The Fannie and Freddie Hate Storm

But the question is phrased badly. Three things happened: a housing bubble, a collapse in lending standards, and a global liquidity panic when markets lost trust in the solvency of financial institutions.

Now comes a Securities and Exchange Commission complaint against former Fannie and Freddie executives. The complaint makes plain that Fannie and Freddie held a lot more subprime loans than they publicly called subprime. It makes plain that Fannie and Freddie were co-sponsors with the private sector in driving down underwriting standards. Case in point: Fannie’s backing in 1999 of Countrywide’s “Fast and Easy” program to give buyers loans without proof of their income or assets.

So why do these SEC actions leave us queasy? The lawsuits don’t aim to do justice for the American people, but—very nominally—for Fannie and Freddie’s shareholders, who were supposedly misled by their disclosures. In fact, the complaints utterly miss the target in this regard.

Fannie and Freddie were under political pressure to underwrite loans to poor and minority borrowers. They were eager to do any business that appeared profitable. But investors knew what was going on. Investors’ biggest concern, as the duo’s losses mounted, was their political status. And right up to the moment it seized them, the Bush administration was insisting both were solvent and well capitalized.

Roll Call/Getty ImagesFormer CEOs of Fannie Mae and Freddie Mac in late 2008

Fannie and Freddie “held loans squarely within the public definition of subprime” that they didn’t call “subprime,” in the SEC’s language. True, but both also published detailed tables showing investors a more realistic picture of their huge holdings of nonconventional mortgages made to people with low credit scores, low down payments or both. It was in a public forum, after all, that Barney Frank called on them to “roll the dice . . . towards subsidized housing.” To add to the pathos, the two former CEOs named in the SEC complaints, Fannie’s Dan Mudd and Freddie’s Richard Syron, were brought aboard after accounting scandals and sought to appease Congress by upping loans to less-capable borrowers.

Yes, we had a housing bubble. Yes, we had deterioration in lending standards. Fannie and Freddie had a role in both. And bordering on lunatic is the claim that Fannie and Freddie came late to subprime so are innocent of the consequences. Even if the premise were true, by definition the last money in, not the first money in, defines a bubble.

But these things did not lead inexorably to the panic of 2008. The housing losses should have been manageable by the financial system. A systemic meltdown came instead because a handful of giant financial institutions in the U.S. and Europe had leveraged up with short-term and even overnight borrowings in order to hold complex mortgage derivatives that suddenly became illiquid and hard to value.

This was the recognized threat to the global financial system from the beginning, the reason for Hank Paulson’s abortive “super SIV” fund, the reason for the Fed’s interventions on behalf of Bear Stearns, the reason for several other inadequate Band-Aids until Lehman’s unraveling finally produced a full Monty panic response from governments around the world.

The role of Fannie and Freddie in all this? Very little, except that their seizure accelerated the unraveling of equity values across the banking system as investors feared nationalization would be the fate of other large and flailing financial institutions.

But here’s the relevance today: We still don’t have consistent and coherent stabilization of the financial sector or fixing of its bad incentives. And don’t kid yourself that these lawsuits are the beginning of such an effort.

They are just another political action. Notice that when their shareholders brought private lawsuits alleging the same disclosure violations the SEC now alleges, the Federal Housing Finance Agency, Fannie and Freddie’s regulator, rushed to their defense and even succeeded largely in quashing the cases on grounds their disclosures were approved by their overseer.

Yet now, when their former executives are being hung out to dry, FHFA guided Fannie and Freddie to sign bizarre “nonprosecution agreements” that basically commit them to support any claim the SEC cares to make against the execs.

FHFA’s motive is no mystery. It wants to protect its wards from further political blowback. FHFA obviously has plans for the pair that don’t involve their wind-down and the eventual privatization of their functions, the avowed goal of President Obama as well as most Republicans.

So where ultimately do Fannie and Freddie rank amid the confluence of ridiculous subsidies, private-sector opportunism and ungovernable global capital flows that contributed to the crisis? Who knows exactly, but the exaggerated ferocity of the debate lately is a reliable Washington hallmark of an argument fading into irrelevancy. The financial crisis isn’t over, and around the world the problem is not housing but governments whose commitments far exceed their resources.