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Fannie Mae and Freddie Mac Print E-mail
Written by Dr Eamonn Butler   
Wednesday, 10 September 2008

Not 'markets' but US government financial regulations were the principal cause of the credit crisis. I've written here before about the 'anti-redlining' laws: regulations to stop lenders refusing loans to people who happened to live in a poor part of town. That gave millions of poor people access to home loans – but at the expense of the institutions taking on riskier customers.

Now the loans have gone bad, the housing market is ailing, and the institutions are in pain. So the government steps in and takes over control of the mortgage lenders Fannie Mae and Freddie Mac.

Once Freddie and Fannie had about three-quarters of the mortgage market. But then the Fed decided that they should be classified more like hedge funds. But of course they then didn't meet the hedge fund accounting regulations... Put into the penalty box, they lost their top management and weren't able to ply their trade – just at the time when, thanks to plummeting interest rates, everyone else was re-financing their book to advantage.

All sorts of new products popped up on lenders' balance sheets – derivatives and other instruments with high yields, large leverage and riskier, narrower spreads. A mix of assets that the rating agencies didn't know how to rate. So trouble was stacking up but few people quite realized it. Fannie and Freddie were eclipsed, their mortgage share slid drastically.

When you snap a twig in a quiet room, the sound echoes. On a busy street, you can't hear it. When markets are changing rapidly, market players can easily miss the signal of things going wrong from the noise of universal change. Until it's too late. It is the regulators, who precipitated the market turmoil, that we should blame for things going wrong, not the market system.

Comments (7)Add Comment
More Detail Please..
written by Lola, September 10, 2008
From my professional experience I could see that a lot of mortgage finance was ludicrously underpriced in the UK since 1997 and a bit as a result of very lose money supply, to low interest rates and banks losing sight of risk. But I would love to read a more detailed article on the US situation. Any chanece you'll be doing something on it?
...
written by Steve Giess, September 10, 2008
Surely a combination of redlining and artificially low interest rates?
Not the only regulation that ended up in that mess
written by Vincent, September 10, 2008
CRA is certainly a huge contributor of the current mess, but in fact, there are many other regulations that prevented things to work properly.

First, the HUD's regulations, since 1992, mandating FNMA and FHLMC to refinance always more and more subprimes credits. 42% in 1992, 50% in 2000, 56% in 2004.

Second, complicity between HUD's officals and fannie & freddie CEOs to use "off balance accounting" extensively, with much more permissivity than for "normal" firms, with special agreements between HUD and Fannie/Freddie in order to hide how dangerous the situation was.

Third, the artificial over evaluation of real estate in 12 states, including almost all the most crowded except Texas, due to abusive land use restrictions, that increased the risk exposure of home credit borrowers by about 4 Bn USD, i.e. 1/3 of the total of running loans.

And w/o doubt many others.

more links
written by Vincent, September 10, 2008
To lola:
http://www.econbrowser.com/arc...and.html
(financial & background data about this mess)
http://www.cato.org/subtopic_display_new.php?topic_id=89&ra_id=14
(several good tribunes by the Cato institute)
To Lola
written by not an economist, September 11, 2008
Also try this:

http://mises.org/story/3104
I understand
written by kate, September 11, 2008
how the current situation has come about what concerns me is that surely there was a point when all the major lenders thought that may be they had leant to too many risky people and stopped, people can only pay their debts off if they make money to pay the debt back, I can see why they were bailed out but they shouldn't have leant the money in the first place.
Tar babying the CRA
written by Ron Legro, October 01, 2008
> CRA is certainly a huge contributor of the current mess

No it's not. The CRA had nothing to do with lenders maing riskier loans than they would have otherwise. The law merely requires that lenders take each applicant on his or her own merits, and give people in poorer neighborhoods the same fair chance at a mortgage that everybody else in the area is getting.

The Gramm-Leach-Bliley Act of 1999 required the Federal Reserve Board to study the profitability of CRA loans. The Fed found that CRA loans were profitable.

Furthermore, the CRA only applies to FDIC member banks and thrifts. Back in the 1970s, these institutions were responsible for most of the country's mortgage lending. But starting in the 1980s on up to the bubble burst, the nation experienced a huge boom in lending businesses such as finance companies like the failed Countrywide that weren't banks, and didn't take deposits that required FDIC insurance. Thus, they didn't have any obligation to the CRA.

An analysis of Home Mortgage Disclosure Act (HMDA) data in the country's 15 biggest metropolitan areas found that 84.3 percent of the high-cost loans made in 2006 were originated by non-CRA lenders—including 83% of high-cost loans to low- and moderate-income individuals.

The Federal Reserve notes that, across the country, non-CRA lenders were twice as likely as CRA lenders to issue subprime loans to vulnerable borrowers. The Fed also reports that responsible mortgages made by CRA lenders have about the same low rate of foreclosure as other traditional mortgages.

So, no, it's not about poor people getting mortgages they can't afford because the CRA forced banks to do that. That's a myth.

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