Did Fannie and Freddie Really Cause the Housing Bubble?

Did Fannie and Freddie really cause the housing bubble? Paul Krugman posted some interesting graphs that suggest the answer is "no." They show the percentage of mortgages securitized by Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) declining in the lead-up to the bubble's peak, while the share of private securitization by top CDO securitizers Merrill Lynch (now part of Bank of America (NYSE: BAC  ) ), Citigroup (NYSE: C  ) , Wachovia (now part of Wells Fargo (NYSE: WFC  ) ), and Goldman Sachs (NYSE: GS  ) went through the roof.

This isn't to suggest that Fannie and Freddie were a paradigm of corporate governance, or that they don't badly need reform. But it does raise some questions about the widespread belief that the government-sponsored entities were the primary cause of the housing bubble and that if we just fix them everything will be hunky-dory.

Fool editor Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool is investors writing for investors.


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  • Report this Comment On June 04, 2010, at 3:57 PM, Desicon wrote:

    So how is the loan portfolio of Fannie and Freddie doing.

    The reality is CRA indirectly forced many lenders to provide loans to many undeserving applicant. The lenders could not afford maintaining an army of compliance staff to respond to federal, state, county and city inquiries on behalf of rejected loan applicants. Lenders feared lawsuits. So working in conjunction with Fannie and Freddie they devised loan programs such as stated income, no income verification, no asset verification and option ARM. Wink-wink, nod-nod Fannie approve and guarantee the loan and lenders fund the loan. After some seasoning (3-6 months) the loans are packaged and sold as MBS, CDO. Every one collected their bonuses unti #$% hit the fan.

    Make no mistake explicitly federal government, Fannie and Freddie are most responsible for creating this mess. Specifically Barney and Dodd are the faces behind that.

    No amount of pretty graphs can hide that fact.

  • Report this Comment On June 07, 2010, at 10:38 PM, charmista wrote:

    Desicon--your facts are wrong but your argument contains a germ of truth.

    The CRA didn't force sub-prime lenders, even through the mechanisms that you describe, to make loans since "The Community Reinvestment Act of 1977 was irrelevant to the subprime boom, which was overwhelmingly driven by loan originators not subject to the Act." (a quote from the article cited by this one).

    Fannie and Freddie don't guarantee loans, although they do buy them and securitize them. But they didn't touch the subprime loans that you mention, since those aren't "conforming loans", e.g. loans that conform to the rules set down by Freddie and Fannie for loans that they'll buy (you have heard of conforming loans, right?). The subprime loans were bought and securitized by the familiar list of financial giants that failed: Bear Stearns, JP Morgan, Lehman Brothers, et. al.

    But there is a germ of truth in your argument: as long as Bear, JP Morgan, et. al. were buying the mortgages and then able to sell them them off to other investors, everyone was happy as a clam and cashing their bonus checks.

    Its just that Freddie and Fannie weren't involved in creating the mess.

    The reason Freddie and Fannie are bankrupt and being bailed out for billions of our taxpayer dollars is that with the implosion of the housing bubble, those "conforming loans"--traditional mortgages with 20% down and decent documentation for the borrowers--are going bad as well. Folks who put down 20%, but see the value of their house drop 30% or 40% are walking away from their loans. And, of course, some of those folks couldn't afford the loans in the first place.

    Fannie and Freddie may have contributed to the housing bubble by making loans available to people who wanted to buy houses at prices that turned out to be unsupportable, but they didn't cause the subprime debacle. The big banks did.

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