Fannie and Freddie - Not Their Fault?

Welcome to Politics Bites, where every afternoon at It's A Free Country, we bring you the unmissable quotes from the morning's political conversations on WNYC. Today on The Brian Lehrer Show Phil Angelides, Financial Crisis Inquiry Commission chairman, disussed the role of Fannie Mae and Freddie Mac in the lead-up to the housing bubble and bust. Angelides is a weekly guest during the month of February. Each week he unpacks the Financial Crisis Inquiry Commission findings on the economic meltdown.

Last Friday President Obama laid out three options for winding down Fannie Mae and Freddy Mac, the faulty tax-payer owned institutions that have been condemned for irresponsibly backing lame sub-prime mortgages. While Angelides isn't about to let Fannie Mae and Freddy Mac off the hook for worsening the financial crisis, but he rejects the argument that they were the main cause of it.

From the Depression era creation of Fannie Mae in 1938, in an effort to bolster and create a market for home loans, up to the year 2000, Angelides says the program worked remarkably well. It was only in 2005 and 2006, when Fannie and Freddie saw they were losing market share because they were not engaging in the risky practices of Wall Street firms, that they started approving sub-prime loans. Soon, like much of the financial industry, they went down the toilet.

Ultimately because they were a profit making organization they decided to try to regain market share, drive up profits, drive up compensation. They joined the party late and unfortunately in the late stages of the crisis they bought a significant amount of sub-prime securities. But even then they peaked, they never bought more than 28 percent of the sub-prime mortgage backed securities on the market. So they helped inflate the housing boom, they added helium to the balloon, but they were not the primary drivers.

Fannie Mae was originally  set up as a government agency during the New Deal, but was transformed into a privately held publicly traded corporation in 1968. That turned out to be a very dangerous model, because even though they were essentially tax-payer owned, they became driven by profits and resisted regulation in their competition with Wall Street firms like Ameriquest. In essence, they were "privatising gains and socializing losses." Angelides believes it was the lack of regulation, "a bipartisan problem," that was the culprit.

There's no doubt that Fannie and Freddie were disasters. They're going to cost the taxpayers—to date they've cost $150 billion. No one should argue that this was a well run set of institutions. In fact one regulator said they were the worst run financial institition they've ever seen.

Yet the worst of the worst mortgages were not backed by Fannie and Freddie. The default rate for loans created by Wall Street firms was much higher—28 percent versus six percent. 

So what now? The Obama administration has laid out a variety of options to change the way home loans are financed—the most extreme would be for the government to have no part at all in private sector loans. Angelides disagrees with that.

I do think there's a legitimate role for some form of government guarantee to help people at the margins—I mean there's just some folks who don't have the income and capacity to own homes and won't be able to. So we shouldn't be stretching in ways that are imprudent, but to provide some stability, some support for the housing market, particularly when private mortgage lending dries up.

The Financial Crisis Inquiry Commission's report is making waves—it's on the New York Times bestseller list. People want to know what went wrong—how 27 million Americans are out of work, four million lost their homes, and yet Wall Street and Washington continue to function.