The big lie about the role of affordable lending goals in the collapse of Fannie Mae

The Big Lie:  Fannie Mae collapsed because of Congressional affordable housing goals and this, in turn, was the cause of the Wall Street collapse that resulted in the $700 billion federal bailout.

The Big Lie has been spreading very rapidly through several sources:

• an oversimplification of the story by the mainstream media (see, for example, today’s NYT story, Pressured to Take More Risk, Fannie Reached Tipping Point);
• the executives who ran Fannie Mae into the ground are spinning this story to the media to try to deflect their culpability;
• anti-government ideologues seeking to destroy existing programs designed to ensure fair lending and community reinvestment; and
• the real culprits: out of control Wall Street creators of the subprime/predatory loan scam, who hope to forestall mortgage and lending reforms so they can resume their disastrous lending practices in the near future.

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Facts about the Big Lie.

Fact #1: The increase in affordable housing goals that most recently occurred was imposed by HUD and not Congress.  True, Congress wanted more lending to lower-income homebuyers and minorities (as did the Bush Administration) but it was HUD that actually dialed up the goals a notch.

Fact #2: In 1992 Congress voiced concern about an “information vacuum” with regard to the low- and moderate-income as well as minority lending records of Fannie Mae and Freddie Mac. Since then, Congress has focused on the cost and risk versus benefit of the federal government’s large public subsidies to Fannie Mae and other GSEs. Congress acted on its concerns by directing the U.S. Department of Housing and Urban Development (HUD) to develop a set of national lending performance goals for the GSEs. The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 requires HUD to establish three affordable housing goals for each of the GSEs. The Act directs HUD to recognize “the ability of the enterprises [GSEs] to lead the industry in making mortgage credit available for low- and moderate-income families.”

These housing goals are intended to measure and encourage the GSEs’ support for very low-, low-and moderate-income lending as well as lending in under served geographic areas. Congress gave HUD the responsibility of monitoring and reporting on GSE performance in meeting these goals.

Congress believed that the GSEs should use their power to profoundly influence the availability of home mortgage credit to these targeted homebuyers. Section 1302 of the Act provides that the GSEs have an “affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families.”

In 1992, when Congress passed  this law there was little subprime lending and it was the explicit policy of the GSEs not to purchase subprime loans.  The assumption behind the affordable housing goals was that Fannie Mae would lead the market by creating conventional loans, traditionally underwritten and properly secured to meet the home mortgage credit needs of the targeted population.  In fact, that is what happened from 1992 to at least 2000.  Fannie Mae led the industry in making conventional loans to qualified low income and minority borrowers who were qualified to and generally did pay back the loans.

The point here is that the goals were established to operate for GSEs that engaged in traditional prime lending and in a world before subprime and predatory lending became he norm.

Fact #3: Fannie Mae got into the subprime market to maintain it’s market share of loans, not to provide loans to low-income and minority borrowers.

As the effects of the disastrous decisions to deregulate banks and Wall Street subprime lending began exploding along about 2002, Fannie Mae began to lose market share to Wall Street firms that securitized and sold these crummy subprime loans without Fannie Mae being involved.  Fannie got scared it would lose market share and its profits (and, in turn, its executive salaries bonuses) would decline.  This is why Fannie became involved in securitizing subprime loans.

Fact #4:  Once subprime lending took off, the market for conventional, prime affordable housing loans dried up.  The demand for subprime loans went through the roof as investors clamored for the higher returns of the non-Fannie securitized, Wall Street created junk subprime loans.  Once the GSEs jumped in the situation became even worse.  Not only did their entrance into subprime lending make more subprime mortgages available, but because of their quasi-government status they reinforced confidence in these loans.

Borrowers were being offered non-qualifying, no paperwork, no downpayment ARM loans with teaser interest rates.  Unsophisticated lower-income first time buyers, many of who had little or no financial literacy flocked to these loans.  If Fannie was offering these products then non-profit affordable housing organizations felt safe in referring their clients to these products.  The market for traditional loans was drastically curtailed.

Fact 5:  By 2004 Fannie decided to jump into subprime lending both to maintain profits and market share and to bolster its justification of it’s public purpose (and public subsidy) that was by then being questioned.

The Congressional Budget Office (CBO) found that the federal subsidy to Fannie Mae for the year 2000 was $6.1 billion, but the CBO reported that only about half of this subsidy was transferred to the benefit of the borrowers. The CBO report showed that Fannie Mae retained the other half of the public subsidy, presumably for the benefit of the corporation and its shareholders.

The justification for the subsidy was that the GSEs would ensure the safe and efficient flow of mortgage funds.  But with more and more low-mod income borrowers bypassing Fannie because of the cheap and easy subpime credit and because of Fannie’s declining market share, Fannie had to retain market share to justify its special subsidized status.

In essence, the deregulation of banking and mortgage markets by Congress and the Clinton and Bush Administrations left Fannie’s purpose for existence in question.

The lobby for the Wall Street subprime securitizers became aggressive in seeking abolition Fannie arguing that the unregulated mortgage securities industry could do the job and that Fannie’s implied federal guarantee against failure (which has since become explicit) amounted to an unnecessary government expense and an unfair business advantage conferred on it by the government.

Fannie responded by trying to prove that it too could be a big-time subprime lender and book a lot of low-income and minority loans.  One of Fannie’s first forays into the field was to buy a bunch of C grade mobile home loans originated by the infamous subprime and predatory lender Conseco.  These loans were total junk and bound to fail.  When Fannie purchased them we were shocked and appalled.  What is the purpose, we asked, of a GSE who was securitizing loans that among the worst in the industry?  This move represented the complete breakdown of lending with a public purpose at Fannie.

Fact #6:  Fannie collapsed due to a complex string of events.  The core factor was the radical realignment of mortgage markets brought about by disastrous deregulation.  Among the least of the causes of Fannie’s problems were the affordable housing goals.

Fannie was backed into buying subprime loans by its own selfish and shortsighted desire to maintain market share in a newly deregulated mortgage environment.  Market share equals profits and executive bonuses.

Low-income and minority lending were merely public relations cover for going after market share by entering the subprime market.  Free market apologists for this disaster and former Fannie executive are both trying to spin Fannie’s failure on the affordable housing goal straw man and some reporters and increasingly the public are falling for it.