The Agenda

Fannie and Freddie and the Subprime Market

Ezra Klein has written a characteristically excellent and thorough post on how Fannie and Freddie fit into the mortgage crisis. Naturally, I have a few small disagreements.

Their failure was not, as some would have it, the cause of the mortgage crisis, or even close. For one thing, only about 2 percent of their portfolio was subprime. For another, they didn’t start backstopping the subprime market till long after it had taken off. And for a third, their greatest losses actually were in non-subprime loans.

While I don’t think that Fannie and Freddie were the sole cause of the mortgage crisis, I do think, following Raghuram Rajan, that a deeper cause was populist credit expansion, and Fannie and Freddie played a vitally important role. In Rajan’s forthcoming book Fault Lines, which, I should stress, is the best and most lucid book on the crisis I’ve read so far, he cites research by Edward Pinto that casts doubt on the notion that Fannie and Freddie were not heavily involved in the subprime market.

It is not easy to get a sense of the true magnitude of subprime lending by Fannie, Freddie, and the FHA, partly because, as Edward Pinto, a former chief credit officer of Fannie Mae, has argued, many loans on each of these entities’ books were subprime in nature but not classified as such. For instance, Fannie Mae classified a loan as subprime only if the originator itself specialized in the subprime business. Many risky loans to low-credit-quality borrowers thus escaped classification as subprime or Alt-A loans. When the loans are appropriately classified, Pinto finds that subprime lending alone (including financing through the purchase of mortgage-backed securities) by the mortgage giants and the FHA started at about $85 billion in 1997 and went up to $446 billion in 2003, after which it stabilized between $300 and $400 billion a year until 2007, the last year of his study. On average, these entities accounted for 54 percent of the market across the years, with a high of 70 percent in 2007. He estimates that in June 2008, the mortgage giants, the FHA, and various other government programs were exposed to about $2.7 trillion in subprime and Alt-A loans, approximately 59 percent of total loans in these categories. It is very difficult to reach any other conclusion than that this was a market driven largely by government, or government-influenced, money.

To be sure, Ezra is talking about Fannie and Freddie, and not Fannie, Freddie, and the FHA, but my sense is that (a) the FHA is a key part of the puzzle and that (b) Pinto’s analysis points to a far larger role for Fannie and Freddie in the crisis regardless.

That said, I think Ezra is very right to suggest that the real issue is the unsustainably massive government subsidy for home ownership, embedded in the tax code but also in the structure of the GSEs. No one really wants to touch it, including conservative Republicans who are essentially passing the buck to the Obama administration. And experience tells us that the Obama administration will not take the necessary political risks.

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