More on Fannie and Freddie - and the intentional ignorance of Mr. Brooks and Mr. Will

In the wake of the financial crisis of 2008, conservatives who rail against government regulation and for the efficacy of unfettered markets have had to circle their wagons and regroup. The crisis was caused by raging greed, lack of transparency in a huge and highly-leveraged market,  and the ability of a few powerful players at the pinnacle of our financial system to endanger the global economy and rob millions of wealth, employment and confidence in the economic and political system.

In order to regain control of their anti-government, free-market narrative we've seen attempts to blame the government-backed mortgage giants, "Fannie Mae" and "Freddie Mac," for creating the conditions that led to a near-total collapse of the housing market, while the big players walked off with enormous rewards for their nihilistic behavior.

This argument has been brewing since the earliest days of the crisis, but most recently two conservative pundits who have some credibility with "thinking liberals" have indulged themselves in the "it's Fannie and Freddie's (ergo, the government's) fault" line of defense for their faith in "free enterprise" ideology.

Both David Brooks and George Will have written high-profile columns mining a recent book that focuses the bulk of the blame for the 2008 meltdown on the "Government Sponsored Enterprises" Fannie and Freddie.  Brooks called the role of the GSEs in allegedly causing the crisis of 2008 "the most important political scandal since Watergate" and Will claimed that the former head of Fannie Mae "may be more culpable for the peacetime destruction of wealth than any individual in history."

As we have noted previously - and not terribly surprising for a Will or Brooks column - the problem with their arguments about the roots of the crisis is that they aren't honest and are based on assertion, not evidence.

Jeff Madrick and Frank Portnoy take the source of these columns apart fairly definitively in a recent New York Review of Books piece:

A debate has erupted anew in Washington over whether Fannie Mae and Freddie Mac caused the credit crisis of 2007 and 2008. Their critics claim that these two Government Sponsored Enterprises (GSEs) deserve a lot of the blame because they encouraged mortgage lending to low-to-middle-income Americans, a goal that Congress required and Bill Clinton advocated. The debate, which faded after a brief fluorescence in 2008, has been revived by a new book, Reckless Endangerment, by the respected New York Times reporter Gretchen Morgenson and the dogged financial analyst Josh Rosner.

Morgenson and Rosner argue that Fannie and Freddie’s affordable lending goals, coupled with their profit-making objectives, were among the most important causes of Wall Street’s collapse. But while the practices of the GSEs are certainly worthy of tough scrutiny…(t)he links they draw from the affordable lending mandate and the aggressive profit-seeking of the GSEs to the recent financial crisis contain more assertion than analysis.

Here is a telling sentence from the book: “How Clinton’s calamitous Homeownership Strategy was born, nurtured, and finally came to blow up the American economy is a story of greed and good intentions, corporate corruption and government support.” A phrase like “blow up the American economy” is not the kind of cautious, specific analysis we expect from Morgenson or Rosner. And here is yet another example: “…the home ownership drive helped to plunge the nation into the worst economic crisis since the Great Depression.”…

In fact, as abundant data show, Fannie and Freddie’s affordable lending programs had virtually nothing to do with the recent crisis. The crisis was caused by Wall Street’s bad bets on complex securities based on subprime mortgages. These bets were mostly placed during the mid-2000s.

Although Morgenson and Rosner provide some fine examples of mortgage brokering chicanery, they spend far less time discussing the reckless practices of private offenders than those of the government programs they eagerly chastise. Most of their animus is aimed at the GSEs, particularly Fannie Mae, the organization formally known as the Federal National Mortgage Association, and James Johnson, the Fannie Mae CEO and consummate political insider…

Johnson probably deserves much of the damning criticism the authors direct at him. But claims that Johnson’s Fannie Mae caused the 2007-2008 crisis by meeting affordable lending goals that were first established and had primary effect in the 1990s are so far-fetched that they require time travel. Home ownership increased during Johnson’s tenure, as did subprime lending, but the surge of risky private lending and securitization that nearly brought down the financial system did not occur until the 2000s, when Johnson was gone.

Nor did Fannie Mae contribute as much to the subprime bubble after Johnson left as is widely thought. The market for home loans shifted away from the traditional, conservative, fixed-rate mortgages backed by Fannie Mae to riskier, subprime, adjustable-rate mortgages sold by private firms such as Countrywide and New Century. In order to meet affordable lending requirements, Fannie Mae did buy some of the subprime mortgages that private lenders made to low-income people with poor credit scores. But even Fannie Mae and Freddie Mac’s purchases combined were always a minority of the subprime mortgage market, and their subprime stake declined substantially as a proportion of the market after 2004.

Moreover, much of what Fannie Mae bought was the safest portion of the mortgage-backed securities. Even when the crisis was underway, Fannie Mae’s losses on subprime loans were minimal, only about 5 percent of its total losses. They were not taking the kinds of risk the private lenders were; for example, they never bought any part of the now infamous collateralized debt obligations…

(T)he default rates on GSE mortgages were far lower than on those bought and issued in the private market. In 2004, the GSE default rate was 4.3 percent of their mortgages compared to a default rate in private industry of 15.1 percent of mortgages. In 2005, the GSE default rate was 7.8 percent—high and disturbing; but in private industry it was 28.7 percent, the source of the severe crisis. In 2006 and 2007, default rates reached 13.2 and 14.9 percent in the GSEs and 45.1 and 42.3 percent in the private market.

We are not defending GSEs: at its core, the GSE model is flawed. GSEs are charged with serving two masters: to keep the mortgage market working but also to maximize profits with the enormous help of an implied government guarantee on their debt. They ignored regulatory requests to raise more capital, instead borrowing at low rates to invest aggressively at the height of the market. As a result, they lost enormous amounts of money once housing prices collapsed, and they are now being bailed out by the federal government to the tune of $150 billion.

But they did not lead the crisis; their collapse followed it...What is disturbing about the currency being given the Morgenson-Rosner argument is that it is supplying ammunition to those who believe government involvement of almost any kind in the markets is bad, and that without a mismanaged Fannie and Freddie all would have been fine.

A new and serious debate is needed about how to reform and reconstitute the GSEs. But it cannot be informed by misleading analysis and over-the-top rhetoric.