Fannie Freddie MYTH.

By Alan White

I?m coming back to a theme here, but the myth that Fannie and Freddie caused the crisis keeps being repeated. The subprime crisis was in no way caused by Fannie Mae and Freddie Mac, nor by Congressional regulation or nonregulation of them. To put some numbers behind the facts, I turned to my two-volume Mortgage Market Statistical Annual for 2008, published by Inside Mortgage Finance. I take it as a given that the current crisis was caused by the rapid and unexpected increase in defaults and foreclosures on subprime mortgages. Subprime losses led to subprime-backed securities losing value, which led to big losses for banks and investment banks, small towns in Norway, the collapse of Lehman Bros, etc. etc. There were of course, other problems, such as excess leverage in investment banks and hedge funds, the opacity of the credit default swap market, etc., but I don?t think anyone is blaming Fannie and Freddie for those systemic problems. When you look at the numbers, it is easy to see that Fannie and Freddie were bit players in the subprime crisis.

Primary Market ? Loan Originations

Fannie Mae and Freddie Mac do not originate mortgages. More than 80% of subprime loans still outstanding were originated in 2004 through 2007. The top ten subprime loan originators in 2006 were: HSBC Finance, New Century Financial, Countrywide Financial, Citimortgage, WMC Mortgage, Fremont Investment and Loan, Ameriquest, Option One, Wells Fargo Home Mortgage and First Franklin Financial. Seven of the ten (the nonbank lenders, who were not regulated by the Community Reinvestment Act) no longer exist, or were merged into banks. The lists for 2005 and 2004 were similar, but also included Washington Mutual. The top ten lenders accounted for about 60% of ALL subprime loans in 2006.

Secondary Market ? Wholesale Loan Buyers

In 2004, 2005 and 2006, securitized mortgages were 73%, 79% and 81% of all subprime mortgages. So for practical purposes the wholesale market was the securitization market. For the same three years, the total volume of subprime loans securitized was $521 billion, $797 billion and $814 billion respectively.

Almost none of those securities were issued by Fannie and Freddie. They were not in the business of purchasing and securitizing subprime mortgages, although they purchased some subprime mortgages to hold in portfolio, and issued about $6 billion in subprime securities in 2004 to 2006 (one-third of one percent of the market.) The top fifteen issuers of subprime mortgage-backed securities, accounting for about 75% of the market, in 2006 were: Countrywide, New Century, Option One, Fremont, Washington Mutual, First Franklin, Residential Funding (GMAC affiliate), Lehman Brothers, WMC, Ameriquest, Morgan Stanley, Bear Sterns, Wells Fargo Securities, Credit Suisse and Goldman Sachs.

Investors in Subprime Mortgage-Backed Securities

After the securities were issued, investors were needed to buy the securities, and thus to fund the mortgages. At this third stage, Fannie and Freddie did play a role, albeit a minor one. As of 12/31/07, Freddie held $234 billion and Fannie held $112 billion in subprime securities, out of a total market of $2,116 billion (i.e. $2.1 trillion). Most of these purchases took place in 2005 and 2006. A significant chunk to be sure (about 15%) but if you took out the GSE purchases, there would still have been a huge subprime market, and there is no way to know whether other buyers might have purchased those same securities if Fannie and Freddie had not (i.e. their presence was probably not vital to the growth of subprime lending and securitization.) Other purchasers of subprime securities included banks and thrifts, foreign investors including sovereign wealth funds, mutual funds, hedge funds, insurance companies, state and local governments, private pension funds, and wealthy institutions and individuals. It is also worth noting that Fannie and Freddie started buying subprime securities late in the game, years after the subprime mortgage market had been launched and its dangerous products deployed.

What Congress Did and Didn?t Do:

The controversy around regulation of Fannie and Freddie did not center on their purchase of subprime mortgage securities. The principal issues were setting adequate minimum capital requirements for the GSE?s, controlling their share of the prime mortgage market, such as by changing the ?conforming loan limit?, i.e. the maximum dollar amount for Fannie and Freddie mortgages, and whether and to what extent the GSE?s should purchase any mortgage securities to hold in their portfolio. The House of Representatives passed H.R. 1427 in May 2007. It replaced the old regulator with a new agency with stronger oversight powers, including the new ability, since exercised, to put Fannie and Freddie into conservatorship, i.e. a government takeover or forced sale. It also increased the conforming loan limit. The Senate did not pass GSE reform legislation until July 2008, when a compromise bill was included in the economic stimulus legislation signed by the President.

It is probably true that if Congress had acted sooner, and if the Administration had appointed a strong regulator based on better legislation, Fannie and Freddie might have been forced to fix their accounting, and buy fewer subprime securities, or build up an adequate capital cushion in other ways, and thus avert their eventual renationalization. But all these measures would have helped prevent the GSEs from being victims of the subprime crisis, they would not have prevented the crisis itself.


Full post as published by CL&P Blog on October 19, 2008 (boomark / email).