“Some would say we were too powerful.”
—Franklin Raines, CEO of Fannie Mae, 1999–2004
Under the leadership of Jim Johnson, Fannie Mae developed a reputation for playing a kind of political hardball that may have ultimately backfired because of the powerful enemies it made for the company. Johnson, who the Washington Post described in a 1998 profile as “one of the most powerful men in the United States,” was a born Democratic operative. The son of a member of the Minnesota House of Representatives, he worked on the unsuccessful presidential campaigns of Eugene McCarthy, George McGovern, and Walter Mondale before founding a consulting firm with diplomat Richard Holbrooke. Before joining Fannie in 1990, he was a banker at Lehman Brothers. “I’m not big on losing,” he told the Post, and it’s unclear to this day whether Johnson embraced Fannie’s mission of providing homeownership because he believed, or because he understood the political cover it could provide. Maybe it was both. Whatever the reason, he was the primary architect of what former congressman Jim Leach of Iowa once called “the greatest, most sophisticated lobbying operation in the modern history of finance.”
The decade of the 1990s at first seemed like a political golden age for Fannie and Freddie. (Freddie, which was much smaller, was mostly happy to follow in Fannie’s footsteps.) For years, there were those inside the government, including Leach, who argued that if Fannie and Freddie were to exist at all, they needed better oversight than the Department of Housing and Urban Development could provide. Finally, in 1992, Congress passed a law establishing the Office of Federal Housing Enterprise Oversight, or OFHEO, a regulatory agency whose charge was to oversee just two companies: Fannie and Freddie.
But “OFHEO was structurally weak and almost designed to fail,” its director from 1999 to 2005, Armando Falcon, later told the Financial Crisis Inquiry Commission. OFHEO’s entire budget, which ranged between $19 million and $30 million during most of the 1990s, was less than the total compensation of the four top executives at Fannie and Freddie, who collectively made $33.6 million in 2000. Treasury official Rick Carnell once described OFHEO as a watchdog that was “hobbled, muzzled, and underfed.”
The legislation creating OFHEO did do two critical things. It set capital requirements for the GSEs—but Fannie succeeded in having its capital levels set at a sliver of what bank capital requirements were. It did so by arguing that home mortgages were far less risky than banks’ typical business. Tim Howard, a highly intelligent and at times acerbic economist who joined Fannie in 1982 and became its CFO in 1990, helped engage Paul Volcker to conduct an independent analysis in which he agreed that Fannie and Freddie should not have to have as much capital as banks did. In a letter, Volcker wrote, “With [Fannie Mae’s] current business practices and assuming it reaches its proposed capital standards, the Company would be in a position to maintain its solvency in the face of difficulties in the housing markets and an interest rate environment significantly more adverse than any experienced in the post-World War II period.” Volcker later told journalist James Hagerty that he would probably not have blessed the capital plans “knowing what I know now.”
The same legislation established the affordable-housing goals, which required the GSEs to buy, as a percentage of their overall business, certain amounts of loans made to, say, people below the median income level, or people living in rural areas. Fannie executives have always said that the goals were not at all onerous, at least initially. At first, as the General Accounting Office later noted, they were actually below HUD’s estimates of what the market naturally did already.
During the ensuing years, Fannie and Freddie became extraordinarily profitable and powerful companies. The mortgage market exploded in size, from just under $3 trillion in 1990 to $5.5 trillion by the end of the decade, in part due to the growth in refinancing. Fannie and Freddie, by setting the standards for what kinds of mortgages they would guarantee, effectively determined the sort of mortgage that much of the American middle class would get—and, of course, they took a toll, in the form of a guarantee fee, on every mortgage that passed through them. By the end of the 1990s, Fannie Mae had become America’s
third-largest corporation, ranked by assets. Freddie was close behind. The companies were ranked one and two respectively on Fortune’s list of the most profitable companies per employee. They were deeply woven into the fabric of the financial system. They raised huge quantities of debt to fund their operations, and as a result paid Wall Street big fees. Because their debt was akin to U.S. Treasuries, Fannie and Freddie securities were often used to grease the wheels of Wall Street, for instance as collateral for a derivatives trade. “They were the proverbial 800-pound gorilla,” says one mortgage industry veteran. “Wall Street had a love-hate relationship with them. Institutions viewed them as having unfair advantages, and yet they were big clients.”
The GSEs were not just forces to be reckoned with domestically, but also internationally. In 1985, Fannie had begun borrowing money from abroad to finance its purchases of mortgages. Foreign central banks soon became big buyers of Fannie-and Freddie-backed mortgage securities, too. In the mid-1990s, as the days when the U.S. ran a budget deficit appeared to be coming to an end, Fannie decided to begin offering what it called Benchmark Notes. In effect, these were an attempt to substitute its debt for the debt of the United States: After all, if there wasn’t going to be any more U.S. debt, couldn’t Fannie take advantage of investors’ desire for a super-safe investment by selling them its own debt instead? In 1999, Fannie sold $114 billion in Benchmark securities, with more than one-third going to foreign investors. The Financial Crisis Inquiry Commission later reported that in 1998, foreign holdings of Fannie and Freddie securities were about what they had been in the previous decade—$186 billion. By 2000—just two years later—foreigners owned $348 billion in Fannie and Freddie securities; by 2004, they owned $875 billion. At the time, it seemed brilliant to have foreign money financing the most domestic asset—homes—there is. The downside would only become apparent in crisis time, when policy makers realized that the presence of foreign investors was one reason they had to do what they always said they wouldn’t, which was stand behind the GSEs.
For all the problems—the lack of capital, the arrogance, the political maneuvering—that would later seem so obvious, Fannie and Freddie, with the help of the U.S. government, accomplished something that Rumpelstiltskin would envy. They took the worst possible investment—a 30-year fixed-rate fully prepayable mortgage—and turned it into the second most liquid instrument in the world, just behind Treasuries. (Liquidity, which means that investors know they can easily buy and sell something, is highly valued in the financial world.) They equalized the flow of credit, so that a wide variety of factors in this country, from geography to income levels, didn’t affect a consumer’s ability to get a mortgage or even the rate they would pay. Fannie Mae and Freddie Mac were long viewed by many as shining examples of public-private partnership—that is, the harnessing of private capital to advance a social good: in this case, homeownership.
It didn’t look like there was any end in sight. “In Johnson’s last years, everyone wanted to be there, everyone wanted to share our aura, everyone wanted our money, everyone wanted to be part of Fannie Mae,” says Bill Maloni, who was a Fannie Mae lobbyist for more than 20 years. “We were on Everest up until 2003.” And then, he says, “We went to Death Valley.”