Wednesday, September 22, 2010

Fannie and Freddie Didn't Do It

Free market ideologues refuse to acknowledge that it was a lack of government regulation rather than too much government regulation that caused the sub-prime mortgage crisis.  Instead, they claim that government policy forced banks to make loans to borrowers who were not creditworthy.  Their primary boogie men are Fannie Mae and Freddie Mac, the government sponsored enterprises that facilitated mortgage lending to low and middle income Americans.  However, any rational analysis of the evidence will lead to the conclusion that Fannie and Freddie, however poorly they might have been run as businesses, were casualties of the crisis rather than its perpetrators.

As Professor Karl Smith of the University of North Carolina-Charlotte writes, "The proper question is not: What story is consistent with my general philosophy or worldview?  The proper questions is: What story is consistent with the facts?"

The wave of housing price increases was kicked off by changes in private label securitization. These changes left Fannie and Freddie with a smaller market share and lower absolute level of securitizations. Fannie and Freddie attempted to adjust their basic business practices to stay competitive in bubble markets and among aggressive borrowers.

These adjustment left Fannie and Freddie exposed to a large decline in housing prices. This is exactly what happened and Fannie and Freddie reaped enormous losses because of their exposure.

Had Fannie and Freddie stuck to their traditional role of guaranteeing low value traditional loans rather than trying to stay competitive in bubble areas their losses would have been substantially less.

In short, attempting to subsidize the American dream for low and moderate income families may be a fundamentally bad policy. However, it does not appear to be either the origin of the housing bubble or the source of Fannie and Freddie’s trouble.
 Reprinted at The Big Picture.

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