Are Fannie and Freddie to blame?

Many people such as Peter Wallison believe that government intervention, through both the Government Sponsored Entities (GSE’s) Fannie Mae and Freddie Mac, and their affordable housing policies, was the main contributor to the crisis.

I agree with him that they were a significant factor but disagree that they were the driving force behind the crisis. The Clinton administration put pressure on the GSE’s to extend mortgages and loans the low and moderate income neighbourhoods set out in the CRA 1977. As a result of this, the GSE’s were pressured into making subprime loans which were more profitable than orthodox loans. This only served to bring further pressure from their shareholders to maintain these profits.

Fannie and Freddie were significant players in the U.S mortgage industry. By 2003, Fannie Mae and Freddie Mac accounted for 52.3% of all residential mortgage loans outstanding (Federal Reserve and Monthly Funding Summaries). However, between 2004 and 2006, research from the St Louis Fed shows commercial banks and investment banks were bigger direct players than the GSEs in the subprime market. In 2006, non-agency production of $1.480 trillion mortgage loans was more than 45 per cent larger than agency production. When the crisis hit, the GSE’s had lost significant market share and it was the commercial and investment banks which held the majority of the toxic mortgages.

I do not believe Fannie and Freddie caused the subprime crisis. They were a contributing player in the subprime market and they did purchase billions of subprime backed securities. They were also involved in buying the AAA pieces of structured deals but these were the least risky sections which were attracting all investors.  However, it is important to recognise that because of regulations, the GSE’s took on much less toxic loans than most banks. They were also not involved in the CDO market or other vehicles selling toxic parts of these instruments.