Fannie and Freddie: How They Went Bad

[dharma]

Flint has asked the question, and it's a fair one: Fannie managed to do fairly well for decades; why did it and Freddie suddenly fall apart? Here's why.

How A Clinton-Era Rule Rewrite Made Subprime Crisis Inevitable

Terry Jones

Wed Sep 24, 7:19 PM ET


One of the most frequently asked questions about the subprime market meltdown and housing crisis is: How did the government get so deeply involved in the housing market?

The answer is: President Clinton wanted it that way.

Fannie Mae and Freddie Mac, even into the early 1990s, weren't the juggernauts they'd later be.

While President Carter in 1977 signed the Community Reinvestment Act, which pushed Fannie and Freddie to aggressively lend to minority communities, it was Clinton who supercharged the process. After entering office in 1993, he extensively rewrote Fannie's and Freddie's rules.

In so doing, he turned the two quasi-private, mortgage-funding firms into a semi-nationalized monopoly that dispensed cash to markets, made loans to large Democratic voting blocs and handed favors, jobs and money to political allies. This potent mix led inevitably to corruption and the Fannie-Freddie collapse.

Despite warnings of trouble at Fannie and Freddie, in 1994 Clinton unveiled his National Homeownership Strategy, which broadened the CRA in ways Congress never intended.

Addressing the National Association of Realtors that year, Clinton bluntly told the group that "more Americans should own their own homes." He meant it.

Clinton saw homeownership as a way to open the door for blacks and other minorities to enter the middle class.

Though well-intended, the problem was that Congress was about to change hands, from the Democrats to the Republicans. Rather than submit legislation that the GOP-led Congress was almost sure to reject, Clinton ordered Robert Rubin's Treasury Department to rewrite the rules in 1995.

The rewrite, as City Journal noted back in 2000, "made getting a satisfactory CRA rating harder." Banks were given strict new numerical quotas and measures for the level of "diversity" in their loan portfolios. Getting a good CRA rating was key for a bank that wanted to expand or merge with another.

Loans started being made on the basis of race, and often little else.

"Bank examiners would use federal home-loan data, broken down by neighborhood, income group and race, to rate banks on performance," wrote Howard Husock, a scholar at the Manhattan Institute.

But those rules weren't enough.

Clinton got the Department of Housing and Urban Development to double-team the issue. That would later prove disastrous.

Clinton's HUD secretary, Andrew Cuomo, "made a series of decisions between 1997 and 2001 that gave birth to the country's current crisis," the liberal Village Voice noted. Among those decisions were changes that let Fannie and Freddie get into subprime loan markets in a big way.

Other rule changes gave Fannie and Freddie extraordinary leverage, allowing them to hold just 2.5% of capital to back their investments, vs. 10% for banks.

Since they could borrow at lower rates than banks due to implicit government guarantees for their debt, the government-sponsored enterprises boomed.

With incentives in place, banks poured billions of dollars of loans into poor communities, often "no doc" and "no income" loans that required no money down and no verification of income.

By 2007, Fannie and Freddie owned or guaranteed nearly half of the $12 trillion U.S. mortgage market -- a staggering exposure.

Worse still was the cronyism.

Fannie and Freddie became home to out-of-work politicians, mostly Clinton Democrats. An informal survey of their top officials shows a roughly 2-to-1 dominance of Democrats over Republicans.

Then there were the campaign donations. From 1989 to 2008, some 384 politicians got their tip jars filled by Fannie and Freddie.

Over that time, the two GSEs spent $200 million on lobbying and political activities. Their charitable foundations dropped millions more on think tanks and radical community groups.

Did it work? Well, if measured by the goal of putting more poor people into homes, the answer would have to be yes.

From 1995 to 2005, a Harvard study shows, minorities made up 49% of the 12.5 million new homeowners.

The problem is that many of those loans have now gone bad, and minority homeownership rates are shrinking fast.

Fannie and Freddie, with their massive loan portfolios stuffed with securitized mortgage-backed paper created from subprime loans, are a failed legacy of the Clinton era.

http://news.yahoo.com/s/ibd/20080924...80924general01

[Flint]

I actually remember paying attention to that at the time it happened, and my memories don't disagree with this. As I recall, the banks were put under some pressure to make more loans to minorities, and the fact that minorities were underrepresented among loan grantees was cited as proof.

"But", the bankers protested, "bias in the loan granting process can't be measured by percentage of applicants turned down, but rather by the loan default rate. If we're systematically denying loans to qualified blacks, one would predict a significantly lower default rate among blacks. But we see that the default rate is constant (and optimal) every which way - across race, religion, national origin, gender, you name it. So there is no discrimination here."

And the government's response was, "So what? Blacks aren't getting easy loans. Give them loans. Find a way to have them qualify, and apply it." Kind of like passing a law requiring more hours of daylight than darkness year around. You can't just regulate that poor people aren't poor anymore.

In one sense, this is an inherent problem that Democratic administratons face. Unlike the Republicans, who can overnight cut tax rates on higher incomes, the Democrats can't overnight render those with the lowest income educated or skilled (much less conscientious and reliable). That takes generations (and social policy sociologists dispute vehemently), and isn't very helpful toward winning next year's election.

But beyond all this, there is no question (I hope) that the housing bubble that started ballooning after the dot-coms went TU, was broadly abused by an unregulated banking industry. It wasn't under the Clinton administration that lenders engineered the whole subprime pyramid scheme, repackaging these guaranteed-to-fail loans and reselling them at a profit, making huge profits on default swaps and other opaque instruments that relied on the ability to sell any house for more than was loaned on it, indefinitely.

And it wasn't any secret that this scheme couldn't last forever, and when it collapsed it would be catastrophic. Now, maybe a Democratic administration, finding the economy humming along as mortgage lenders materialized money from thin air, would also have looked the other way. Wouldn't surprise me at all. But the fact remains that the most damaging abuses we're fighting now, happened under Bush's watch.

Clinton's attempt to pretend the poor were solvent was surely misguided, political in the worst sense. But in 2001, the current problems simply weren't there. The potential for them was, but the housing bubble abuse has been a Bush-era phenomenon.

[Michael]

"Clinton's attempt to pretend the poor were solvent was surely misguided, political in the worst sense. But in 2001, the current problems simply weren't there. The potential for them was, but the housing bubble abuse has been a Bush-era phenomenon."

I agree.

Only the hardest core Republicans are using this rationale to blame Clinton in 2008 after almost two full terms of Bush and a decade of Republican control of congress.

I have even heard that the high risk loans were being made because Clinton was forcing bankers to do those loans. And by the same rationale Clinton must of been forcing those high interest rates onto the people getting those loans and high profits for those drawing up those loans.

Nope - that describes loan sharking.


AS I SAID PREVIOUSLY, IT WAS OBVIOUS TO MANY IN 2005 THAT THE HOUSING BUBBLE WAS GOING TO BURST. ALL THAT TIME WAS THERE TO INTERVENE TO PREVENT DISASTER WITH REGULATION. BUT WHO HAS BEEN ASLEEP AT THE WHEEL?

[Curious]

The amount of BAD loans that exist because of the push to lend to poor people in the Fannie Freddie portfolio is actually VERY SMALL (on the order of maybe 3 to 5% of the losses that they suffering). I have somewhere on my computer the actual breakdown ... but those are NOT the reason for their failure.

The BLAME GAME is trying to cast this issue into a Republican vs Democratic issue ... BUT IT IS BULLSHIT!! That is being done merely for partisan purposes!!

The real underlying reason for Fannie/Freddie's problem is a culture of increasingly loose underwriting standards to MIDDLE CLASS people that goes back nearly 20 years (to just after the real estate collapse in 89-90). It got VERY BAD starting about late 2001/early 2002 (fwiw when the Republicans were still in control of the Congress AND the White House), when they basically threw underwriting standards out the window.

It took a while for the big developers to catch on to what they could get away with wrt Fannie and Freddie ... but not too long, about 18 months, and then the floodgates allowing bad paper were fully opened up.

At first the bad paper was not noticable since the rising real estate prices allowed those who were overextended to sell out for a higher price and thus cover the loans that they should not have gotten to begin with. Alas ... real estate prices can only go up 20 to 30% per year when incomes are only going up 3% to 5% per year for so many years before you finally have the bubble blown up so big that it can't go any bigger.

Most of the bad Fannie and Freddie paper, if you actually look at it, is from loans to middle class and upper middle class people who were buying out on the very edge of loan qualification standards in bubble markets. It is NOT from those low income loans (although enough of those are bad ... but not enough to severely damage Fannie and Freddie's Balance Sheet if their other loans were within normal parameters).

Rush and his "Ditto Heads" are "Idiot Heads" about this issue as far as I am concerned.

They have NEVER looked at the real numbers ... and are trying to set up a bogy man as responsible merely because they don't want to admit ANY culpability of their own party at having been part and parcel to the problem (even though it was Republicans in control of both Congress AND the White House when the loan standards were basically thrown out the window).

Sheesh ... no wonder people are having a hard time understanding what happened with EVERYTHING going on. Many people only want to look at what happened PRIOR TO 2001 ... as if NOTHING that happened after 2001 had any impact upon the events today. Nothing could be further from the truth.

(I guess that entire housing bubble I saw in 2004/5/6 was just a figment of my imagination ... prices I guess were FLAT after Clinton left office and all these bad loans were written while Clinton was President)

Curious

[dharma]

Numbers and links, Curious. You know what Shakespeare said about sound and fury.

As for the housing bubble: ever hear of a guy named Alan Greenspan?

[dharma]

According to the mortgage bankers’ survey, 6.14 percent of all home loans were past due or in foreclosure in the fourth quarter [of 2006], up from 5.72 percent. The portion of subprime loans, which are given largely to poor and minority borrowers, past due or in foreclosure rose to 17.86 percent, from 16.42 percent.

http://www.nytimes.com/2007/03/14/bu...end.html?fta=y

That's as of first quarter '07; I'm sure I can find more current—and much worse—numbers, but it's late and I'm tired.

[Flint]

The portion of subprime loans, which are given largely to poor and minority borrowers, past due or in foreclosure rose to 17.86 percent, from 16.42 percent.

Sounds right to me. After all, it's only in the bank's interests to issue a subprime loan if the borrower can't qualify otherwise - AND if the bank can repackage and sell that loan before the borrower defaults.

[Michael]

Was Clinton responsible for the Financial Crisis?

The basis for the argument is that in 1992, Congress that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers (I believe through a 20 year old law called the Community Reinvestment Act). Operating under that requirement, Fannie Mae, in particular, was more aggressive and creative in stimulating minority gains. It aimed extensive advertising campaigns at minorities that explain how to buy a home and opened three dozen local offices to encourage lenders to serve these markets. Most importantly, Fannie Mae agreed to buy more loans with very low down payments–or with mortgage payments that represent an unusually high percentage of a buyer’s income. That made banks willing to lend to lower-income families they once might have rejected.

Since HUD became their regulator in 1992, Fannie and Freddie each year are supposed to buy a portion of "affordable" mortgages made to underserved borrowers. Every four years, HUD reviews the goals to adapt to market changes.

In 1995, President Bill Clinton's HUD agreed to let Fannie and Freddie get affordable-housing credit for buying subprime securities that included loans to low-income borrowers. The idea was that subprime lending benefited many borrowers who did not qualify for conventional loans. HUD expected that Freddie and Fannie would impose their high lending standards on subprime lenders.

Banks typically back prime loans with customers' deposits. But subprime lenders often rely on money from Wall Street investors , who buy packages of loans as investments called mortgage-backed securities.

In 2000, as HUD revisited its affordable-housing goals, the housing market had shifted. With escalating home prices, subprime loans were more popular. Consumer advocates warned that lenders were trapping borrowers with low "teaser" interest rates and ignoring borrowers' qualifications.

HUD restricted Freddie and Fannie, saying it would not credit them for loans they purchased that had abusively high costs or that were granted without regard to the borrower's ability to repay. Freddie and Fannie adopted policies not to buy some high-cost loans.

That year, Freddie bought $18.6 billion in subprime loans; Fannie did not disclose its number.

In 2001, HUD researchers warned of high foreclosure rates among subprime loans.
"Given the very high concentration of these loans in low-income and African American neighborhoods, the growth in subprime lending and resulting very high levels of foreclosure is a real cause for concern," an agency report said.

But by 2004, when HUD next revised the goals, Freddie and Fannie's purchases of subprime-backed securities had risen tenfold. Foreclosure rates also were rising.

That year, President Bush's HUD ratcheted up the main affordable-housing goal over the next four years, from 50 percent to 56 percent. John C. Weicher, then an assistant HUD secretary, said the institutions lagged behind even the private market and "must do more."

In 2003, the two bought $81 billion in subprime securities. In 2004, they purchased $175 billion -- 44 percent of the market. In 2005, they bought $169 billion, or 33 percent. In 2006, they cut back to $90 billion, or 20 percent. Generally, Freddie purchased more than Fannie and relied more heavily on the securities to meet goals. Because Fannie and Freddie were buying mortgage-backed securities rather than the actual subprime loans, their involvement came too late to require stiffer standards from lenders.

Neither they nor HUD had the staff or ability to look through all those loans to determine whether they met the lending guidelines of Fannie and Freddie even though their money was used to capitalize them.

It was a mistake to credit Fannie and Freddie for investing in subprime securities toward their affordable housing goals. That's on the Clinton administration in a general, theoretical way. But it was under Bush when the practice began to threaten the economy in a very real way and it was allowed to continue and even encouraged. It was also a mistake to expand the program after 2000 and that is all on Bush's HUD crew. However, there was a large push among individual, mostly Democratic members of Congress in 2004, the last time the HUD strategies were revisited (prior to this year) but to blame them (or the CBC) for the problems when they had so little power seems a bit of a stretch.

http://www.blogfordemocracy.org/2008...le_for_th.html