Can We Please Stop Pretending that Fannie and Freddie Weren’t Part of the Problem?

The Securities and Exchange Commission has charged the CEOs of Fannie Mae and Freddie Mac with civil fraud. Oh my, what will their defenders say now?

There’s been an effort among liberals to deny that Fannie Mae and Freddie Mac had anything to do with the mortgage crisis. I find this effort hard to understand except as a desperate effort to deny that a government-sponsored enterprise with a good social purpose could actually do wrong. So Krugman, for example, or the folks at Rortybomb. That these enterprises effectively created the secondary-mortgage market and that Fannie began the mortgage-backed security business in the 1980s, without which the crisis could not have occurred, weren’t relevant. And great effort went into denying that Fannie and Freddie held enough high-risk mortgages to have played a role in the crisis, despite the fact that in 2006 Fannie and Freddie bought 15% of all loans originating with less than a 5% down payment, and in 2007 bought 23% of such loans (see here). Is it conceivable that if two wholly private mortgage firms held almost a quarter of such loans when the market collapsed that they wouldn’t be the target of liberals’ condemnation?

But now we find, assuming the SEC’s claims are accurate, that Fannie and Freddie not only owned large amounts of bad debt, but that they were lying about it. Reportedly, Fannie’s 2007 report claimed $4.8 billion in subprime loans (0.2% of its total loans), while it actually had $43 billion in subprimes, 11% of its total debt ownership. Freddie reported $2-$6 billion in subprime mortgages in 2006 while actually carrying about $140 billion, and by 2008 over $240 billion. If these were private firms, how vocal would the liberal condemnation (rightly) be?

This is not an argument that the government is solely responsible for the mortgage crisis. As I’ve written elsewhere, I think a disparate set of government policies interacted in unexpected ways to inadvertently create a situation that stimulated the housing bubble, so it bears underlying responsibility. But private actors in the secondary mortgage market were foolishly buying mortgage-backed securities that were deeply opaque, whose real value and risk was not just unknown, but unknowable. So “the market,” or more specifically, private actors, don’t get off the hook here.

But on what possible logical basis can anyone assume that “public actors” operating in the same business were going to be fundamentally different? Anti-market liberals (a subset of liberals) like the government for the same reason that liberals and conservatives distrust it–government actors normally have different incentives than private actors, because the profit motive is not present. (The more sophisticated approach is to recognize that whether that absence is good or bad depends on what type of activity is being considered.) But the inescapable truth is that Fannie and Freddie had a profit motive in this case, but combined with the certainty that they would be bailed out by public funds if their finances went south. The irony is that this combination is exactly what liberals hate when it exists in the private market–the privatization of benefits and socialization of costs. The mystery is why would anyone believe believe that the veneer of “publicness” for Fannie and Freddie was sufficient to fundamentally change those organizations’ behavior?

About J@m3z Aitch

J@m3z Aitch is a two-bit college professor who'd rather be canoeing.
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7 Responses to Can We Please Stop Pretending that Fannie and Freddie Weren’t Part of the Problem?

  1. Matty says:

    Quick question, why would the government set up two separate organisations to do the same thing? Was it simple incompetence or are there differences I’m not aware of.

  2. Chris says:

    You don’t actually address the points made by Krugman or Konczal. I don’t think they are making an argument that Fannie and Freddie had absolutely no role at all, just that the rush to subprime was driven by the private market in 2002-2005 and then Fannie and Freddie followed in 2006-2007. Your points do not seem to contradict this story.

  3. Neildsmith says:

    Can we please stop pretending that this debate is anything but political posturing? Everyone involved made a calculation during the bubble. Borrowers calculated they could make money with no money down. Mortgage brokers, real estate agents, home appraisers, condo flippers, developers, lenders, investment bankers, regulators, and ratings agencies all made the same calculation: that they could profit from the run up in prices and get out before disaster struck. And then, they all ran for the exit at the same time and got trampled. This isn’t a story about policy or politics, it is a story about greed and human stupidity.

  4. Jennifer says:

    This is indeed a story of greed and stupidity, but government incentives made it worse. One of the more ludicrous bubble anecdotes told of the $25,000-per-year strawberry picker who got a mortgage loan for $750,000 — ten times greater than the amount he “should” have been able to borrow according to the old “Take out a mortgage three times your annual salary” formula, not to mention greater than the sum total of money that strawberry picker was likely to earn in his entire working life — I doubt any banker would be fool enough to make such a loan if he knew he’d have to eat the loss himself.

  5. James Hanley says:


    The major involvement of Fannie and Freddie did indeed follow that of the private firms. But as I said, this is a case of both private firms and GSEs being guilty, and I don’t see how the sequence undermines that. Krugman et. al were, I think, very clearly trying to absolve Fannie and Freddie of having any real responsibility at all.

  6. Dr X says:

    James, I found your post persuasive, but now I’m not sure how to weigh responsibility after reading Nocera.

    Questions raised by this article:

    Are what we’re calling subprime at Fannie and Freddie really subprime, using honest or at least honestly comparable definitions?

    What were the default rates for Fannie and Freddie versus the national averages? Is Nocera right on this? This seems critical for comparison of performance and contribution.

    Another question, looking at the total dollars in the Fannie Freddie defaults, had the non-guaranteed mortgage market not had problems, would we have seen the massive credit contraction and rapid recession? How much of a recession if this was only happening with guaranteed loans?

    The other way around, if Fannie and Freddie, continued without problems, how much would the impact of the mortgage collapse on the economy been mitigated?

    Obviously, these aren’t easy calculations because effects of dynamic, but they’re interesting hypotheticals.

  7. Passing By says:

    Professor Hanley –

    I’m afraid that you’re fighting an imaginary opponent.

    Neither Krugman and Konczal is making some some “desperate effort to deny that a government-sponsored enterprise with a good social purpose could actually do wrong”. To the contrary, they call Freddie and Fannie “corrupt”, “poorly designed”, “creepy”, and “unsavory”.

    Their central point is that F&F, even if founded by Voldemort personally and staffed entirely by Death Eaters, simply didn’t play much of a role in causing the financial crisis and the subsequent recession. Rather, they’d say, some other government policies, notably slackened regulation of the financial sector, did play the central role.

    So they’d say those policies need badly need revision. And conversely, they’d say that curbing, or even abolishing, F&F wouldn’t do much to protect us from a future recurrence. So they believe that going on about F&F is a distraction from the real problem … perhaps a deliberate distraction by those who want to avoid a debate over the slackened regulation. (Krugman has called the focus on F&F “deliberate deception”.)

    None of which has a damn thing to do with “defending” Fannie and Freddie.

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