Rewriting Fannie Mae History

Mr. Raines writes that “the facts about the financial collapse of Fannie and Freddie are pretty clear.” So let’s review those facts. In Mr. Raines’s telling, Fannie Mae was undone by a decision—made after he left in 2004—to purchase loans “with lower credit standards” just before the bust. But even this managerial decision wasn’t entirely the companies’ fault. Rather, according to the man who presided over one of the largest accounting scandals in history while at the helm of Fannie Mae in 2003, Fan and Fred’s big mistake was chasing Wall Street’s credit standards downward at the end of the boom.

Former Fannie Mae Chief Executive Officer Franklin Raines

What he doesn’t say is that Fan and Fred had a political and legal mandate to support low-income housing. At the end of 2004, the U.S. Department of Housing and Urban Development released its “housing goals” for Fannie Mae and Freddie Mac for 2005-2008.

The new rule required the two government-sponsored mortgage giants to increase each year the share of their business that went to low- and moderate-income borrowers, with subgoals for “underserved areas” and “special affordable” housing. The purpose, according to HUD, was to ensure that Fannie’s and Freddie’s mortgage purchases would “promote the national priority of increasing homeownership.”

The mandate had two effects. First, it meant that in order to keep growing, Fan and Fred had to grow their affordable-housing business even faster to meet the targets. But not every borrower is a prime borrower, and that goes triple for low-income borrowers. Fannie and Freddie could only meet their politically mandated lending goals by looking for new ways to extend credit to subprime borrowers.

So when Mr. Raines says that “the cause of the financial problems for Fannie and Freddie was bad decisions, not their government sponsored status,” well, let’s just say he’s not telling the whole story.

Mr. Raines also says that neither “leverage” nor mortgage-backed securities portfolios were a problem. Hmmm. In fact, the wonder twins were put into federal conservatorship in September 2008 because their losses in the first eight months of that year had very quickly overwhelmed their capital cushion, which under law needed to be the irresponsible level of less than 2% of their assets. Only some of those losses came from their portfolios directly; most of the rest came on MBS they’d guaranteed. But if the companies had been required to hold more capital (and less leverage) in the first place, they, and taxpayers, would have had a much larger margin for error.

Former Treasury Secretary Hank Paulson has also said explicitly that he rescued Fan and Fred in part to reassure foreigners that the U.S. government stood behind their debt. With some $5 trillion in liabilities at the time, they were too indebted to fail. So their leverage was a problem.

Of the many private companies that got into trouble in the fall of 2008, most have since rebuilt their balance sheets and repaid their TARP money. But not Fannie and Freddie. Their direct cost to taxpayers so far, $145 billion, is only the beginning as Congress and the Obama Administration continue to use them to rescue homeowners from foreclosure.

Mr. Raines is signaling the coming political debate when he says “that Wall Street and the commercial banks have virtually abandoned the mortgage market.” But this is like murdering your parents and demanding clemency because you’re an orphan. No private bank can compete with the federal government’s borrowing costs, so no one can afford to compete with Fannie and Freddie. It was hard enough to compete when the two companies had to maintain a (subsidized) profit margin for their shareholders. Now that they’re being run at an intentional loss, it’s impossible.

Before Fan and Fred collapsed, in July 2008, NYU professor Lawrence White estimated that the two had saved homebuyers $100 billion, total, in interest over the companies’ lifetimes. If that number is remotely accurate, Fan and Fred have already cost far more than they ever saved borrowers. Taxpayers would have been better off handing out checks to everyone who bought a house.

On second thought, forget we said that. Fan and Fred, having distorted the housing market for decades, have now all but nationalized it, and their losses continue to mount. And yet Mr. Raines is speaking for the Beltway chorus in insisting that this only makes them more indispensable than ever. They want to go back to the status quo pre-panic, resurrecting Fannie and Freddie as mortgage oligopolists, using them to subsidize the housing industry and leverage campaign contributions. And they’ll get away with it unless the American public says no.

Other countries have a buoyant home mortgage market without a Fannie or Freddie, and Canada has higher rates of home ownership than the U.S. without having either Fannie or Freddie or a home-mortgage interest tax deduction. American capitalists could also figure out a way to lend to homeowners, if the political class would let them.