NCPA - National Center for Policy Analysis


September 24, 2008

The vast accumulation of toxic mortgage debt that poisoned the global financial system was driven by the aggressive buying of subprime and Alt-A mortgages, and mortgage-backed securities, by Fannie Mae and Freddie Mac.  The poor choices of these two government sponsored enterprises (GSEs) -- and their sponsors in Washington -- are largely to blame for our current mess, says the Wall Street Journal.

How did we get here?  According to the Journal:

  • In order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie and Freddie committed to increased financing of "affordable housing."
  • They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion.
  • In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.

Moreover, Fannie and Freddie were viewed in the capital market as government-backed buyers; thus, they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities, says the Journal.

Their strategy of presenting themselves to Congress as the champions of affordable housing appears to have worked.  They retained the support of many in Congress, particularly Democrats, and were allowed to continue unrestrained.  In fact, Congress basically told them that if they concentrate on affordable housing, despite their problems, congressional support is secure, says the Journal.

But Democrats are now criticizing the risk-tolerant regulatory regime, blaming the current crisis on deregulation.  However, deregulation in the financial world in the last 30 years has permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable.

Deregulation of branching restrictions and limitations on bank product offerings has made it possible for the banks to save lending institutions; thus saving billions in likely resolution costs for taxpayers, says the Journal.

Source: Charles W. Calomiris and Peter J. Wallison, "Blame Fannie Mae and Congress for the Credit Mass," Wall Street Journal, September 23, 2008.

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