could not be more rich. Neither Peter Wallison nor Edward Pinto would ever subject themselves to a free and open competition of ideas, because their “research”  cannot withstand a modicum of scrutiny.  FCIC staffers carefully reviewed Pinto’s work, but neither they nor Pinto were ever able to reconcile his risk categories with actual loan performance, which seemed to nullify Pinto’s thesis. So Wallison simply lied to Congress, when he testified that the FCIC never reviewed Pinto’s work.

The schism described by Wallison is not between left and right, between Democrats and Republicans, or between regulation and laissez-faire. It is the divide between capitalists and crackpots. In the world of capitalism, everyone takes risks. Some pay off; some do not. Capitalists study the results in order to ascertain who was lucky and who was smart. Not crackpots like Wallison and Pinto.  They declare that, “28 million mortgages, were subprime or otherwise low-quality,” of which, “three quarters were on the books of government agencies.” But they refuse to examine loan performance over time.

Wallison and Pinto maintain their media platforms because they are protected by a vast conspiracy of silence–an informal agreement among conservative think tanks, Republican politicians, academic shills, and friendly media outlets–which insulates the words of Wallison and Pinto to any kind of fact checking.

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Consequently, there has never been an adequate takedown of the multifarious lies and deceptions embedded within the Wallison/Pinto “narrative.” So, what follows is a description of the elephant in the room, a brief explainer of some of Wallison’s more egregious whoppers. The list is by no means comprehensive. And it merely touches upon Pinto’s new disinformation campaign against FHA, which deserves a separate  debunking. (Spoiler Alert: If you believe Pinto’s claim that, “FHA’s Estimated GAAP Net Worth Equals –$26.27 Billion,” you don’t know much about GAAP or finance.)

A Few Basic Metrics

But first, a few basic metrics.

Best Loan Performance: Over the past few decades, Fannie and Freddie’s loan performance has always been exponentially superior to that of any other segment in the mortgage market. The first chart covers the period of 1998 – 2010, the second from the beginning of the 2008 crisis until now.


by James Lockhart/ Public Domain


$216 Billion versus $888 Billion:  Similarly, the total credit losses incurred by the GSEs are about one-fourth those incurred about by private label mortgage securitizations, which are packaged and sold by Wall Street.

Laurie Goodman of Amherst Securities estimated that losses on private label securitizations issued between 2005 – 2007 total about $714 billion, a number fairly close to Moody’s current estimates. Add in another $133 billion in losses from synthetic subprime CDOs, which never financed a single mortgage, plus another $41 billion from CDOs issued before 2005, and the total approaches $888 billion.

The total credit losses on the GSEs’ entire $4.5 trillion mortgage  book, since the beginning of 2008, is about $216 billion.

A Blueprint of The Big Lie

“For those not familiar with the argument that the financial crisis was caused by government policy,” said Wallison at an AEI luncheon last week, “let me state it as succinctly as I can.” And with 500 words he mapped out the genetic code of The Big Lie.  Below is his verbatim text, interrupted by my identifiers (e.g. Whopper 1:) and Notes to decipher his mendacity. Here goes:

Before 1992 the vast majority of mortgages and United States were prime mortgages, With down payments of 10-20%, and made to people with good credit records. Fannie Mae and Freddie Mac were the principal enforcers of these rules. Delinquencies and defaults were a few.In 1992 Congress adopted legislation that required Fannie and Freddie to meet what were called, “Affordable Housing Goals.” The legislation initially required that at least 30% of the mortgages that Fannie and Freddie made, had to be made to people who were at or below the median Income in the places where they lived. HUD was given the authority to increase that quota and it did so, raising the quota to 50% by the end of the Clinton administration, and to 55% in the Bush administration.

Whopper 1: Statements by HUD throughout this period made clear that the agency’s intention was to reduce the underwriting standards that were then prevailing in the market in order to make mortgage credit available to a larger number of borrowers. There is no ambiguity about this issue.


Note 1:  Here we get to the heart of Wallison’s deceptive technique, wherein he claims that HUD’s efforts to prod the GSEs into extending credit to certain underserved sectors translated into, “the agency’s intention was to reduce the underwriting standards that were then prevailing in the market.”

That’s not how it works in the real world.  When large lending institutions devise their underwriting guidelines, they set up internal portfolio limits, and sub-limits, for different types of loans with different types of risk exposures.  So, for example, if a bank has a $1 billion balance sheet, it may cap the limit of its exposure to high-risk loans to no more than $50 million.  For instance, GSE originations, when segmented according to FICO score, were remarkably stable. About 65% had FICO scores higher than 700, about 18% had scores between 699 and 660, and about 17% were below 660.

by FHFAAs we’ll see, HUD prodded the GSEs to set up small sub-limits for riskier types of loans. But these efforts never reshaped “the prevailing market.”

Whopper 2: It was difficult for Fannie and Freddie to find prime mortgages among borrowers who are at or below the median income, especially when the quota had been raised to 50%.  So in the mid-1990s they began to reduce their underwriting standards, accepting 3% down payments by 1995, And zero down payments by the year 2000.  Acceptable FICO scores were also reduced.

Note 2: Lots to unpack here:A. Wallison’s claim, about the GSEs loading up on low income borrowers in the mid-1990s, is false.

As HUD Secretary Mel Martinez, a Bush appointee, testified i 2003:

[N]umerous HUD studies and independent analyses have shown that the GSEs have historically lagged the primary market, instead of led it, with respect to funding mortgages loans for low-income and minority households. The GSEs have also accounted for a relatively small share of first-time minority homebuyers.

Joe Nocera and Bethany McLean confirm this point:

Here’s the great irony of the mortgage market in the 1990s: to the extent that lower- and moderate-income Americans were being swept along in the rising tide of home ownership in the 1990s, it was happening not because of Fannie and Freddie, but despite them… Fannie and Freddie may have been given a federal mandate to help lower- and moderate-income Americans buy homes, but that GSEs were cautious about the credit risk they took… They wanted nothing to do with subprime. Subprime loans didn’t conform. And anyway, there was so much money to be made elsewhere…. Repeated studies by HUD showed that GSEs purchases of loans made to lower income borrowers lagged the market.

B. There is zero evidence that the GSE’s underwriting standards deteriorated in the 1990s. As reflected in the GSEs’ stellar loan performance:

by FHFA Report to Congress

C. Wallison’s claim, about the GSEs’ acceptance of low down payments, is misleading because its presented outside the context of risk limits.  

Every bank extends loans that are somewhat riskier than their overall portfolios. But unless the amounts are quantified and put in context, they are meaningless. It’s like focusing on the player who struck out in the third inning, while ignoring the final score.D. Private insurance companies, not the GSEs, set market demand for low-downpayment mortgages.Fannie and Freddie could not, by law, assume the primary credit risk on any mortgage loan in excess of 80% of the home’s appraised value. If a loan had an LTV higher than 80%, then the first loss was covered by private mortgage insurance.  In other words, the amount of low-down payment loans available in the marketplace was never decided by the GSEs. It was the private market, private mortgage insurers, which  were not regulated by the federal government. In addition, the GSEs’ policies prevented them from assuming 80% credit exposure on high LTV loans. So, for example, if a loan had an LTV of 85%, the minimum insurance coverage was 12%, so that Fannie’s net risk exposure would be no more than 73% of the total.E. FICO were not “reduced’ because they were not used in the underwriting process prior to 1996. Thereafter, they were used as an initial screening device, not as a proxy for creditworthiness.

Whopper 3: Because Fannie and Freddie were the dominant players and largely set the standards for the housing mortgage market, these lower underwriting requirements spread throughout the market, not just of those mortgages the qualified For the affordable housing goals.

Note 3: Nobody in the mortgage business would be dumb enough to believe, “Fannie and Freddie are taking on greater risk, so I can take on greater risk as well.” First of all, what businessperson would want to repeat someone else’s mistake? Secondly, the GSEs had an entirely different level of risk capacity:A. The GSEs, unlike the banks, had enormous balance sheets of super-safe mortgages to balance out any higher risk mortgages they financed. 

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B. Private label mortgage securitizations cannot diversify market timing risk. Since time immemorial, real estate lending has been governed by two immutable rules: (1) Location, location, location; and (2) Timing is everything. The most important risk factor is that level of property price appreciation, positive or negative, after the loan closes. With securitizations, the investor risks taking on loans that were booked at the peak of the cycle. Whereas the GSEs book loans continually, before, during and after the peak, and so their capacity for taking on risk exceeds that of the private label securities market.

Yet is was private label deals that continually lowered their credit standards, as illustrated Subprime Mortgage Derivatives: 

by Subprime Mortgage Derivatives

Whopper 4: The availability of government support for low quality mortgages and the easy availability of mortgage credit substantially increased demand for housing and built an enormous bubble, nine times larger than any previous bubble, between 1997 and 2007.

Note 4: You could easily write 2,000 words debunking that singular whopper.A. Most mortgage originations were not for new homes or home purchases; they were for refinancings. 

by HUD Report
The subprime sector was dominated by cash outs, larger home mortgages based on inflated appraisals. And a huge percentage of subprime mortgages were extended as part of fraudulent home flipping scheme, not because of government policy.


B. The GSEs and FHA were constrained by predatory lending rules, not private lenders or Wall Street. Consequently, Affordable Housing Goals did not include loans for which the lender did not adequately consider the borrower’s ability to make payments.(65 FR 65069, Oct. 31, 2000)

C. The GSEs’ affordable housing goals excluded the “B&C mortgage” segment, aka subprime mortgages.(65 FR 65090)

D. Ever hear of FRAUD? Check out the lawsuits filed by the Federal Housing Finance Agency alleging securities violations by 18 major banks. The word “fraud” appears 67 times in the Federal Housing Finance Authority’s complaint against JPMorgan, 53 times in its complaint against Countrywide, and 41 times in its complaint against Merrill Lynch. It’s impossible to read those filings and not be struck by all the damning evidence of the banks’ complicity, as underwriters subprime and Alt-A mortgage securities, in promoting systemic fraud throughout the loan distribution chain. Not the FHFA was the first to the courthouse.    AllstateAIGMBIAMassMutual , and a multitude  other investors    had all filed suits alleging substantially identical allegations of fraud in the sale of the same types of securities.

Wallison is famous for denying the existence of Wall Street fraud. As he wrote in his FCIC dissent:

The Commission’s report also blames predatory lending for the large build-up of subprime and other high risk mortgages in the financial system. This might be a plausible explanation if there were evidence that predatory lending was so widespread as to have produced the volume of high risk loans that were actually originated.

As it happened, Wallison along with all but one of the GOP members, boycotted the FCIC hearings in Miami, Bakersfield, Las Vegas, and Sacramento, where the evidence of widespread fraud was laid out in detail.

Whopper 5: By 2008, half of all mortgages In this bubble, that was 28 million mortgages, were subprime or otherwise low-quality. Of these, three quarters were on the books of government agencies, such as FHA, or other entities controlled by the government such as Fannie  and Freddie.

Note 5: One can write many words about why Pinto’s tally of 28 million” subprime or otherwise low-quality” mortgages is a complete crock.But why bother? The world of free market capitalism does not revolve around the labeling schemes of Peter Wallison and Edward Pinto. It revolves around performance.

Whopper 6: This shows incontrovertibly, in my view, where demand for these loans came from, and why these mortgages proliferated.

Note 6:  The foregoing explains, incontrovertibly, how easy it is to use cherry picked data, embellished with a few rhetorical sleights of hand, to fabricate a false history.

Whopper 7: When the bubble finally deflated In 2007 and 2008, these loans defaulted in unprecedented numbers, driving down housing values and weakening financial Institutions in the US and around the world. When Lehman Brothers collapsed, financial panic ensued, with banks and other financial institutions hording cash and refusing to lend to one another and that was what we knows the financial crisis.

Note 7:A. In 2007 and 2008, GSE and FHA defaults were relatively minor. As shown below:

by Mortgage Bankers Association

B. Mortgages do not all suddenly default overnight.  

Mortgages do not instantaneously “default.” In almost every case, the loan servicer exercises some discretion as to the initiation of foreclosure proceedings following a period of 90+ days delinquency. Mortgages did not suddenly transform the financial markets between September 8 and September 16, 2008.C. The financial panic was not triggered by mortgage defaults, but by liquidity crises tied to derivatives.AIG lost $30 billion in liquidity because of ratings triggers following a ratings downgrade, which was precipitated by margin calls from Goldman Sachs. Lehman triggered a panic, because its bankruptcy caused a money market fund to break a buck. Thanks to credit default swaps, transparency in the credit markets was compromised. None of this had anything to do with the GSEs and their underwriting standards.

Whopper 8: It’s not as if these facts were unknown or unknowable. Fannie and Freddie were two of the largest financial in the world, and were taken over by the before Lehman Brothers failed.

Note 8:  Once again, Wallison conflates liquidity and solvency. Hank Paulson decided that, given his projections of future losses at the GSEs, they should be taken into conservatorship. But the GSEs did not face a sudden liquidity crisis, a perennial run on the bank like the ones that caused the downfalls of Bear Stearns and Lehman.

Whopper 9: You don’t become insolvent by acquiring and guaranteeing prime mortgages.

Note 9:  Here we see the disconnect between Wallison’s sophistry and the reality of free market capitalism. Try and complete this sentence: “You don’t become insolvent by acquiring and guaranteeing  __.”The statement is patently nonsensical, because no business activity is exempt from the risk of insolvency.  A number of Texas banks and S&Ls had acquired nothing but prime mortgages in the mid to late-1980s, yet they became insolvent anyway. Businesses become insolvent because their leverage provides an insufficient margin for error. The GSEs became insolvent because their statutory capital was razor thin, which is very different from poor underwriting standards.

How dishonest is Peter Wallison? How deep is the ocean? How high is the sky? But the bigger scandal is not Wallison’s mendacity, but Wallison’s enablers, the perpetrators of that vast conspiracy of silence.



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