Well, I know that I should be blogging about the Republicans’ attack on organizing. However, I am weary of the topic and I am hereby risking my current 200+ hits a day by actually writing about something of much greater substance. Before leaving, I must say it is something when you latch into a national meme and get lots of hits, comments both good and bad and links from many interesting websites. Now—lets get back to the 15-25 hardcore readers of this site.
Over the weekend, the federal government seized control of the two major players in mortgage lending, Federal National Mortgage Assn. (Fannie Mae) and Federal Home Loan Mortgage Corp. (Freddie Mac.) These entities are government-sponsored entities (GSE’s) created by the federal government to ensure more liquidity in the mortgage business.
(full disclosure: my employer receives funding from Fannie Mae to work on the issue of mortgage lending in low income communities.)
The reason for the creation of these companies was relatively uncontroversial. Fannie and Freddie could buy the 30-year mortgage loans made by traditional lenders, freeing up the banks from dealing with the hassles of collecting payments and using the payments to make more mortgage loans. All of this made sense when the mortgage business was the staid enterprise of making conventional loans to people who made down payments and were judged to have the financial wherewithal to pay off the loan.
Of course, all this went out the window with the rise of non-traditional lenders in the wake of the repeal of the Glass-Steagall Act (thank you strange bedfellows Phil Gramm and Chuck Schumer!) creating a financial sector largely beyond the regulatory reach of the U.S. government. Community groups raised a fit that these lenders weren’t covered by the Community Reinvestment Act, but we should have also noticed that these lenders were also outside any ability to regulate their safety and soundness. When they started pouring sub-prime and predatory loans into our neighborhoods community groups complained, but no one took notice until the shiny new tract mansions in the exurban wilderness started to sprout pools full of algae.
Fannie and Freddie complicated this matter. The companies may have been created by the government, but they were private, stock-issuing corporations. Both companies wanted to maximize their return on investment, see their stock rise and pay dividends to shareholders. The relatively staid business of buying 30-year fixed loans and then selling them as securities to Wall Street investors started out small, but became the Wild Wild West of our speculative market economy. Fannie and Freddie caved into the pressure to make more money by agreeing to buy sub-prime loans and by buying and selling these loans on Wall Street in increasingly complex financial vehicles (for instance derivatives–betting on the rise or fall of small fractions of larger financial products.)
Ordinarily, this would be a problem for the private market to sort out. Not in today’s world. Fannie and Freddie made so much money because, despite the risk of its sub-prime products, most investors looked at their government soundness rating of AAA. This rating was so high because the assumption behind the companies was that the government would step in to guarantee losses. Socializing risk and privatizing profit. A neat trick. It got to the point where Fannie and Freddie were involved in 70% of all mortgage transaction in the country–too big to fail indeed.
Fannie and Freddie compounded the problem, as did most companies in the non-traditional, unregulated portion of the mortgage lending market by borrowing heavily to maximize the amount of loans they could pull together and package for Wall Street. Traditional bank regulators worry when a bank has more than 4-5% more debt than assets. Fannie and Freddie had more than 20%. The swiftness of the government takeover suggests the numbers may have been even worse. Just a month ago Treasury Secretary Paulsen stated that the Feds wouldn’t need to takeover the GSE’s when the authority to do so was granted under the Housing and Economic Recovery Act.
New Yorkers are wondering if the recently leashed Fannie and Freddie will continue to refuse to buy loans in New York State, a threat that they made once Governor Patterson signed into law our state’s reforms to the foreclosure process. Fannie and Freddie have a history of throwing their weight around to stop states and localities from clamping down on sub-prime lending. Now that Fannie and Freddie are no longer beholden to private stockholders, perhaps they can do the right thing and promote sound lending policy that helps all our citizens–not just Wall Street.