F. Government Sponsored Enterprises
Between 1990 and 2004, homeownership rates in the United States increased rapidly from 64% to 69%, the highest level in 50 years. |93| While many highly regarded economists and officials argued at the time that this housing boom was the result of healthy economic activity, in retrospect, some federal housing policies encouraged people to purchase homes they were ultimately unable to afford, which helped to inflate the housing bubble.
Fannie Mae and Freddie Mac. Two government sponsored entities (GSE), the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), were chartered by Congress to encourage homeownership primarily by providing a secondary market for home mortgages. They created that secondary market by purchasing loans from lenders, securitizing them, providing a guarantee that they would make up the cost of any securitized mortgage that defaulted, and selling the resulting mortgage backed securities to investors. Many believed that the securities had the implicit backing of the federal government and viewed them as very safe investments, leading investors around the world to purchase them. The existence of this secondary market encouraged lenders to originate more loans, since they could easily sell them to the GSEs and use the profits to increase their lending.
Over time, however, Fannie Mae and Freddie Mac began to purchase larger quantities of higher risk loans, providing a secondary market for those loans and encouraging their proliferation. Between 2005 and 2007, Fannie Mae alone purchased billions of dollars in high risk home loans, including Option ARM, Alt A, and loans with subprime characteristics. For example, data from Fannie Mae shows that, in mid 2008, 62% of the Option ARM loans on its books had been purchased between 2005 and 2007. |94| Likewise, 84% of its interest-only loans were purchased in that time frame, as were 57% of those with FICO scores less than 620; 62% of its loans with loan-to-value ratios greater than 90; and 73% of its Alt A loans. |95| While these loans constituted only a small percentage of Fannie Mae's purchases at the time, they came to account for some its most significant losses. By the middle of 2009, Fannie Mae reported an unpaid principal balance of $878 billion for its loans with subprime characteristics, nearly a third of its total portfolio of $2.7 trillion. |96|
According to economist Arnold Kling, Fannie Mae and Freddie Mac purchased these loans after "lowering their own credit standards in order to maintain a presence in the market and to meet their affordable housing goals." |97|
Throughout their history, Fannie Mae and Freddie Mac were able to bundle the mortgages they purchased into securities that were popular with investors, because many believed the securities carried the implicit support of the federal government. The Congressional Budget Office found the following:
"Because of their [Fannie Mae and Freddie Mac] size and interconnectedness with other financial institutions, they posed substantial systemic risk—the risk that their failure could impose very high costs on the financial system and the economy. The GSEs' market power also allowed them to use their profits partly to benefit their other stakeholders rather than exclusively to benefit mortgage borrowers. The implicit guarantee created an incentive for the GSEs to take excessive risks: Stakeholders would benefit when gambles paid off, but taxpayers would absorb the losses when they did not.
... One way that Fannie Mae and Freddie Mac increased risk was by expanding the volume of mortgages and MBSs held in their portfolios, which exposed them to the risk of losses from changes in interest or prepayment rates. Over the past decade, the two GSEs also increased their exposure to default losses by investing in lower-quality mortgages, such as subprime and Alt-A loans." |98|
The risks embedded in their mortgage portfolios finally overwhelmed the GSEs in September 2008, and both Fannie Mae and Freddie Mac were taken into conservatorship by the federal government. Since that time, the Treasury Department has spent nearly $150 billion to support the two GSEs, a total which projections show could rise to as high as $363 billion. |99|
Ginnie Mae. Additional housing policies that allowed borrowers with less than adequate credit to obtain traditional mortgages included programs at the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA). Both agencies provided loan guarantees to lenders that originated loans for borrowers that qualified under the agencies' rules. Many of the loans guaranteed by the FHA and VA, some of which required down payments as low as 3%, were bundled and sold as mortgage backed securities through the Government National Mortgage Association (Ginnie Mae), an additional government sponsored enterprise. Like Fannie Mae and Freddie Mac, Ginnie Mae guaranteed that it would make up for any securitized loan that defaulted, producing another type of mortgage backed security that was popular with investors, many of whom believed that the security carried an implicit federal guarantee.
In the years leading up to the financial crisis, FHA guaranteed millions of home loans worth hundreds of billions of dollars. |100| According to FHA data, as of 2011, nearly 20% of all FHA loans originated in 2008 were seriously delinquent, meaning borrowers had missed three or more payments, while loans originated in 2007 had a serious delinquency rate of over 22%. The 2007 and 2008 loans, which currently make up about 15% of FHA's active loan portfolio, remain the worst performing in that portfolio. In 2009 and 2010, FHA tightened its underwriting guidelines, and the loans it guaranteed performed substantially better. By early 2011, the serious delinquency rate for all FHA borrowers was about 8.8%, down from over 9.4% the prior year.
93. U.S. Census Bureau, "Table 14. Homeownership Rates by Area: 1960 to 2009," http://www.census.gov/hhes/www/housing/hvs/annual09/ann09t14.xls. [Back]
94. Fannie Mae, 2008 Q2 10-Q Investor Summary, August 8, 2008, http://www.fanniemae.com/media/pdf/newsreleases/2008_Q2_10Q_Investor_Summary.pdf. [Back]
95. Id. [Back]
96. Fannie Mae, 2009 Second Quarter Credit Supplement, August 6, 2009, http://www.fanniemae.com/ir/pdf/sec/2009/q2credit_summary.pdf. [Back]
97. "Not What They Had In Mind: A History of Policies that Produced the Financial Crisis of 2008," September 2009, Mercatus Center, http://mercatus.org/sites/default/files/publication/NotWhatTheyHadInMind(1).pdf. [Back]
98. Congressional Budget Office, "Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market," December 2010, at x, http://www.cbo.gov/ftpdocs/120xx/doc12032/12-23-FannieFreddie.pdf. [Back]
99. Federal Housing Finance Agency, News Release, "FHFA Releases Projections Showing Range of Potential Draws for Fannie Mae and Freddie Mac," October 21, 2010, http://fhfa.gov/webfiles/19409/Projections_102110.pdf. [Back]
100. The statistics cited in this paragraph are taken from the U.S. Department of Housing and Urban Development, "FHA Single-Family Mutual Mortgage Insurance Fund Programs, Quarterly Report to Congress, FY 2011 Q1," March 17, 2011, at 4 and 19, http://www.hud.gov/offices/hsg/rmra/oe/rpts/rtc/fhartc_q1_2011.pdf. [Back]
Back to Contents E. Market Oversight G. Administrative and Legislative Actions
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