Wall Street Sank Freddie and Fannie

Coverage of the bailout could use a dose of recent history

My only quibble with the gusher of stories this morning on the government’s takeover on Fannie Mae and Freddie Mac is my usual one—ahistoricism.

Reading all this, one gets the impression that those politically protected mortgage buyers and fee machines caused the global credit crisis.

They didn’t.

The fact is: Wall Street sank Freddie and Fannie, not the other way around.

It was only a few years ago, during the heyday of the housing bubble, that these government-sponsored enterprises were elbowed aside by Wall Street, which was busy furiously shoveling money to the Countrywides, New Centurys, Ameriquests, and other bucket shops that provided the rotten mortgages that were the raw material Wall Street repackaged and foisted onto return-hungry global bond markets.

This Credit Suisse report (from March 2007 and eerily prescient) reminds us that the government sponsored entities’ share of the overall new mortgage market had fallen to 42 percent by the end of 2006 before shooting up to 76 percent at the end of 2007 (on their way toward 90 percent now) as the market collapsed.

And that’s the overall market. As Paul Krugman points out, a “subprime borrower is basically someone whose credit wasn’t good enough to qualify for a Fannie- or Freddie-backed mortgage”. The subprime market&the really toxic stuff—was always dominated by Wall Street and Wall Street-backed lenders.

According to Bloomberg’s tally, bank write-offs from the subprime and credit calamity have now passed $500 billion.

As I argue in the current print edition of the Columbia Journalism Review, the business press has largely missed the extravagant corruption that overtook the mortgage-lending leaders, which threw away any semblance of underwriting in favor of what can only be called boiler room-style sales tactics—deception on a mass scale and as a matter of corporate policy—in order to meet Wall Street’s demand for product.

The Orange County Register found a neighborhood where a staggering 75 percent of home loans were subprime, i.e., non-Fannie and Freddie.

That’s crazy.

And let’s not forget that Wall Street firms themselves, to cut out the middleman, bought their own subprime retail operations as the frenzy continued, as Bloomberg reminds us. It’s interesting to note how late Wall Street continued its push into retail, subprime lending. Now-floundering Merrill Lynch bought First Franklin in September 2006; the now-defunct Bear Stearns bought Encore Credit in October 2006; Morgan Stanley bought Saxon Capital in December 2006.

Indeed, as late as August 2007, Morgan Stanley was still trying to grab a bigger share of the subprime market as the rest of the industry fled in panic: “Morgan Stanley’s Saxon maneuvers to boost subprime.”

This is the firm, mind you, advising the U.S. Treasury.

The point is, Wall Street dominated the subprime market, which crashed the credit market, which crashed the asset values of Freddie and Fannie, obliterating their (very thin) capital bases and leading us to this moment.

Listen, you’ll get no elegies from me for these government-sponsored candy stores. It’s clear they used their taxpayer-supported advantages in the financial markets to keep their regulators at bay and buy protection from Congress. That stinks.

The Wall Street Journal today smartly reminds readers of the staggering size of the GSEs’ lobbying bill—$170 million over ten years.

Ponder that one for a second. As their time was running out, they spent $3.5 million in the first quarter alone on forty-two lobbying firms. That’s $83,000 a piece— probably enough to pay the sushi bills.

And to the extent that Democrats participated in the backslapping—using affordable housing as a fig leaf—shame on them. The fact that the GSEs were able to fend off proper regulation during a time when Republicans controlled the Treasury and both houses of Congress indicates that these were, at a minimum, bipartisan feedbags. Still, it’s a bigger problem for the Democrats, who believe the government should help provide affordable housing. Using the housing-affordability argument as a club to protect a corrupt system is deplorable.

It was a further disgrace for the GSEs to loosen their own standards in a grab for market share after 2005, as they expanded their buying of so-called Alt-A (not well-documented) loans.

Still, as the Journal points out, Alt-As were still a small part of their business even though they made up a big part of the losses.

Yet both companies expanded their exposure to riskier loans. At both Fannie and Freddie, so-called Alt-A loans, a category between prime and subprime, accounted for roughly 50% of credit losses in the second quarter, even though such loans accounted for only about 10% of the companies’ business.

In truth, it is the ocean of toxic-waste mortgages funded and sold by Wall Street that ultimately has put taxpayers at risk.

Some context just seems in order.

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Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014). Follow Dean on Twitter: @deanstarkman.