7
Fannie and Freddie—Cause or Effect?
People inside the mortgage and investment world have two different perspectives on Fannie and Freddie’s role. The first view is that Fannie and Freddie were followers, not leaders. They put up with the affordable housing mandates because they were already involved in loans to low-income borrowers. They loosened credit standards between 1998 and 2003 to keep market share. They got involved in Alt-A and subprime loans in 2005 and 2006 for the same reason. They were just victims of the crisis.1
The second view is best summarized by a hedge fund manager who told me that Fannie and Freddie “made their own weather.” Fannie and Freddie were such a large part of the market’s liquidity that they were the underlying cause of what went wrong. They created the originate-and-sell market. They steered the mortgage lending business with the dominance of their automated underwriting systems. Encouraged by HUD, they poured hundreds of billions of dollars into home purchases made by borrowers with low incomes. And ultimately, through their purchases of subprime securities (purchases they used to help satisfy their HUD affordable housing goals),2 they helped create the market for subprime.3
There is some truth in both views. It’s important to distinguish between two periods: the mid-1990s through the early 2000s, when subprime was relatively unimportant, and 2000 onward—especially 2004 onward—when subprime grew dramatically. Before 2004, Fannie and Freddie definitely helped inflate the bubble. The question is by how much? Did they make a large difference, or did their growth merely crowd out Federal Housing Administration (FHA) and private mortgage activity?4 Did their substantial purchases of private label mortgage-backed securities expand the demand, or would other investors simply have made those purchases?
These are hard questions to answer in any systematic way. Fannie and Freddie activity in one city may have no effect on housing prices because of supply conditions in that market. Elsewhere, pushing up the demand may have dramatic effects. Controlling for all of the relevant factors is extremely difficult. The same is true for estimating Fannie and Freddie’s impact on the demand for subprime mortgage-backed securities.
There is strong evidence that the availability of mortgage credit had much to do with the pre-2004 period in which prices were rising and homeownership reached record heights.5 Long before the surge in subprime securitization, lenders were making a lot more loans to people who normally wouldn’t have received loans. Some of this lending was based on irrational exuberance. But much of it came from a national policy pushed by a Democratic and then a Republican administration to encourage homeownership.
Initially cautious about meeting those housing goals, Fannie and Freddie became more aggressive. They played a significant part in the expansion of mortgage credit to low-income borrowers, an expansion that presumably pushed up housing prices in low-income neighborhoods, making subprime securitization more attractive.
My judgment is that Fannie and Freddie helped push up the price of housing and inflate the housing bubble between 1998 and 2003, though it may be hard to know the magnitude of their impact with any precision. But this isn’t the whole story of the rise in housing prices during this period. The availability of piggyback loans and federal and state programs to help people buy houses with no money down did much to create homeowners with little or no home equity, the proximate cause of the crisis.6
After 2003, Fannie and Freddie didn’t exactly stand on the sidelines. They didn’t “fade away” or “pull back sharply.” Between 2004 and 2006, they still purchased almost a million home loans each year made to borrowers with incomes below the median. They still purchased 268,000 loans with less than 5 percent down in 2004, almost 400,000 such loans in 2006, and over 600,000 such loans in 2007. They purchased hundreds of billions of subprime mortgage-backed securities and were a significant part of the demand for those securities.
What is true is that between 2004 and 2006, commercial banks and investment banks were bigger direct players than the GSEs in the subprime market. The role of commercial banks and investment banks in the subprime market is the rest of the story.
NOTES
1. Many have argued that Fannie and Freddie couldn’t be the cause of the housing bubble because many other countries had housing bubbles, but they didn’t have Fannie and Freddie. But the United States is not the only country that pushed homeownership via national policy initiatives. The full story of the global housing market has yet to be told. For an argument that monetary policy errors are correlated with housing bubbles around the world, see Rudiger Ahrend, Boris Cournede, and Robert Price, “Monetary Policy, Market Excesses and Financial Turmoil,” OECD Economics Department Working Papers, No. 597 (2008), http://www.sourceoecd.org/rpsv/cgi-bin/wppdf?file=5kzpp5qcghg0.pdf.
2. See Carol Leonnig, “How HUD Mortgage Policy Helped Fuel the Crisis,” Washington Post, June 10, 2008, http://www.washingtonpost.com/wp-dyn/content/article/2008/06/09/AR2008060902626.html.
3. They were also an important part of the Community Reinvestment Act’s (CRA) impact on the price of real estate in low-income areas. The CRA was not an important cause of the crisis, but it contributed by helping to drive up the demand for real estate in low-income areas. Fannie and Freddie were deeply entangled with the CRA, making it difficult to measure any independent effect of CRA. That entanglement included Fannie and Freddie guaranteeing securitized CRA loans and direct purchases of CRA loans to make them more palatable to the banks and to meet Fannie and Freddie’s housing goals. See Wachovia, “First Union Capital Markets Corp., Bear, Stearns & Co. Price Securities Offering Backed by Affordable Mortgages,” Press Release, October 20, 1997, https://www.wachovia.com/foundation/v/index.jsp?vgnextoid=dde12e3d3471f110VgnVCM200000627d6fa2RCRD&crd&vgnextfmt=default&key_guid=52e84a86591eb110VgnVCM100000ca0d1872RCRD; and Jamie S. Gorelick, “Remarks,” American Bankers Association National Community and Economic Development Conference, October 30, 2000, http://web.archive.org/web/20011120061407/www.fanniemae.com/news/speeches/speech_152.html.
4. Stuart Gabriel and Stuart Rosenthal find no evidence of crowd-out between 1994 and 2003 (the GSEs had a real impact on credit availability) but do find crowd-out between 2004 and 2006. See “Do the GSEs Expand the Supply of Mortgage Credit? New Evidence of Crowd Out in the Secondary Mortgage Market,” paper prepared for the National Association of Realtors, December 2, 2009, http://faculty.maxwell.syr.edu/rosenthal/Recent%20Papers/Gabriel-Rosenthal-GSE%20Purchase%20Goals%20and%20Crowd%20Out%20-%2012-2-09.pdf.
5. See Jonas D. M. Fisher and Saad Quayyum, “The Great Turn-of-the-Century Housing Boom,” Economic Perspectives 30, no. 3 (Third Quarter 2006), http://ssrn.com/abstract=925280; and Atif R. Mian and Amir Sufi, “The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis,” working paper, December 12, 2008, http://ssrn.com/abstract=1072304.
6. In 2003, a National Association of Realtors survey found that 28 percent of all first-time homebuyers bought their homes with no money down. See Sarah Max, “Home Buying with No Money Down,” CNNMoney.com, December 23, 2003, http://money.cnn.com/2003/12/23/pf/yourhome/nodownpayment/index.htm. By 2005, that number was 43 percent. The median first-time homebuyer put 2 percent down. See Noelle Knox, “43% of First-Time Buyers Put No Money Down,” USAToday.com, January 17, 2006, http://www.usatoday.com/money/perfi/housing/2006-01-17-real-estate-usat_x.htm. See also National Association of Realtors, “Profile of Home Buyers and Sellers,” http://www.realtor.org/research/research/reportsbuysell. Who funded those mortgages? Fannie and Freddie funded some but not all of them. Who funded the rest? How many were securitized privately? It would be useful to know.