Meltdown Revisited

Mother Jones shoots and misses at Dave Brat on Fannie, Freddie

By Robert Romano

Formerly unknown congressional candidate Dave Brat has been in the headlines ever since he ousted soon-to-be former House Majority Leader Rep. Eric Cantor for Virginia’s 7^th Congressional District Republican nomination.

Now, Brat faces an even greater challenge in the general election. First up is taking on the left-wing political intelligentsia, which is attempting to eviscerate his election chances.

For example, writing for Mother Jones, Molly Redden and David Corn try to discredit Brat’s critique of government policies that led to the financial crisis.

“An economics professor at Randolph-Macon College in central Virginia, Brat frequently has repeated the conservative canard that Freddie Mac and Fannie Mae brought down the housing market by handling the vast majority of subprime mortgages,” write Redden and Corn, adding, “That is, he absolves Big Finance and the banks of responsibility for the financial crisis that triggered the recession.”

Redden and Corn are referring to Brat’s frequent refrain on the campaign trail that “Fannie and Freddie made two-thirds of all subprime mortgages.”

At this point, it is probably best to defer to American Enterprise Institute resident fellow Edward Pinto, former Fannie Mae executive vice president and chief credit officer, on this count. After all, he literally wrote the book on how Government Sponsored Enterprise (GSE), congressional, and Department of Housing and Urban Development (HUD) policies were among the primary causes in the build-up of hundreds of billions of dollars non-traditional mortgages that nearly crashed the global economy.

Now, even if one takes a broad view of “subprime” as “residential mortgages issued to high-risk borrowers, such as those with a history of late payments or bankruptcy,” as the Financial Times does, or simply, mortgages that are not prime, a better term would be Pinto’s non-traditional mortgages.

Also, it would be more accurate to say more than two-thirds of the crappy loans were Fannie, Freddie, the Federal Housing Administration (FHA), Federal Home Loan Bank, and Community Reinvestment Act (CRA) required loans.

Per Pinto’s forensic study: “As of June 30, 2008 over 70 percent of the 26.7 million NTMs with weak or high risk characteristics — 19.25 million loans – were owned or guaranteed by (a) Fannie Mae and Freddie Mac (11.9 million), (b) the Federal Housing Administration and other federal agencies (4.8 million); (c) Federal Home Loan Bank (FHLB) investments in Alt-A and Subprime Private MBS (0.3 million) or (d) banks and other lenders originating loans pursuant to CRA requirements and HUD‘s Best Practices program (2.2 million, net of CRA loans already accounted for in (a) and (b). These numbers suggest that government policies and requirements were the source of the loans with weak or high risk characteristics, and thus the cause of the financial crisis.”

Those quibbles aside, Brat is pretty much right. The federal government was responsible for more than two-thirds of the risky mortgages that were made in the bubble.

Adding to the trouble, the GSEs were undercapitalized as a matter of policy, and enabling them to lead the market in low-income borrowing, according to Pinto: “The GSEs only needed $900 in capital behind a $200,000 mortgage they guaranteed — many of which by 2004-2007 had no borrower downpayment. In order for the private sector to compete with Fannie and Freddie, it needed to find ways to increase leverage.”

When Americans for Limited Government reached out to Pinto in 2010 about a draft version of his forensic study, he told us that the GSEs were driving the market for non-traditional mortgages and that the “market response was: if it’s okay with Fannie and Freddie (the de facto standards setters) it must be okay for us.”

The build up by Fannie and Freddie was deadly, would have never been possible without HUD mismanagement, and had unquestionably negative feedback throughout mortgage markets, Pinto notes: “HUD’s policy of continually and disproportionately increasing the GSEs’ goals for low- and very-low income borrowers led to further loosening of lending standards causing most industry participants to reach further down the demand curve and originate even more NTMs. As prices rose at a faster pace, an affordability gap developed, leading to further increases in leverage and home prices. Once the price boom slowed, loan defaults on NTMs quickly increased leading to a freeze-up of the private MBS market. A broad collapse of home prices followed.”

Together with the HUD and the FHA, Fannie and Freddie helped to cause the crisis by weakening underwriting standards, lowering down payments, and generally degrading the quality of credit in both government and private backed loans.  Also, because of the implicit backing of taxpayers, the GSE-issued securities were automatically granted AAA bond ratings, and the Fannie and Freddie were even able to misrepresent the quality of mortgages that underlined those securities.

As if that was not bad enough, Fannie and Freddie crafted a marketing plan that promised a higher rate of return than treasuries, but with the same risk associated with a taxpayer guarantee.

It was that implicit guarantee that enabled the GSEs to sell some $4.7 trillion of mortgage-backed securities, $1.5 trillion of which were sold overseas to investors, as reported by the New York Times. As more securities were sold, Fannie and Freddie bought more mortgages and bundled them into securities. As a direct result, Fannie and Freddie were able to acquire about half of all mortgages as of July 2008.

By 2008, Fannie and Freddie held $1.835 trillion in higher-risk mortgages and mortgage-backed securities: $1.646 trillion, were GSE-issued mortgage-backed securities, and $189 billion of subprime and Alt-A private mortgage-backed securities.

Brat is correct to lay the crisis largely at the feet of Fannie and Freddie. They, along with HUD, FHA, and Congress were the ones that loosened the underwriting standards. Private sector leverage was largely a response to what Fannie and Freddie were doing in the market.

To see which institutions had the larger role to play, just look at the size of the bailouts. To date, the Federal Reserve has bought back more than $1.6 trillion of mortgage backed securities (MBS) that were issued by the GSEs, including Fannie, Freddie, and also Ginnie Mae (which guarantees FHA and VA loans), according to the 2010 Federal Reserve audit of the MBS purchase program. In addition, the GSEs received $187 billion directly from taxpayers.

Therefore, the GSEs were responsible for approximately $1.8 trillion of the crisis. Comparatively, AIG needed an infusion of $182 billion of loans from the Federal Reserve and TARP for its role in insuring subprime and other risky loans against default. The Bear Stearns deal was $25 billion. Another $289 billion in TARP loans were made to affected institutions, too. So, on a bailout scale, $1.8 trillion was spent on GSEs in direct bailouts and about $500 billion was lent to the private sector. More than 3 to 1.

The difference is the private sector paid back their emergency loans. The $1.8 trillion spent on Fannie and Freddie was a direct subsidy from the Fed and from Congress. How it will be recouped, for example, if the Fed will simply hold the mortgages to maturity, transmitting interest earned to the Treasury, or the securities are sold to private sector actors, remains to be seen.

But on Brat’s primary contention, yes, government policies, including the GSEs, were responsible for 72 percent of the risky lending. Private institutions on their own accounted for 28 percent.

Brat was not absolving anyone, but he could be more specific — perhaps just include Ginnie in the statement “Fannie and Freddie made two-thirds of all subprime mortgages” — but the general idea that the government was responsible for the vast majority of the risky lending is spot on accurate.

Robert Romano is the senior editor of Americans for Limited Government. 

Source: http://netrightdaily.com/2014/06/mother-jones-shoots-misses-dave-brat-fannie-freddie/?utm_source=WhatCounts+Publicaster+Edition&utm_medium=email&utm_campaign=Liberals+Wrong+about+Dave+Brat+on+Fannie%2c+Freddie&utm_content=Mother+Jones+shoots+and+misses+at+Dave+Brat+on+Fannie%2c+Freddie%0d+

Read more at NetRightDaily.com: http://netrightdaily.com/2014/06/mother-jones-shoots-misses-dave-brat-fannie-freddie/#ixzz34WdMIvXQ

Comments

This still isn’t fixed.  Dodd-Frank codified bailouts into “wind-downs” (same thing), the Community Reinvestment Act was not repealed and HUD rules were not removed.  These legislative action should be taken, otherwise, we have the same extortion-ridden bad laws and regulations in force.

Liberals will want us to forget about this, but we can’t.  Unless we rip this crap out of the regulations, it will happen again, except the Fed will end up buying all the toxic assets, again. Congress needs to get the government out of the lending business for good.

Norb Leahy, Dunwoody GA Tea Party Leader