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December 18, 2010



"The Obama administration has been pushing for banks and investors to cut mortgage balances for homeowners who owe more than their home is worth. But the regulator for the biggest investors of them all — the government-controlled Fannie Mae and Freddie Mac — won’t let the two do it."
Fannie and Freddie opposes reducing mortgages for struggling homeowners.

Total confusion in government policy!

Cecil Turner

Okay, I have to retract that SWAG on FM/FM securitization levels above. The assumption was that the originations and MBS issuance were somewhat congruent by type, which appears unwarranted. In fact, I'm seeing claims that 75% of sub-primes were securitized, as opposed to what looks like less than 10% of total originations, so they are totally unrelated, and it looks like the Enterprises can only be responsible for a small fraction of the total.

A question for the experts out there. Does anyone know what percentage of the total subprime market was securitized by Fannie Mae and Freddie Mac? Or even if it's possible to estimate it?

Cecil Turner

Never mind, I found a good estimate:

Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding a high of 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent, according to data from Inside Mortgage Finance, a specialty publication.
Contrary to the thrust of the article, that still leaves the Enterprises as the biggest single players, but they're clearly not holding anything like a majority of the toxic assets.



With Fannie and Freddie securitizing sub-prime loans, they were giving them a US government guarantee and private lable players could then bootstrap off of the AAA Fannie and Freddie paper.

Add in the mathematical tailsmans and computer totems and BOOM!

Cecil Turner

I think it's obvious they started a trend and others jumped in. The question appears to be what portion of the blame properly lies with Fannie and Freddie, and what part goes to those who leaped later. I can't see any way to give F/F less than half of it, but neither do they appear to be (effectively) wholly responsible as I once thought.


"they started a trend"

ISTM they also established a false value floor with expected guv backing that was all too real.


The question appears to be what portion of the blame properly lies with Fannie and Freddie,

Cecil, I think that's Ritholtz's point:

The Gang-o-four [GOPers] absolves Wall Street and the banks, blames the government — for everything — and ignores the data that conclusively demonstrate otherwise.

It's a shortish blog, he's trying to make a point of the lack of balance in the report, and he has a book that goes into it in more detail. I haven't read the book, but his claim is that in it

I blamed Republicans, I blamed Democrats, I blamed the Federal Reserve, Congress, the ratings agencies, mortgage originators and lending banks, the biggest Wall Street firms, the SEC. I blamed US borrowers and home buyers, the RE agents, the mortgage brokers, and appraiser. I blamed the other end of the sausage factory, the collateralized debt obligation (CDO) underwriters, managers and the funds that bought them. I blamed Greenspan & Gramm, Bush & Clinton, Paulson & Bernanke & Rubin & Summers. Even mutual funds, compensation consultants and crony corporate board members come in for criticism. (This is only a partial list).

I think that's a pretty fair list of players who have earned varying degrees of blame, and I think it's fair for Ritholtz to challenge the GOPer report for not being either more even handed or more comprehensive, however you wish to characterize it. I see that you appear to be in substantial agreement with TM's major point and I think Ritholtz feeds into that.


Mel, I'll keep that in mind. I leafed through parts of the book at a B&N on our morning walk. They touch on some of the same or similar points that were mentioned in that longish economics paste job I did yesterday.

The point re China--I wish I could remember where I saw this but I know I read that the linkage with China that's been talked about so much was part of a conscious decision that it would be a good thing for the US economy to hold wages down. Contrary to the way that sounds, as I recall my source was neither lefty nor neo-mercantalist: it was a matter of fact description. The policy makers--GOPers and Dems alike--had what they thought were legit concerns and thought this would be a good way to address those concerns. Keep wages from increasing much, but compensate with cheap imported consumer goods, was the idea, if I recall correctly.


This isn't where I read it, but it's a good read from a piece by Niall Ferguson: What’s to Become of "Chimerica"?

Here's a longish excerpt that summarizes the nature of the beast. It also leads me to pose the question again re the "independence" of the Fed--what role did the Fed play in this? Anyway:

For a time, it was a symbiotic relationship that seemed like a marriage made in heaven. Put simply, one half did the saving, the other half the spending. Comparing net national savings as a proportion of gross national income, American savings declined from above 5 percent in the mid 1990s to virtually zero by 2005, while Chinese savings surged from below 30 percent to nearly 45 percent. This divergence in saving patterns allowed a tremendous explosion of debt in the United States, for one effect of the Asian "savings glut" was to make it much cheaper for households to borrow money than would otherwise have been the case. Meanwhile, low-cost Chinese labor helped hold down inflation.

The crucial mechanism that bound the two halves of Chimerica together was currency intervention. To keep the renminbi (and hence Chinese exports) competitive, authorities in Beijing consistently intervened to halt the appreciation of their own currency against the dollar. The result was a vast accumulation of dollar-denominated securities in the reserves of the People’s Bank of China, which became one of the world’s biggest holders of U.S. Treasuries as well as bonds issued by the government-sponsored (now government- owned) agencies Fannie Mae and Freddie Mac. Had it not been for the Chinese willingness to fund America’s borrowing habit this way, interest rates in the United States would have been substantially higher. It was Chimerica that kept the Age of Leverage going in its final phase, as total public and private debt as a percentage of GDP surged from 250 to 350 percent.

It was not, of course, just the United States that was borrowing, and not just China that was lending. All over the English-speaking world, as well as in countries such as Spain, household indebtedness increased and conventional forms of saving gave way to leveraged plays on real estate markets. Meanwhile, other Asian economies joined China in adopting currency pegs and accumulating international reserves, thereby financing Western current account deficits. Middle Eastern and other energy exporters also found themselves running surpluses and recycling petrodollars to the Anglosphere and its satellites. But Chimerica above all others was the real engine of the world economy.

It seems to me this was a deliberate policy. The Fed couldn't have been unaware of it, and wouldn't they have had to facilitate it in some way? Anyway, he has a lot of other interesting observations.

Comments? Criticisms? Anybody want to call me a name?


reading ferguson, i can see how other countries might come to view the u.s. as a predatory empire.

Cecil Turner

Hey, if we just read Ritholtz's conclusions and reason backwards it makes so much more sense. [/eyeroll]

But even that's more sensible than blaming the PRC's currency manipulations on the US.


AODs and RichardUF have thr real estate finance part of this right. fannie for over 40 years had been the dominant source of liquidity and market making in the mortgage business. The 1997 Clinton/Repub deal on cap gains gave unprecedented preferential treatment to home ownership. Marginal income tax rates stayed high, cap gains to first home sales dropped to zero, and long-term interest rates were low, and Greenspan wasn't raising them despite the stock bubble. Basically, the gov't had set up the shift from the technology stock buble to the real estate bubble. Yes community reinvestment contributted, but in absolute terms, wasn't driving the bubble. The fuel had been established in 1997 and Greenspan/bernanke kept adding more during 2002-2004 by driving interest rates lower out of a concern of deflation (9/11, jobless recovery etc). But no one --not even TM-- can deny the explosive fuel Fannie/freddie added in 2004 by buying up securitized home mortgage tranches. That opened the flood gates. Community bankers/ Wall Streeters fell into line and issued stoopid debt, because it had no apparent risk to them Fannie was buying most of --ALL mortgages, not just sub-prime. Fannie skewed risk immeasurably-- I can't quantify the effect, but to me it drove the gigantic losses. Bankers just follow spreads. fannie mae widened the spreads and in bankers eyes reduced risk to nil. We are now all going to pay for it.


I think that the "price support" paradigm is useful. The government sets a floor for the price of milk, and buys up and destroys the milk if the price goes below that level. They don't have to buy all the milk -- and the whole point of it is to have the rest of us buy the milk, at the higher price. In the same way, Fan/Fred set a AAA "price support" for "stinky" mortgage-backed securities -- securities that never should have been rated AAA because they contained all those pieces of subprimes in them.


Cathyf-- not only the price floor, but Fannie ostensibly took the risk out of issuing, rating and underwriting stoopit mortgages-- subprime, "prime", Jumbo, all of them, by putting the taxpayers on the hook by buying these tranches of ugly mortgages at purported AAA prices. That was the oxygen for the firestorm of losses.


"Market investors [in the run-up to the Second Great Contraction], in turn, relied on the central banks to bail them out in the event of any trouble. The famous 'Greenspan put' was based on the (empirically well-founded) belief that the US central bank would resist raising interest rates in response to a sharp upward spike in asset prices (and therefore not undo them) but would react vigorously to any sharp fall in asset prices by cutting interest rates to prop them up. Thus, markets believed, the Federal Reserve provided investors with a one-way bet. That the Federal Reserve would resort to extraordinary measures once a collapse started has now been proven to be a fact. In hindsight, it is now clear that a single-minded focus on inflation can be justified only in an environment in which other regulators are able to ensure that leverage (borrowing) does not become excessive." Reihnart/Rogoff p. 291

Nice for the investing class, but who ultimately foots the bill?

Elsewhere, R/R note that housing bubbles in e.g. the UK and other Euro countries were fueled by massive inflows of funds, without specifying the source.

"Bernanke, while still a Federal Reserve governor in 2004, sensibly argued that it is the job of regulatory policy, non monetary policy, to deal with housing price bubbles fuelded by inappropriately weak lending standards. Of course, that argument begs the question of what should be done if, for political reasons or otherwise, regulatory policy does not adequately respond to an asset price bubble. Indeed, one can argue that it was precisely the huge capital inflow from abroad that fueled the asset price inflation [as Ferguson also states] and low interest rate spreads that ultimately masked risks from both regulators and rating agencies." R/R p. 213

Cecil Turner

That was the oxygen for the firestorm of losses.

Exactly. The Enterprises still had a plurality (borderline majority) of all loans either directly or securitized, and were the biggest players of the subprime MBS market as well (despite losing market share at the end). They also bear some responsibility for inspiring the johnny-come-latelies who essentially copied their business practices, and much of the blame for the general market overheating. By comparison, the other players only account for one aspect, and are less dominant than FM/FM even in the aspect they represent.

Moreover, Fannie and Freddie represent almost the entire cost to the taxpayer. The current CBO TARP program estimate is $25Bil, which represents a $7Bil profit from the financial institutions, $19Bil to the automotive industry, and $12Bil in mortgage payment grants (from the HAMP program split 50/25 between TARP and Fannie/Freddie). Compare that to the $291Bil already sunk on FM/FM (and the prospect of another $79Bil over the coming decade), and it's clear where the taxpayers' money went.


Cecil-- I hope TM is reading these comments, I think we make a very persuasive case of why Fannie/Freddie were so instrumental in the financial collapse. I'm the first to concede that bamkers, regulators, mortgage brokers, the Fed (Big Time) and greed of the borrowers (zero down no doc 100% loans they couldn't afford) all played their part. But make no mistake Fannie/Freddie leveraged it (pun intended) into today's disaster. I'll quibble with only one thing you said-- the "automotive industry" didn't get the $19Billion, the UAW did. Every Voter needs to be educated that the banks paid back the TARP with interest, even AIG may break even for the taxpayers, fortunately the Treasury Dept. Inspector General forced BarryO to pull the deadbeat borrower HAMP program before it got too out of control, the 1/2 TRILLION the taxpayers will lose is for Fannie/Freddie, frikkin' GOVERNMENT SPONSORED ENTITIES. Why are Jim Johnson, Frank Raines and Jamie Gorelick not in Federal prison?

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