Last week, Philip Angelides, the chair of the Financial Crisis Inquiry Commission, made another attempt to justify the commission’s report with an article on Bloomberg.com. Like all defenders of the Commission’s majority report, he had the impossible task of trying to deny that the government’s housing policies had any responsibility for the financial crisis, without explaining why Fannie Mae and Freddie Mac—the two companies that were the principal implementers of these policies—had become insolvent and had to be taken over by the government. This task has become even more difficult in the wake of the publication of Reckless Endangerment, a new book by New York Times reporter Gretchen Morgenson and financial analyst Josh Rosner, that blames Fannie Mae for the financial crisis. There is only one way to make Angelides’s argument: ignore the facts.
One can read the Commission’s report from beginning to end without ever finding out how many subprime and other weak and risky loans were in the financial system before the financial crisis. The number is 27 million, and it is half of all mortgages outstanding at the time of the financial crisis.
Why would the report shy away from this number? Because when you examine the holders of these mortgages—in other words those who created the demand for them—you find that two-thirds were on the books of Fannie Mae, Freddie Mac, the Federal Housing Administration, and the insured banks and S&Ls subject to the Community Reinvestment Act. All these agencies and firms subject to government regulation were required, beginning in the early 1990s, to acquire loans that that were made to borrowers at or below the median income in the places where they lived—and in some cases to people who were at 80 percent or 60 percent of the median income in their communities.
It is of course possible to find prime mortgages in these areas, but when all these entities had to comply with government quotas of various kinds, only one thing could happen—they had to allow mortgage underwriting standards to deteriorate in order to find enough qualifying loans.
I always find it amusing when defenders of the Commission like Angelides say that the mortgages made by Fannie and Freddie were not as bad as the mortgages made by others. That’s certainly true. In my dissent from the Commission majority’s report, I outline these differences in detail. But Angelides and others don’t mention that the mortgages acquired by Fannie and Freddie were bad enough that they caused both companies to become insolvent, requiring them to be taken over by the government. The projected losses to the taxpayers, incidentally, have been estimated by their regulator at between $221 billion and $363 billion.
Angelides could not remind readers of this fact because it would call into question his absurd argument that my dissent was based on a faulty definition of low quality loans. We can argue all day about the right definition, but when two companies—with gold-plated franchises and government backing that allowed them to be borrow money at below market rates—become insolvent through the acquisition and guaranteeing of U.S. mortgages, one would have to be very biased to ignore the fact that these were truly bad mortgages.
Angelides cites the old saw that Fannie and Freddie followed Wall Street into low quality mortgage lending, not the other way around. This is nothing but an urban myth, and is thoroughly disproved not only by Reckless Endangerment, but by the facts in my dissent. There, I show conclusively that Fannie and Freddie began to buy these mortgages in the early 1990s, and by 2000 were offering mortgages with no down payments. In the year 2002, for example, when the entire Wall Street market was only $134 billion, Fannie and Freddie alone acquired $206 billion in whole subprime mortgages and $368 billion in other low quality loans (such as mortgages without down payments), demonstrating that the GSEs were no strangers to risky lending well before the Wall Street market began to develop.
Finally, in order to explain why Fannie and Freddie would buy these poor quality loans, Angelides relies on suggestions of greed, profit motive, and lack of adequate regulation. Certainly all were factors, but the most important factor was the government requirements—beginning in 1992—that Fannie and Freddie meet certain quotas for acquiring loans to borrowers at or below the median income in their communities. Here is an excerpt from Fannie’s 2006 10-K report to the SEC, as these government requirements were driving them down:
We have made, and continue to make, significant adjustments to our mortgage loan sourcing and purchase strategies in an effort to meet HUD’s increased housing goals and new subgoals. These strategies include entering into some purchase and securitization transactions with lower expected economic returns than our typical transactions. We have also relaxed some of our underwriting criteria to obtain goals-qualifying mortgage loans and increased our investments in higher-risk mortgage loan products that are more likely to serve the borrowers targeted by HUD’s goals and subgoals, which could increase our credit losses. [Emphasis added.]
Somehow, this language did not find its way into the Commission’s report. Readers of that report, and others who are interested in the truth about what caused the financial crisis, might well wonder why.
The answer is an indictment of the Commission’s objectivity. From the beginning, the Commission refused to consider the possibility that government housing policy was a significant cause of the financial crisis. Fannie and Freddie’s roles were characterized as “marginal.” This should not be a surprise. The people in Congress who appointed a majority of the Commission, and Angelides to chair it, were the very people who had designed and maintained those policies over many years.