Dear GOP: Fannie, Freddie Did Not Cause the Financial Crisis

[one...two...tree 2,762]

By Andy Kroll, Mother Jones

It's time to put to rest a lingering myth that, all evidence to the contrary, just won't die. On the Senate floor this morning, Senate Minority Leader Mitch McConnell (R-Ky.) repeated, for the umpteenth time among Republicans and conservatives, a pernicious misconception that places most, if not all, of the blame for the financial crisis on the government-sponsored housing corporations, Fannie Mae and Freddie Mac:

"[The financial reform bill] does nothing—nothing—as I indicated, to rein in Fannie Mae and Freddie Mac, the main protagonists in the financial meltdown. This is absolutely worse than irresponsible; it's the legislative equivalent of wrongful conviction."

Not only is McConnell's basic grasp of storytelling wrong—if Fannie and Freddie are to blame, shouldn't they be the antagonists?—but his understanding of what caused the financial crisis is deeply flawed. Sadly, this misconception is a longstanding meme among Republicans and conservatives. In 2008, then-Republican presidential candidate John McCain said Fannie and Freddie were "the catalyst for this housing crisis" and thus the spark that ignited the broader economic meltdown. House Majority Leader John Boehner has said, "How you can attempt to fix [the financial system] without going to the root of the problem, Fannie Fae and Freddie Mac, is really beyond me." And a roster of conservative pundits has played the Fannie-Freddie blame game so many times it's hard to keep track.

But a look at the actual data shows that Fannie and Freddie—while certainly plagued with problems—are not the root causes of the subprime mortgage meltdown nor the financial collapse. First, context: Fannie and Freddie's roles, in part, consisted of buying up lots of mortgages in the secondary mortgage markets, i.e., taking them off the books of mortgage originators, and allowing those originators to extend more credit to potential homeowners. Over time, the two GSEs' positions as secondary purchasers of mortgages was used to try to expand homeownership to groups of Americans that traditionally didn't have access to this kind of credit—namely, low-income citizens.

Now to Barry Ritholtz. An financial expert and wildly popular blogger, Ritholtz has written time and time again about the lunacy of blaming Fannie and Freddie. He's so sure of his position that he's offered $100,000 to anyone who can prove him wrong. Here's Ritholtz debunking the Fannie and Freddie meme:

• The origination of subprime loans came primarily from non-bank lenders not covered by the [Community Reinvestment Act, a law pushing the two GSEs to purchase more loans in the secondary markets and thus expand access to housing loans to low-income neighborhoods];
• The majority of the underwriting, at least for the first few years of the boom, were by these same non-bank lenders;
• When the big banks began chasing subprime, it was due to the profit motive, not any mandate from the President (a Republican) or the Congress (Republican controlled) or the GSEs they oversaw;
• Prior to 2005, nearly all of these sub-prime loans were bought by Wall Street—NOT Fannie & Freddie;
• In fact, prior to 2005, the GSEs were not permitted to purchase non-conforming mortgages;
• The change in FNM/FRE conforming mortgage purchases in 2005 was not due to any legislation or marching orders from the President (a Republican) or the the Congress (Republican controlled). It was the profit motive that led them to this action.

That's Ritholtz's perspective, which he backs up in more detail in his book, Bailout Nation. Rep. Henry Waxman (D-Calif.), who as then-chair of the House oversight and government reform committee, put it this way in 2008: "It is a myth to say they were the originators of the subprime crisis. Fundamentally, they were following the market, not leading it."

Here are three economists' takes:

Paul Krugman, Nobel Prize winner in economics and New York Times columnist: "[W]hile Fannie and Freddie are problematic institutions, they aren't responsible for the mess we're in."

University of Oregon economist and popular blogger Mark Thoma: "est behavior of Fannie and Freddie would not have been enough to stop the bubble from inflating in other parts of the financial sector."

N. Gregory Mankiw, a former adviser to President George W. Bush: Fannie, Freddie "were only one element" of the financial crisis.

A report (pdf) by the Government Accountability Office, the non-partisan investigatory arm of Congress, supports all these arguments. According to the GAO report, Fannie and Freddie didn't go wild in the mid-2000s buying up mortgages in the secondary market because of some government mandate, like the 1977 Community Reinvestment Act, to increase homeownership among low-income Americans. On the contrary, "Former [Federal Housing Finance Agency] Director [James] Lockhart stated that the enterprises' primary motivation in purchasing [Alt-A and subprime mortgage backed] assets was to restore their share of the mortgage market, which declined substantially from 2004 through 2007 as the 'nontraditional' (for example, subprime) mortgage market rapidly increased in size. FHFA further stated that the enterprises viewed such mortgage assets as offering attractive risk-adjusted returns." In other words, they wanted to be bigger players in the mortgage business again, to make money where they thought they could—not because Rep. Barney Frank (D-Mass.) or some other politician told them what to do.

Now, there's no denying that the current precarious state of Fannie and Freddie is a huge issue. Thanks to the Treasury Department, they're entitled to unlimited bailout money from taxpayers, which it looks like they'll need as they continue to bleed billions in cash. They're a headache, a problem lawmakers need to grapple with sooner rather than later. The House and Senate aren't going to deal with the twins with their current financial reform bill, so they'll need to take up the cause soon after.

The Democrats say the twins are too big and complex and troubled to include in this bill; GOPers say the bill is a failure if it doesn't address the GSEs. I won't say who's right or wrong. But, as the above arguments show, the claim that Fannie and Freddie caused the crisis—and should thus be the most urgent targets of reformers—is just not true.

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[fiffjtw24 2]

Two words - Barney Frank.... I was in the mortgage industry back in the day and he pushed the government to pass laws to make available and to make it extremely easy for EVERYBODY to get mortgages to buy a house. Well, most EVERYBODY cannot buy a house and we see that NOW. I put a lot of the blame on Barney Frank. Fannie and Freddie and the mortgage brokers were just selling what the government wanted us to do. FU Barney Frank........

Do the research and you will see what I am talking about......

[one...two...tree 2,762]

Two words - Barney Frank.... I was in the mortgage industry back in the day and he pushed the government to pass laws to make available and to make it extremely easy for EVERYBODY to get mortgages to buy a house. Well, most EVERYBODY cannot buy a house and we see that NOW. I put a lot of the blame on Barney Frank. Fannie and Freddie and the mortgage brokers were just selling what the government wanted us to do. FU Barney Frank........

Do the research and you will see what I am talking about......

Sounds like you've got the proof to challenge Barry Ritholtz offer of $100,000 to anyone who can prove that Fannie and Freddie caused the financial meltdown. Do it. You'll be $100,000 richer.

[JohnSmith2007 353]

How the Democrats Created the Financial Crisis: Kevin Hassett

Commentary by Kevin Hassett

Sept. 22 (Bloomberg) -- The financial crisis of the past year has provided a number of surprising twists and turns, and from Bear Stearns Cos. to American International Group Inc., ambiguity has been a big part of the story.

Why did Bear Stearns fail, and how does that relate to AIG? It all seems so complex.

But really, it isn't. Enough cards on this table have been turned over that the story is now clear. The economic history books will describe this episode in simple and understandable terms: Fannie Mae and Freddie Mac exploded, and many bystanders were injured in the blast, some fatally.

Fannie and Freddie did this by becoming a key enabler of the mortgage crisis. They fueled Wall Street's efforts to securitize subprime loans by becoming the primary customer of all AAA-rated subprime-mortgage pools. In addition, they held an enormous portfolio of mortgages themselves.

In the times that Fannie and Freddie couldn't make the market, they became the market. Over the years, it added up to an enormous obligation. As of last June, Fannie alone owned or guaranteed more than $388 billion in high-risk mortgage investments. Their large presence created an environment within which even mortgage-backed securities assembled by others could find a ready home.

The problem was that the trillions of dollars in play were only low-risk investments if real estate prices continued to rise. Once they began to fall, the entire house of cards came down with them.

Turning Point

Take away Fannie and Freddie, or regulate them more wisely, and it's hard to imagine how these highly liquid markets would ever have emerged. This whole mess would never have happened.

It is easy to identify the historical turning point that marked the beginning of the end.

Back in 2005, Fannie and Freddie were, after years of dominating Washington, on the ropes. They were enmeshed in accounting scandals that led to turnover at the top. At one telling moment in late 2004, captured in an article by my American Enterprise Institute colleague Peter Wallison, the Securities and Exchange Comiission's chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's position on the relevant accounting issue was not even ``on the page'' of allowable interpretations.

Then legislative momentum emerged for an attempt to create a ``world-class regulator'' that would oversee the pair more like banks, imposing strict requirements on their ability to take excessive risks. Politicians who previously had associated themselves proudly with the two accounting miscreants were less eager to be associated with them. The time was ripe.

Greenspan's Warning

The clear gravity of the situation pushed the legislation forward. Some might say the current mess couldn't be foreseen, yet in 2005 Alan Greenspan told Congress how urgent it was for it to act in the clearest possible terms: If Fannie and Freddie ``continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road,'' he said. ``We are placing the total financial system of the future at a substantial risk.''

What happened next was extraordinary. For the first time in history, a serious Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.

Different World

If that bill had become law, then the world today would be different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest and most venerable institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed.

But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.

That such a reckless political stand could have been taken by the Democrats was obscene even then. Wallison wrote at the time: ``It is a classic case of socializing the risk while privatizing the profit. The Democrats and the few Republicans who oppose portfolio limitations could not possibly do so if their constituents understood what they were doing.''

Mounds of Materials

Now that the collapse has occurred, the roadblock built by Senate Democrats in 2005 is unforgivable. Many who opposed the bill doubtlessly did so for honorable reasons. Fannie and Freddie provided mounds of materials defending their practices. Perhaps some found their propaganda convincing.

But we now know that many of the senators who protected Fannie and Freddie, including Barack Obama, Hillary Clinton and Christopher Dodd, have received mind-boggling levels of financial support from them over the years.

Throughout his political career, Obama has gotten more than $125,000 in campaign contributions from employees and political action committees of Fannie Mae and Freddie Mac, second only to Dodd, the Senate Banking Committee chairman, who received more than $165,000.

Clinton, the 12th-ranked recipient of Fannie and Freddie PAC and employee contributions, has received more than $75,000 from the two enterprises and their employees. The private profit found its way back to the senators who killed the fix.

There has been a lot of talk about who is to blame for this crisis. A look back at the story of 2005 makes the answer pretty clear.

Oh, and there is one little footnote to the story that's worth keeping in mind while Democrats point fingers between now and Nov. 4: Senator John McCain was one of the three cosponsors of S.190, the bill that would have averted this mess.

(Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist.)

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aSKSoiNbnQY0

[mawilson 2,133]

Sounds like you've got the proof to challenge Barry Ritholtz offer of $100,000 to anyone who can prove that Fannie and Freddie caused the financial meltdown. Do it. You'll be $100,000 richer.

No single entity caused the meltdown, but Fannie and Freddie didn't exactly help either.

[JohnSmith2007 353]

Sounds like you've got the proof to challenge Barry Ritholtz offer of $100,000 to anyone who can prove that Fannie and Freddie caused the financial meltdown. Do it. You'll be $100,000 richer.

Convincing him he is wrong would be like turning you into a Regan conservative. No matter what evidence or argument you offer he would never admitt he is wrong. The offer of $100K is just a way of making people think he is right, it is just a dishonest ploy.

[one...two...tree 2,762]

Convincing him he is wrong would be like turning you into a Regan conservative. No matter what evidence or argument you offer he would never admitt he is wrong. The offer of $100K is just a way of making people think he is right, it is just a dishonest ploy.

Facts are not negotiable. The GOP keeps telling the lie that the Community Reinvestment Act forced banks to give mortgages to people who couldn't afford them. If that were factual, it'd be pretty easy to collect that 100 grand.

[_Simpson_ 250]

Facts are not negotiable. The GOP keeps telling the lie that the Community Reinvestment Act forced banks to give mortgages to people who couldn't afford them. If that were factual, it'd be pretty easy to collect that 100 grand.

Steve its nice to see you boycotted your avatar.

[mawilson 2,133]

Facts are not negotiable. The GOP keeps telling the lie that the Community Reinvestment Act forced banks to give mortgages to people who couldn't afford them. If that were factual, it'd be pretty easy to collect that 100 grand.

Forced is a strong word, but the government certainly didn't think that lending to anyone

with a pulse was a problem until it blew up in their faces. Hindsight is 20/20.

[Ban Hammer 14,364]

No single entity caused the meltdown, but Fannie and Freddie didn't exactly help either.

amen, gecko

[SMR 368]

Facts are not negotiable. The GOP keeps telling the lie that the Community Reinvestment Act forced banks to give mortgages to people who couldn't afford them. If that were factual, it'd be pretty easy to collect that 100 grand.

No. It's sort of like me saying I'll give $100k to anyone that can prove that the World War II was caused by the League of Nations, or the depression was caused by prohibition. The main issue is that a) the evidence will inevitably be subjective and b) there is no appeal to any sort of unbiased judge who would decide. That is you can bring whatever evidence you want but he can always simply deny it, say you are wrong, and then refuse to give you the $100k.

As was said, it's really just a dishonest ploy.

[JohnSmith2007 353]

Facts are not negotiable. The GOP keeps telling the lie that the Community Reinvestment Act forced banks to give mortgages to people who couldn't afford them. If that were factual, it'd be pretty easy to collect that 100 grand.

I wouldn't expect you to agree, in fact I knew you wouldn't. It isn't a lie that the CRA caused a large part of the reasons for the melt down. Your "facts" are viewed through the filter of partisanship. The government caused the meltdown. Not just dems or reps but the government in general. The CRA was the fuse that started the whole thing.

[one...two...tree 2,762]

No. It's sort of like me saying I'll give $100k to anyone that can prove that the World War II was caused by the League of Nations, or the depression was caused by prohibition. The main issue is that a) the evidence will inevitably be subjective and b) there is no appeal to any sort of unbiased judge who would decide. That is you can bring whatever evidence you want but he can always simply deny it, say you are wrong, and then refuse to give you the $100k.

As was said, it's really just a dishonest ploy.

The argument is pretty straightforward and he gives the points he's offering anyone to disprove.

It might help to actually read it:

My approach to everything I have written, studied and analyzed in this space is pretty straight forward: Start with the data and evidence and go forward from there. Figure out what the “Truth” is; try to get as close to the objective reality beneath the noise in order to make intelligent investing decisions for myself and my clients.

There are others who do not share this objective. Their goals are either political (winning the next election) or ideological (having their belief system become dominant). Truth is irrelevant to these people.

Not surprisingly, these folks — many of whom contributed to the crisis in a mighty way — are desperately trying to duck responsibility for what happened. Those who helped cause the crisis are engaged in an ongoing effort to rewrite its history.

Their goal? Exonerate their own bad behavior, throw off any responsibility for the collapse, blame anything but their own ideology and horrific decision making. They want to keep pushing their tired political agendas, despite the damage they may have caused.

When writing Bailout Nation, I tried to steer clear of partisan finger pointing. I kept the focus on what actually occurred, what could be proven mathematically. I blamed Democrats and Republicans — not equally, but in proportion to their actions, and what they did. Unsupported theories, tenuous connection, loose affiliations were not part of the analysis.

To be blameworthy, every legislative change, each regulatory failure, any corporate action had to manifest themselves in actual mathematical proof. This led me to ascertain the following 30 year sequence:

-Free market absolutism becomes the dominant intellectual thought.

-Deregulation of markets, investment houses, and banks becomes a broad goal: This led to Glass Steagall repeal, unfettering of Derivatives, Investing house leverage exemptions, and a new breed of unregulated non bank lenders.

-Legislative actions reduce or eliminate much of the regulatory oversight; SEC funding is weakened.

-Rates come down to absurd levels.

-Bond managers madly scramble for yield.

-Derivatives, non-bank lending, leverage, bank size, compensation levels all run away from prior levels.

-Wall Street securitizes whatever it can to satisfy the demand for higher yields.

-”

Lend to securitize

” nonbank mortgage writers sell enormous amounts of subprime loans to Wall Street for this purpose.

-To meet this huge demand, non bank lenders collapse lending standards (banks eventually follow), leading to a credit bubble.

-The Fed approves of this “innovation,” ignores risks.

-Housing booms . . . then busts

-Credit freezes, the markets collapse, a new recession begins.

You will note that the CRA is not part of this sequence. I could find no evidence that they were a cause or even a minor factor. If they were, the housing bubbles would not have been in California or S. Florida or Las Vegas or Arizona — Harlem and South Philly and parts of Chicago and Washington DC would have been the focus of RE bubbles.

Nor do I blame Fannie and Freddie. Now understand, there is no love lost between myself and the GSEs. For years, I have called them “Phoney and Fraudy.” Since George Bush and Hank Paulson nationalized them, I have accused the government of using these two as a backdoor bailout for banks — a hidden PPIP/TARP used to buy all the garbage mortgages that banks are desperate to get off their balance sheets. Longtime readers will recall we very publicly shorted Fannie based upon their fraudulent practices and horrific balance sheet when FNM’s stock was in the $40s (it soon after collapsed).

But even I cannot reconcile reality with the movement to place all of the world’s troubles at the feet of the GSEs. Not, at least, according to the data.

That lack of evidence, however, doesn’t stop ideologues from trying.

http://www.ritholtz.com/blog/2010/05/rewriting-the-causes-of-the-credit-crisis/