Fannie May Was No Angel But They Did Not Cause the Housing Bubble
How did Gretchen Morgenson, one of America’s best financial reporters, get the story of Fannie Mae’s role in the financial collapse so wrong?
But most disappointing—disgraceful—-is a third book that blames the entire financial collapse on misguided efforts to increase homeownership among minority and moderate-income Americans and places Fannie Mae at the center of that enterprise. “Fannie Mae led the way in relaxing loan underwriting standards,” Morgenson and Rosner write, “a shift that was quickly followed by private lenders.” They have that backward.
The public record is unequivocal: The private lenders led the deterioration of mortgage standards; Wall Street financed them; and Fannie resisted and then belatedly followed. This part of the book, from the first pages in the opening chapter, is overheated in its prose, sloppy with its facts, and disingenuous in its story line. It is a serious disservice to a fair understanding of the crash and its origins.
According to Morgenson and Rosner, here is how Fannie Mae caused the great collapse. In 1994, President Bill Clinton launched the National Partners in Homeownership. At the time, Jim Johnson, aspiring financial mogul, wanted to build Fannie Mae into a giant, but he faced enemies and needed cover. And what better cover than a social mission of expanded homeownership? The plan “was to commit so much money to low income housing,” Morgenson and Rosner write, “that no one would dare to criticize its other activities.”
The enemies included other bankers who resented both the credit line at the Treasury and the implicit government guarantee that allowed Fannie to sell bonds and obtain capital at lower cost than its purely private competitors. Fannie’s quasi-governmental status and growing market share as a private financial—services company also enraged intellectuals at conservative think tanks. The Wall Street Journal editorial page and the American Enterprise Institute regularly excoriated Fannie. Johnson worried that the free-marketeers in power in Congress would revise Fannie’s charter to cut it loose from the government guarantee.
The discussion of Fannie’s jousting with critics is accurate and compelling—but then Morgenson and Rosner make two leaps not supported by the evidence. In their account, the increased commitment to moderate-income housing in the 1990s was nothing but a cynical move in a Washington chess game. In their rendition, Fannie’s decision, in league with Clinton’s housing goals, to liberalize terms of the mortgages the company purchased led directly to the subprime epidemic and subsequent collapse.
The first contention is speculative. But even if Fannie’s embrace of expanded homeownership was entirely self-serving, the second and more serious allegation is false. For starters, the timing is off. Fannie did start purchasing large numbers of sketchy mortgages, in an effort to defend its market share, but only around 2004. By then, subprime was a huge industry with plenty of buyers on Wall Street. As late as 2005, according to Reckless Endangerment, non-Fannie mortgage-backed securities packaged by Wall Street investment banks accounted for 55 percent of mortgage volume.
As Morgenson and Rosner obliquely acknowledge elsewhere in the book, other Wall Street firms created the subprime bubble precisely because Fannie would not buy those loans. Morgenson and Rosner admit this contradiction when they write of the Wall Street-financed boom in poor-quality loans that took off circa 2001: “Because higher-quality borrowers were still at this time the domain of Fannie Mae and Freddie Mac, Wall Street could not hope to compete in this area. So the big investment firms stepped up their interest in alternative mortgage products offered to sub-prime or near-prime borrowers.” In other words, Wall Street went where Fannie prudently feared to tread.
Morgenson and Rosner contend that Fannie’s perdition began in the mid-1990s when the company started purchasing mortgages with down payments of just 5 percent. “Traditionally,” they write, “banks had required that borrowers put 20 percent of the property price down to secure a mortgage loan.” That’s an embarrassingly novice mistake. Veterans’ loans under the GI bill accepted zero down payments. For decades, the Federal Housing Administration has insured loans with down payments of 5 percent—and these loans were purchased by Fannie Mae. Private mortgage insurers, which began competing with the FHA in the 1960s, also offered insured loans with small down payments. How could Morgenson and Rosner have missed something so basic and central to the story? What made these loans safe and insurable and liquid in the secondary market was careful underwriting, of the property value and the borrower’s capacity to pay, not the down payment. It was the lack of serious underwriting that made subprime such a disaster.
Morgenson and Rosner also repeat the red herring that efforts to combat racial discrimination and redlining led to pressure to lower lending standards, which in turn led to the crash. Extensive research shows that honorable lenders who avoided subprime were able to expand their origination of conventional, fixed-rate loans to minority and moderate—income homebuyers without any increase in defaults. (Authoritative work on this has been done by scholars at the Center for Community Capital at the University of North Carolina.)
Only late in the game did Fannie Mae seriously water down its standards. It’s true—and appalling—that Fannie became the largest purchaser of subprime loans from one of the worst mortgage hustlers in the game, Jim Johnson’s pal Angelo Mozilo, the CEO of Countrywide Mortgage. But that was in the period from 2003 to 2005, when Wall Street had already provided the financing and created the securities market for subprime. Fannie was playing catch-up.
So in the rogues’ gallery of scoundrels that caused the financial collapse, a fair reckoning would rank Fannie Mae fifth or sixth. Far higher on the list would be:
Alan Greenspan’s Federal Reserve, which lowered interest rates without increasing regulation, refused to enforce a 1994 law requiring prudent underwriting standards and turned a blind eye to abuses in the process of loan securitization.
The Office of Thrift Supervision, which let savings banks under its supervision engage in outlandishly risky practices.
The Wall Street firms that bankrolled subprime lenders and turned their high-risk loans into securities
The credit-rating agencies that blessed toxic subprime securities with Triple-A ratings.
The SEC’s failure to police those agencies.
And, of course, the subprime lenders themselves.
These other malefactors are mentioned willy-nilly by Morgenson and Rosner, but they stick to their improbable story line of Fannie as villain-in-chief. In the book’s penultimate chapter, which recapitulates the role of giant firms like Goldman Sachs, Morgenson and Rosner abruptly go off on a different tangent: “Of all the partners in the homeownership push, no industry contributed more to the corruption of the lending process than Wall Street.” So which is it—Fannie or Goldman? Inconsistency like this pervades the book.
Fannie and Freddie were not perfect little angels. The story is more subtle than all good versus all evil, and with right-wing conservatives determined not to do subtle there is a chance the real story will be drowned in a bath of revisionism. The fact is that private banks through their own devious devices did most of the subprime leading. Fannie and Freddie could not even make such loans. This last fact, a fact bigger than Moby Dick, somehow gets lost in all the yelling and trying to blame either the working poor or some government agency for the housing meltdown. Conservatives just have to have this narrative because in their mental bubble the private sector can do no wrong. A dangerous notion.
