Friday, September 26, 2008

Fannie/Freddie Didn't Create the Crisis..They Contributed to Making it Worse

The partisan and ideological opportunism is at full swing. Both sides of the ideological spectrum are using the financial crisis to try and score cheap political points. While liberals are blaming deregulation, the Republicans are blaming social engineering and Fannie Mae/Freddie Mac. Why blame these two giants? I myself pointed out that both these giants are much closer to Democrats than Republicans. Furthermore, they have a quasi Socialistic structure which conservatives can then blame on the crisis. (In fact, I myself also pointed out that these two are the best argument against universal health care) So, the opportunity for ideological points are plenty.

As such Conservative media gives reports like this.

Sometimes the greatest blame comes from great praise when viewed in hindsight. The Los Angeles Times proves that with an article from 1999 heaping praise on the very people most responsible for the credit-market meltdown. Ronald Brownstein lauded the Clinton administration for boosting minority ownership by forcing lenders to offer better terms to marginally-qualified borrowers — and noted the financial
creativity from Fannie Mae and Freddie Mac as a crucial component of Bill Clinton’s efforts. It also demonstrates why Congress mandated the failure of the lending system, and why it has to act to fix it (via Hot Air reader abinitoadinfinitum):

You also get reports like this.



The only problem is that these reports are either a distortion of reality or even worse just flat lies.

To blame Fannie/Freddie for creating this crisis is to simply act naively about where it started, or worse yet, to hope that you can fool others that are naive. Everyone is in agreement that this crisis is rooted in sub prime mortgages. How then are Fannie/Freddie responsible for the crisis? Fannie/Freddie securitize conforming loans (as we call them in the business), and those are loans to people with good credit. Sub prime mortgages are those for people with bad credit. The loans that started this crisis had absolutely nothing to do with either of the two giants. They were done totally outside their scope. So, how can people claim this started as a sub prime crisis and also lay the blame at the feet of Fannie/Freddie at the same time? It's because they themselves likely have little grasp of the entire situation.

Last night, Laura Ingraham was peddling this meme on the O'Reilly Factor. She blamed the social engineering in the form of the Community Reinvestment Act for creating this crisis. O'Reilly agreed with her. Except, there is only one problem with this meme. Mortgage Backed Securities are bundles of loans with absolutely ZERO loans securitized by Fannie/Freddie. Fannie/Freddie securitize their own loans. They don't put their loans into bundles with MBS. So, how could Fannie/Freddie be responsible for the crisis when the problem mortgages that started this crisis were done outside their scope? It's because they aren't responsible for the crisis.

They did however contribute quite largely to expanding this crisis. For instance Fannie/Freddie had a hand in buying a lot of these mortgage backed securities. This seems awfully peculiar given their mission statement.

Freddie Mac continues to fulfill its mission to provide liquidity, stability and affordability to the nation's residential mortgage market, even as other investors have left the market.

What in the world does buying up bundles of risky mortgages have to do with providing liquidity in the market place? It has absolutely nothing to do with this. These two giants bought these mortgages for one reason only...they saw an opportunity to clean up and make lot's of money for the company. Therein lies the real problem here. Both these giants were involved in risky behavior that fell totally outside the scope of their mission. Why? It's because they knew full well that if it worked the company, it's shareholders, and most importantly senior management would make out like bandits. If it didn't, the government would have to bail them out because they are too vital to fail.

That's one way they contributed to the crisis. They fed into the feeding frenzy of MBS' which were the securitization of largely risky and fraudulent sub prime mortgages. Second, they responded to the aggressive posture of sub prime by loosening their own restrictions on the loans they securitized. This was further risky behavior that contributed to the crisis. Yet, they were responding to outside sources. Now, there is no doubt that government should have been overseeing all of this and they weren't. There is no doubt that much needed reforms would have prevented much of their own behavior, but it is a total distortion to claim their behavior is responsible for the crisis itself. Conservatives see an opportunity to pin all the blame for this crisis on Democrats by pinning all the blame for the crisis on Fannie Mae/Freddie Mac and linking them to the Democrats. The problem with setting the right context for Fannie/Freddie's contribution to the crisis is that you would then also find other contributing factors, and those might have Conservative fingerprints. As such, some partisans want to put all the blame on institutions they can then link to their opponents. Unfortunately, in order to do this, one would have to distort what happened and create an alternate reality that didn't exist.

For a full summary of how this crisis started, developed and took on a life of its own please read this piece.

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