Affordable lending is not to blame for the demise of Fannie and Freddie

Sen. Alan Cranston was author of legislation that established affordable housing lending goals on the GSEs in 1992,
Sen. Alan Cranston was author of legislation that established affordable housing lending goals on the GSEs in 1992,

Floyd Norris, writing in Sunday’s New York Times, lays the blame for the government takeover of Fannie Mae and Freddie Mac to their attempt to serve two masters, “…the investors who put up capital and a government that wanted to help the housing industry and extend home ownership.”

Norris specifically blames the affordable housing goals imposed by Congress for the GSEs ending up holding a bunch on nonperforming mortgages.

Norris is generally correct in his analysis of what went wrong but wrong in placing the blame on GSE affordable housing goals.

Here is his argument…

It was during the long housing boom that the seeds of destruction were sowed for Fannie and Freddie. They appeared to be very profitable, so pressures mounted for them to find ways to finance housing for poorer Americans, often living in areas where banks had historically been hesitant to lend. Congress set goals for such lending.

At the same time, the private mortgage industry was becoming more and more reckless in its own lending – in part because the lenders were selling the home loans as soon as they were made, and therefore had less reason to care if the loans were repaid.

As those standards deteriorated, there was pressure on Fannie and Freddie to relax their own standards, both to remain competitive and to meet the Congressional goals. In some cases, the goals were met by buying subprime mortgage securities sold by private lenders.

For many years the loans made to finance homes of poorer Americans and homes “in areas where banks had historically been hesitant to lend” performed well for the GSEs — until subprime lending fueled by private mortgage backed securities exploded.

Now the GSEs did get eventually get into buying subprime loans.  They did this because their market position was undercut by the frenzy of subprime and predatory lending that was going on.  That was a stupid mistake on the part of the GSEs but no one has come forth to show that the GSE’s modest protfolios of subprime loans caused their meltdown.  The problem was much bigger than this,

What brought down the GSEs was something different.  The complete collapse of the non GSE securitized subprime portfolio undermined housing values in general.  As defaults in subprime loans ballooned the cancer spread beyond the subprime loans to the prime mortgages as foreclosures undercut housing values.  That is what pulled the GSEs under.

The affordable housing goals Congress imposed on the GSEs did not per se force them engage into risky lending nor did it compel them to invest in subprime mortgages. The affordable housing lending goals did not force the GSEs to lend to unqualified borrowers as Mr. Norris implies.

Absent the reckless presence of the non GSE securitized subprime lenders the presence of the GSEs in affordable housing lending was safe and proper and would have provided safe and secure loans while expanding low income home ownership.

A properly regulated market, without the excesses of subprime lending, worked. From 1992 when the Federal Housing Enterprises Financial Safety and Soundness Act which established the GSE affordable goals was enacted, until the explosion of unregulated subprime lending ten years later it dramatically increased minority and low income home ownership rates without high levels of mortgage defaults.

Congress was correct to demand that the GSEs “lead the market” in creating prime conventional loans for affordable housing in exchange for the $6 billion per year tax exemption they enjoyed (according to Congressional Budget Office estimates).  Where Congress and the Administration erred was in allowing the Federal Reserve and the federal regulators to ignore the massive fraud perpetrated by subprime and predatory lenders.

The GSEs were not done in by affordable housing goals as Mr. Norris suggests.  They were done in by a combination of private greed and governmental indifference to private mortgage backed securities that fueled predatory and subprime lending.

Congress must keep this in mind as the inevitable restructuring of the GSEs takes place next year.