TOPICS > Economy

Investigating Fannie Mae and the Housing Bubble

April 9, 2010 at 12:00 AM EDT
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Former executives of mortgage giant Fannie Mae testified about their role in the collapse of the housing market and the ensuing economic crisis before the Financial Crisis Inquiry Commission. Jeffrey Brown talks to two housing experts for more.

JEFFREY BROWN: Yesterday, Citigroup executives were on the hot seat. Today, top officials from housing finance giant Fannie Mae got their turn before the Financial Crisis Inquiry Commission, the panel looking into the causes of the financial meltdown.

How did things go so wrong? Former Fannie Mae vice president Robert Levin:

ROBERT LEVIN, former vice president, Fannie Mae: We, like everyone else, were surprised by the unprecedented extent of the economic crisis.

JEFFREY BROWN: His colleague former chairman Daniel Mudd, who was ousted after Fannie fell, said he was ultimately responsible.

DANIEL MUDD, former CEO, Fannie Mae: I was the CEO of the company, and I accept responsibility for everything that happened on my watch.

JEFFREY BROWN: Fannie Mae, and its sister organization, Freddie Mac, were government-chartered, but private companies, set up to buy mortgages from lenders and package them into securities sold to investors.

And, by 2008, the two agencies owned half the country’s $11 trillion in mortgages. But when the housing market collapsed, so did Fannie and Freddie, and the government was forced to step in, a move that’s so far cost taxpayers $126 billion.

Today, Mudd said the GSEs, or government-sponsored enterprises, were legally barred from making non-housing investments, leaving them especially vulnerable to a downturn.

DANIEL MUDD: Unlike other financial institutions, this left the GSEs unable to diversify and, therefore, to avoid losses stemming from any U.S. housing finance crisis. And 2007 to 2010 wasn’t merely a housing crisis. We witnessed a market collapse, a collapse of the only market that the GSEs were in.

JEFFREY BROWN: But commission chairman Phil Angelides said Fannie Mae’s eagerness to compete with Wall Street led it to take on too much risk. He cited a 2008 report recommending the government takeover.

PHIL ANGELIDES, chairman, Financial Crisis Inquiry Commission: It’s a pretty damning document in terms of its assessment of Fannie. And I’m just — you know, it refers to members of the executive management team made imprudent decisions. Many of the decisions were unsafe and unsound.

JEFFREY BROWN: What’s next? The Obama administration has promised to come up with a plan to restructure Fannie and Freddie.

And, for more on this, we turn to Andrew Jakabovics, associate director of housing and economics for the Center for American Progress, and Edward Pinto, a longtime consultant to the financial service industry. He was chief credit officer at Fannie Mae in the late 1980s.

Welcome to both of you.

EDWARD PINTO, Financial Services Industry Consultant: Thank you, Jeff.

JEFFREY BROWN: Let’s start with the “What went wrong?” question. What — to what extent were Fannie Mae and Freddie Mac vehicles for the subprime debacle?

ANDREW JAKABOVICS, director of housing and economics, Center for American Progress: They were actually not as responsible as a lot of people would think.

And I know that Ed disagrees with me. I think that the real problem here was the creation of an unregulated mortgage market. Wall Street was funneling trillions of dollar through unregulated channels into private-label securities. These were largely where the subprimes were.

And what ultimately happened was the GSEs, Fannie Mae and Freddie Mac, were losing market share. They are government-chartered, but they were also shareholder-owned. And so they basically put short-term profits ahead of long-term safety and soundness responsibilities. And they basically sort of followed everybody else down the rabbit hole.

JEFFREY BROWN: What is your view of victim or — or villain here?

EDWARD PINTO: My view is more villain. It goes back to the early 1990s and a number of federal housing policies that were put in place that pushed very low down payment lending and other loosening of underwriting.

Fannie and Freddie were leading that charge starting in the early 1990s. And that eventually, along with all the advantages that they had, led to a tremendous disruption of the market, which culminated in 2004, with the subprime market really ballooning, and following the lead for low down payments and higher risk.

JEFFREY BROWN: And another way of addressing this is helping people understand what these entities are. As you have both said, they are government, but private. So, they were set up as a — to do a public good, in a sense, right, to help foster homeownership.

ANDREW JAKABOVICS: Yes, they — exactly. Well, they were there actually to funnel credit ultimately for the purpose of homeownership…


ANDREW JAKABOVICS: … if you sort of look back to their original purpose.

Back before banks could be national, you had a problem if you had sort of a growing area without a lot of depositors, and, yet, you wanted to funnel money so, that way, people who wanted to move into those places could buy houses in those communities. And, so, that’s really what the original intent was, was basically to say to other banks, well, if you buy loans, we will buy your loans. That way, you will have — be able to sell them off to somebody else.

And so people, for 75 years, had no problem with sort of the Fannie Mae structure. It was ultimately privatized largely because of the interest to get them off the government balance sheet for the reasons of the Vietnam War. So, for a very long time, they had been doing exactly what they did.

Their bread and butter was actually guaranteeing these mortgages. It’s only when they sort of decided to chase Wall Street and chase the profits that they really got into problems.

JEFFREY BROWN: And you are saying something went wrong with that original model, or…

EDWARD PINTO: Something went wrong with the original model was they — in 1992, Congress hard-wired the amount of capital they needed. And they were tremendously overleveraged. And that is really what drove the market off a cliff.

JEFFREY BROWN: So, the government comes in at the end of 2008. What has happened since? What shape are these organizations in? What are they doing in terms of lending now?

EDWARD PINTO: Well, in terms of what shape they’re in, they have losses that are, for the foreseeable future based on the business that they did in 2004, ‘5, ‘6, ‘7 and 8. Recently, they are the secondary market, along with Fannie and Freddie, along with Ginnie Mae. They account for 95 percent of all the lending in the United States is guaranteed by the federal government.

So, we have a nationalized market in terms of housing finance. And the challenge is going to be how to undo that. But, right now, that’s the role that they are performing. They have been turned into public policy vehicles.

JEFFREY BROWN: So, before we get to where we are going, but — so how would you define where we are now? They’re still huge. They’re still big players.

ANDREW JAKABOVICS: Yes, they are. And, in part, it’s because of the absolute disappearance of the private sector in lending. And the conduits, the Wall Street conduits, that existed basically disappeared overnight.

JEFFREY BROWN: Because of what has happened in the economy and the housing market.

ANDREW JAKABOVICS: Well, even — it was largely the housing market. These guys sort of saw the writing on the wall and a lot of them just went belly-up. Guys were relying on the flow of these mortgages coming through the small independent lenders, the mortgage brokers, who really were basically originating for the purpose of securitizing them through Wall Street.

And so those guys are out of the market. So the only guys left standing, basically, are the GSEs. And even the large banks are basically funneling their loans, whereas, in the past, they were sending some to Wall Street and some through Fannie Mae and Freddie Mac. At this point, Fannie Mae and Freddie Mac are basically the only game in town.

JEFFREY BROWN: Well, so, that commission we were watching today, they are looking at what happened.


JEFFREY BROWN: But there is a lively debate about what to do with these entities now. What do you think should happen?

EDWARD PINTO: What I think should happen is, there needs to be a plan to bring private capital back into the housing market. And that needs to be done by slowly phasing Fannie and Freddie out, reducing their…

JEFFREY BROWN: Out altogether?

EDWARD PINTO: Out altogether. How that gets replaced with a number of private sector and other alternatives is going to be a point of discussion. I think the key is not to have the federal government guarantee, explicitly or implicitly, this housing debt, because once…

JEFFREY BROWN: Just get the government out of that kind of…

EDWARD PINTO: And whatever the government wants to do, do very transparently, on budget, through FHA and Ginnie Mae, and let the private sector handle the rest.


I suspect — I suspect we have a debate here.

ANDREW JAKABOVICS: Yes. I mean, I think that you can’t just sort of turn these — turn a switch and, suddenly, these guys disappear, and there is nothing to replace them at this point.

I think the conversation is really centering around how you would transition them in to some new ownership structure, some new institutional structure. There is still tremendous amount of mortgage capacity, the analytics, the risk analysis, the conduits, the relationships, all of those that exist inside Fannie Mae and Freddie Mac today.

You need to figure out where they are ultimately going to end up. And I think that investors, who are ultimately the buyers of the securities which allows the money to flow back for making more mortgages, you need to have a system, and I think transparency is absolutely right.

People need to understand exactly how the system works. Part of the problem now is that — or part of the — during the crisis — was that these were black boxes. These securities were originating without any sort of oversight. The types of loans that were being made were often very exotic when you talk about subprime, but interest-only.

There were all sorts of weird loans that were made for a variety of reasons, largely because they were profitable for the people making them. And I think that you need to ensure that the market as a whole is appropriately regulated, so there isn’t any sort of regulatory arbitrage between the Wall Street guys and Fannie Mae and Freddie Mac.

JEFFREY BROWN: Yes, because particularly at a moment like this, when the country still is in a housing crisis, to — you have to figure that into this debate, right, in terms of what — the role for a Fannie Mae.

EDWARD PINTO: Absolutely, although the general view is — and this is what was the problem as we got to this crisis — there were calls for requiring Fannie and Freddie to have more capital.

Fannie and Freddie fought that. Many of the industry participants fought it: It’s not the right time. We can’t do it now.

And it seems like it’s never the right time. And, so, I think we need to start figuring out how we reintroduce the private sector back into the process. It is going to be a slow process. We have really sort of almost destroyed the system in bringing it back. It is not going to be simple.

JEFFREY BROWN: And it is part of a political process?

EDWARD PINTO: And it is very much a part of a political process.

And I think there’s a fair view that having the federal government really in control of this process is not all bad. I mean, there’s — that was how Fannie was set up in the first place, was, it was really a politicization of the housing finance process. And I think there is a fair view that, if we can figure out a way to keep that by some members of Congress, they wouldn’t be against it.

JEFFREY BROWN: Just a brief last word on that process that you see.

ANDREW JAKABOVICS: I think it’s — I think it’s going to be a slow process. And I think that, I mean, the administration is going to be coming out with a set of questions, I believe next week, asking for input as to where people think that the — this process should go, in part because they need to move slowly because there is a tremendous amount of money at stake.

There’s confidence in institutions, as well as in the federal government at stake, and I think particularly from a perspective of foreign investors, a lot of money comes into this country through the mortgage-backed securities issued by Fannie Mae and Freddie Mac.

And to suddenly turn that off or to create new entities that people don’t have comfort with, I think would be incredibly problematic. And, so, if you have a political process that kind of takes lurches to the right, lurches to the left, that leads to spooking the markets. And that is, I think, the last thing we can afford.


Andrew Jakabovics and Edward Pinto, thank you both very much.


EDWARD PINTO: Thank you, Jeff.