Shaky Ground: What Investors
Can Learn from the Strange Saga
of Fannie and Freddie
Bethany McLean
Contributing Editor
Vanity Fair
Chicago
Many observers believe that the policies of Fannie Mae and Freddie Mac led to the financial crisis of 2008–2009,
and many would like to remove them from the US mortgage market. Although Fannie and Freddie were not
blameless, their policies were less destructive than those of private lenders. Unless the US housing market is
thoroughly reformed, Fannie and Freddie will remain essential to its existence.
T
he Federal National Mortgage Association
(Fannie Mae) and the Federal Home Loan
Mortgage Corporation (Freddie Mac) are immensely
important companies. They own or guarantee more
than $5 trillion in US mortgage debt; together they
are the largest financial institution in the world. At
one time, they were also great investments, as many
investors can attest. By the end of the 1990s, Fannie
Mae (established in 1938) was the United States’
third-largest company ranked by assets, and Freddie
Mac (established in 1970) was close behind. They
were ranked first and second on Fortune’s list of the
most profitable companies per employee.
Fannie and Freddie are part of the hidden
machinery that makes the United States work and that
everyone tends to take for granted until it malfunctions. They should matter to everyone in the United
States, not only because they help determine the price
and availability of mortgage credit—and even help
dictate the price of homes—but also because housing makes up some 15%–20% of US GDP. Marriner
Eccles, chairman of the Federal Reserve Board from
1934 to 1948, said that President Franklin Roosevelt,
in his New Deal programs, understood that housing
“would act as the wheel within the wheel to move the
whole economic engine.”1 It still does.
I will discuss the nature and history of these
two institutions, the resentment and animosity (both
deserved and not) with which they are perceived,
1Marriner
S. Eccles, Beckoning Frontiers: Public and Personal
Recollections (New York: Alfred A. Knopf, 1951): 145–146.
the role they did and did not play in the 2008–09
financial crisis, the need for reform in US housing
policy, the factors working against such reform, and
the reasons that Fannie Mae and Freddie Mac (no
matter how disliked) remain a necessary element in
the US housing market.
Recent History
Jim Johnson, a Washington, DC, power broker who
served as Fannie Mae’s CEO from 1991 to 1998,
was once described by politician Harold Ickes as
the “chairman of the universe,”2 so powerful did
the institution appear to outsiders. Johnson himself
used to paraphrase the famous General Motors quote
in this way: “What’s good for American housing is
good for Fannie Mae.”3
When Johnson stepped down in 1998, Franklin
Delano Raines became Fannie’s CEO. Raines grew
up in Seattle, where his father was a custodian for the
city parks department and his mother was a cleaning woman for Boeing, a company on whose board
Raines would later serve. Raines was a star student
who earned a scholarship to Harvard University,
was named a Rhodes Scholar, interned at the White
House during the Nixon administration, and served
in the Carter administration before leaving for Lazard
Frères. He later returned to Washington, DC, to run the
Office of Management and Budget under President Bill
Clinton and received enormous credit for balancing the
2Lloyd Grove, “The Big Chair,” Washington Post (27 March 1998).
This presentation comes from the Equity Research and Valuation conference held in Philadelphia on 17–18 November 2015 in partnership with
CFA Society Philadelphia.
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3Bethany
McLean, “Fannie Mae’s Last Stand,” Vanity Fair
(February 2009): www.vanityfair.com/news/2009/02/
fannie-and-freddie200902.
First Quarter 2016 • 27
CFA Institute Conference Proceedings Quarterly
budget. There was even talk that he might one day be
the first black president of the United States.
Both Raines and Johnson were architects of what
former Congressman Jim Leach once described as
the greatest, most sophisticated lobbying operation
in the history of modern finance. A congressional
source once said, “Fannie has this grandmotherly
image, but they will castrate you, decapitate you,
tie you up and throw you in the Potomac. They are
absolutely ruthless.”4
Facing Increased Scrutiny. Both Fannie and
Freddie started receiving additional attention in
2004, partly as a result of an apparent accounting
scandal.5 Fannie and Freddie have always been controversial because they are a weird mix of public
and private. They are called “government-sponsored
enterprises” (GSEs). Many people have questioned
the purpose of a GSE in a free market economy; why
should the government have its thumb on the scales
of mortgage credit?
Fannie and Freddie are like unimaginably gigantic mythical beasts but with shareholders and a board
of directors, just like normal companies. They have
a responsibility to help the flow of housing credit in
the form of affordable housing goals, and they are
required to buy a certain amount of loans made to
middle- and lower-income people. The two companies are very much insurance companies. They
purchase loans from other lenders, put a stamp on
them that homeowners will pay, package the loans
into securities, and sell them off. Back in 2005, Fannie
Mae’s executives argued that their enemies wanted
to turn Fannie’s operations over to the big banks,
along with its profits.
The Financial Crisis. As most people know,
the US government took over Fannie and Freddie
during the 2008 financial crisis and put them into a
state of conservatorship. In this state, they were (and
continue to be) supported by a line of credit from
the US Treasury and effectively run by a government agency. Henry Paulson, the secretary of the
Treasury at the time, referred to the conservatorship
as a “time-out.” It was supposed to be temporary
while the government assessed how to resolve the
inherent problems in these two companies.
Some in government were even discussing a
reassessment of the role that government has long
played in promoting and supporting the US “cult”
of homeownership. Had that occurred, it might have
been the silver lining of the financial crisis. But now,
4 Owen Ullman, “Crony Capitalism: American Style,” International
Economy (July/August 1999): 6–11.
5Bethany
McLean and Ryan Oliver, “The Fall of Fannie Mae,”
Fortune (25 January 2005): 122–140.
28 • First Quarter 2016
more than seven years after the takeover of Fannie
and Freddie, little has changed.
The big banks have at least superficially paid
back the money the government gave them during
the crisis. General Motors and Chrysler are out of
bankruptcy. But Fannie and Freddie are still in conservatorship, and there is no plan for getting them
out. Furthermore, about 80% of mortgages made
today are guaranteed by a government agency,
which is a far greater percentage than before the
financial crisis.
Mervyn King, the former governor of the Bank of
England, once noted that most countries have socialized health care and a free market for mortgages
but that the United States does not. In the United
States, these roles are exactly reversed. Although
homes are the most domestic asset possible, Fannie
and Freddie are, in effect, global entities. Through
the securities they issue—more than $5 trillion of
mortgage-backed securities (MBS)—foreign investors, including China’s central bank, finance the
purchases of US homes.
Having a savior in China financing the purchase
of a home in Kansas may appear to be a good thing,
an example of globalization that has worked. But such
globalization can tie the hands of the government.
Resentment of Fannie and
Freddie
Fannie Mae has been around since the Great
Depression. But throughout its history, a certain
number of people (in and out of government) have
wanted Fannie and Freddie dead. Bill Maloney,
Fannie Mae’s chief lobbyist, used to call it the “vampire issue” because as powerful as Fannie is and as
much as it lobbied, it has never been able to squelch
people’s desire to see it shut down.
Part of this antagonism arises from the private
mortgage industry, in which many participants have
an ideological opposition to GSEs. Another part
arises from economists—including liberal economists—who generally view hidden subsidies as a
bad thing and have never been entirely comfortable
with the idea of GSEs.
Political Entanglements. One visceral reason
that people hate these two GSEs is a deep resentment of Fannie and Freddie’s entanglement with
politics. Political players have come to these two
companies to get rich. The sheer volume of money
that their executives have made is mind-boggling.
And the list of those who have lobbied or worked
for Fannie and Freddie mirrors a “who’s who” of
Washington, DC—Tom Donilon, President Barack
Obama’s national security administrator; Aaron
Christensen, chief of staff to former Speaker of the
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Shaky Ground
House of Representatives Newt Gingrich; Newt
Gingrich himself; right-wing godfather Grover
Norquist; and conservative political activist Ralph
Reed. The list goes on and on.
The Big Fat Gap. Another reason to resent
Fannie and Freddie arose precisely from the thing
that made them such a great investment during the
1990s. By the late 1990s, the substantial profits that
Fannie and Freddie were reporting came not only
from the traditional business of stamping mortgages
with a guarantee, collecting a fee, and packaging
them into securities but also increasingly from
Fannie and Freddie’s ability to buy their own MBS
and hold them on their balance sheets. Because of
their special position, they could make money on the
difference between the higher yield of the mortgage
and their cost of funds; the two companies had an
implicit guarantee. Although the US government
disavowed that it stood behind the two companies,
most people believed that if times got hard enough,
the government would bail Fannie and Freddie out.
Alan Greenspan—the very powerful chairman
of the Federal Reserve in the 1990s—referred to the
spread between the cost of funds and the higher
yield of the mortgages the two companies held as
“the big fat gap,” and he was enraged by it.6 The
GSEs’ combined portfolios of mortgage holdings
would peak in 2008 at a stunning $1.6 trillion. To put
that in context, the entire national debt at the end of
2007 stood at approximately $9 trillion.
The political power amassed by Fannie and
Freddie backfired in many ways. It created an animosity toward the companies that continues to this
day. Fannie and Freddie seem to have pushed around
so many people in their prime that people now want
to get even. The resentment has a very personal edge.
Gene Sperling, an economist who served in both
the Clinton and Obama administrations, considers
himself a progressive, but he has marveled at how
Fannie and Freddie have brought out the conservative in him. He was appalled that two companies
completely dependent on the US government for
their profit would spend so much time and money
lobbying that very same government.
In 2004, the resentment crystallized in the
accounting scandals at Fannie and Freddie. In retrospect, both of the accounting scandals are very
odd. In Freddie’s case, the problem was that it was
understating, not overstating, earnings. Fannie was
supposedly overstating earnings. Fannie’s regulator at the time called it a “government-sponsored
Enron,” and the scandal led to the ejection of Raines
as CEO and Tim Howard as chief financial officer.
But when Fannie Mae’s earnings restatement was
completed, shareholders’ equity actually increased.
Both Raines and Howard ended up settling the
charges that their regulator brought against them.
Neither man admitted guilt, and most of their combined $31 million settlement consisted of worthless
stock options that the regulator valued at their grant
prices rather than at the actual stock price at the time
in order to arrive at a settlement that sounded impressive. In The Mortgage Wars, Howard wrote, “In an ironic
way it was a fitting climax. A suit that began with our
regulator accusing us of deliberate fraud ended with
our regulator putting a deliberately fraudulent value
on what we paid to settle it” (p. 267).7
As a result of the settlement, both the SEC and
the US Justice Department quietly dropped their
investigations into wrongdoing at Fannie. And in
September 2012, when no one was paying attention
any longer, after eight years and 67 million pages
of documents and testimony from more than 150
witnesses, a civil suit against Raines, Howard, and
another executive ended with a federal judge dismissing all charges. He concluded there was no
evidence that Raines and Howard had ever tried to
deceive anyone.
Be very careful of investments when politics is
involved.
The Financial Crisis
Less than Principled Opposition. Although
some of the opposition to Fannie and Freddie is principled, much of it is not. The US mortgage market is
one of the largest markets in the world. An enormous
amount of money is at stake. Much of the opposition
to Fannie and Freddie has arisen from private sector
players who were enraged that such a substantial
portion of the profits should go to these two GSEs.
From time to time, bank executives at large banks and
others have referred to Fannie and Freddie as “the
hidden secret of the financial crisis,” as if the financial
crisis had occurred because Fannie and Freddie were
pursuing their affordable housing goals and giving
mortgages to people who could not afford them. This
narrative appeals to many people, perhaps because it
simplifies the financial crisis and offers the illusion of
clarity. Furthermore, if the entire financial crisis can be
blamed on government interference with the markets,
then the solution is obvious: Get government out of
the markets. And get rid of government regulation
because it is also detrimental to the markets.
6Ari
7Timothy
Weinberg, “Greenspan Concerned by Freddie, Fannie,”
Forbes (24 February 2004): www.forbes.com/2004/02/24/cx_
aw_0224greenspan.html.
© 2016 CFA Institute. All rights reserved. • cfapubs.org
Howard, The Mortgage Wars: Inside Fannie Mae, BigMoney Politics, and the Collapse of the American Dream (New York:
McGraw-Hill Education, 2013).
First Quarter 2016 • 29
CFA Institute Conference Proceedings Quarterly
What Did Not Cause the Crisis. Whether
regulation makes things better or worse is a worthy topic for an entirely separate discussion. But
the argument that Fannie Mae and Freddie Mac
caused the financial crisis because of their pursuit
of affordable housing goals cannot be true. As typically stated, this argument asserts that the weakness
of the GSEs’ holdings of MBS sparked fear in the
market, which then led to the crisis. But one of the
largest subprime private lenders—New Century—
was actually bankrupt in early April 2007, when
Fannie’s and Freddie’s stock prices were at a high
and no one had any indication there would be any
problems at Fannie and Freddie. So, it is difficult to
argue that loans backed by the government started
the conflagration. Furthermore, none of the losses
that almost took down the big banks—and did take
down AIG—came from GSE-backed loans. Because
Fannie and Freddie insured loans, they bore the
losses for the loans they backed on their own books.
The corollary to this argument is that the crisis is
the result of society encouraging homeownership for
people who cannot afford to own homes. Although
this sentiment is a common one, it is not true either.
Most of the risky loans that were made in the run-up
to the crisis—both subprime mortgages and Alt-A
securities that were packaged into securities—were
cash-out refinancings and purchases of investment
homes. After stripping out those two categories,
as few as 10% of mortgages are estimated to have
gone to first-time homebuyers. Homeownership
actually peaked in 2004, long before the worst two
and a half years of lending. Homeownership may
or may not be a good idea, but the crisis does not
settle the question. If risky loans had been limited
to first-time homebuyers, the financial crisis would
not have occurred.
Fannie and Freddie Take the Blame. Unfortunately, the theory that Fannie and Freddie
caused the financial crisis became the dominant narrative in Washington, DC. The damage was done. Even
people who had previously been on the side of the
GSEs now ran from them. Barney Frank, the former
Massachusetts congressman who was a long-time
supporter of Fannie and Freddie, said they should be
abolished. Paul Volcker, former Fed chairman, agreed.
No one in Washington, DC, would publicly support
the GSEs. They became pariahs. Under the terms of
conservatorship—and unlike the big banks—Fannie
and Freddie had to fire all of their lobbyists and they
were not allowed to speak up in their own defense,
write op-eds, or have employees attend conferences
to rebut the dominant narrative.
There is another reason Fannie and Freddie became
such pariahs—$187 billion. If people in the United States
know one thing about Fannie and Freddie, it is this
30 • First Quarter 2016
number. It is the amount that taxpayers purportedly had
to cough up to save Fannie and Freddie. I say “purportedly” because it is a made-up number.
Under the terms of conservatorship, the government obtained the right to take 79.9% of Fannie’s and
Freddie’s equity. Furthermore, Fannie and Freddie
had to pay a 10% dividend on any money that they
took from the Treasury. But they are required to draw
money from the Treasury based on their net worth,
and net worth is an accounting creation based not
only on losses today but also on estimated losses for
the future. So, Fannie and Freddie took these huge
draws from the Treasury based on the amount of
money they were expected to lose in the future. But
most of the losses never occurred.
Another $45 billion of Fannie’s and Freddie’s
bailout consisted of money that they had to draw
from the Treasury, only to pay the dividend directly
back to the Treasury. A former executive described
it as a payday lender situation, like borrowing from
a loan shark.
Ultimately, Fannie took $116 billion and Freddie
took $71 billion from the Treasury (i.e., $187 billion),
but an analysis performed on behalf of a major
investor has shown that almost all of the losses
were noncash charges. But when the government
took Fannie and Freddie over, it left outstanding
not only about 20% of the common stock trading
but also the preferred stock that the two companies
had sold in the run-up to the crisis. In a sense, the
government created its own problem. Big investors
who search for deep value investments began to buy
both the preferred and the common stock. After all,
if the companies were going to turn profitable again,
would that stock not be worth a lot of money when
the government ultimately restructured Fannie and
Freddie?
The So-Called Third Amendment. Fastforward to the sleepy August day in 2012 when the
government filed the so-called third amendment
(Third Amendment to Amended and Restated Senior
Preferred Stock Purchase Agreement) and changed
the rules of the game.
The third amendment cleared the way for the
Treasury to confiscate every single penny Fannie
and Freddie made instead of taking the originally
agreed-on 10% dividend, leaving the companies with
almost no capital cushion to weather any losses in
the future. Bruce Berkowitz, founder of Fairholme
Capital Management, likens it to a lender saying to
a borrower in the financial crisis, “I am going to take
80% of your home, which you will have to pay back
to me.” So, the borrower works and saves to repay
the 80%. Then the lender says, “Well, no, I am actually
going to take 100% of your home.”
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Shaky Ground
It is especially mind-boggling, considering that
the public believes that financial institutions need
more capital to be safer, that the US government
would force Fannie Mae and Freddie Mac—together,
the largest financial institution in the world—to
operate with almost no capital.
There is significant speculation about why the
third amendment was enacted. The government’s
response has always been that the two companies were
losing money and were not going to be able to pay
their dividends. But that is not so. It became obvious
from fairly early on that both companies were going
to become very profitable again. Thanks to their profits, the government was able to underreport federal
spending by a combined $178 billion in 2013 and 2014,
according to a Heritage Foundation paper.8
Not surprisingly, the investors who bought
Fannie and Freddie securities sued, and two dozen
lawsuits against the US government are now winding
their way through various courts. Perversely enough,
these investor lawsuits probably provide yet another
reason to destroy Fannie and Freddie because no one
wants to be responsible for a hedge fund or investor
payday, even if such a payday is justified.
Once again, be very careful of investments when
politics is involved.
No Plan to Reform Housing
Policy
If so many people want Fannie and Freddie gone,
why are they still here? One reason is found in the
extremely effective, incredibly durable, and debatably
unhealthy alliance of politicians, private industry, notfor-profit community organizations, and Fannie and
Freddie themselves—all of which have a stake in this
enormous enterprise that is the US mortgage market.
Some might call it the housing–industrial complex.
Difficulties Facing Reform. But more importantly, when talk turns to killing off Fannie and
Freddie, two thorny questions result. First, how does
the United States shut down the current system and
transition to a new one? Second, what will the new
system be?
Approximately $5 trillion in GSE-issued MBS is
now outstanding, and a good part of the MBS value
is in their liquidity. They trade like water. Any move
to shut down Fannie and Freddie would immediately
reduce the liquidity of these securities, thereby reducing their value, thereby sparking rage among the foreign holders of these securities and potentially affecting
8Romina
Boccia, “Revealing Fannie Mae’s and Freddie Mac’s
Budget Costs: A Step toward GSE Elimination,” Heritage
Foundation, no. 2892 (16 March 2014).
© 2016 CFA Institute. All rights reserved. • cfapubs.org
the Treasury market. Shutting down and transitioning
to a new system would be very tricky.
Furthermore, something would need to replace
Fannie and Freddie. After all, mortgage credit risk is
an unappealing investment. Even in the boom times,
investors did not want it and many were not allowed
to take it. The majority of investors do not have the
resources to evaluate the mortgage credit risk represented by millions of US homeowners, which is why
the entire system of tranching securities and creating
AAA slices was developed—so investors could buy
into that portion of the mortgage market that was
supposedly free of credit risk, which of course did
not work out so well.
The Value of GSEs. Most observers agree that
the 30-year fixed-rate, fully prepayable mortgage
would not exist without a government backstop.
Investors do not want the risk. Without the government, not much would change for the very wealthy,
but most analysts think that a great swath of lowerand middle-class homebuyers would probably be
limited to 5- to 15-year mortgages with floating
rates—rates that would vary dramatically depending on income and geography. Mortgage credit
would be hard to come by during times of stress in
the market, and home prices would likely fall.
When an affordable housing crisis is in the
works, when even the Wall Street Journal is publishing editorials about the squeeze on the middle class,
and when income inequality is the topic of the day
in the United States, it is hard to believe that politicians are going to push for the type of market that
would exist without government-backed mortgages,
no matter how theoretically appealing it might be.
In addition, a good private market solution is an
illusion. Any options that do not include a Fannie
Mae and a Freddie Mac would entrench the big
banks in mortgage finance. But the big banks were
bailed out in 2008. In fact, most investors would take
their bailouts over the GSE bailouts. Those bailouts
made it quite clear who the favorites were.
The Dodd–Frank Act supposedly fixed the issue
of too-big-to-fail companies, but if the big banks control the nation’s mortgage market, they will certainly
not be allowed to fail in the next crisis, which means
that they are, in essence, GSEs.
As ugly as Fannie and Freddie’s political behavior was at the height of their success, an even uglier
situation is possible. Envision a big bank executive
in a congressman’s office. The congressman says,
“We need to boost the economy in my state.” The
big banker replies, “Sure. I will loosen the terms of
mortgage credit in your state, but I need you to go
easy on the derivatives legislation that is currently
moving through Congress.” This scenario makes the
old Fannie and Freddie look almost pure.
First Quarter 2016 • 31
CFA Institute Conference Proceedings Quarterly
The silver lining of the financial crisis is the
opportunity it provided to reform US housing finance
policy, debate the mortgage interest tax deduction,
question the use of a house as a credit card, examine
whether cash-out refinancings should be treated in
the same way that mortgages are treated, and perhaps
encourage the rental market. Such discussions go well
beyond Fannie and Freddie. But now it appears that
nothing is going to be done. President Obama has
avoided the issue so far. The US presidential campaigns to date have said little of substance about the
economy.
Another Potential Crisis. In the meantime,
some argue that another crisis is brewing. Since 2008,
when Fannie and Freddie were put into conservatorship, the homeownership rate has plunged. During
the summer of 2015, the Census Bureau reported that
homeownership fell to 63.4%, which is the lowest
percentage in the United States in the past 48 years.
One blog calls the United States the “renter nation.”9
Some have argued that the homeownership rate
before the crisis was too high and that perhaps it is
still too high, which might be correct. But people still
have to put their heads down somewhere at night; if
they do not own a home or sleep on the street and we
have not yet developed collective bedding the way
9See
www.renternation.com.
32 • First Quarter 2016
we have developed collective car rides and collective
office space, then people have to go somewhere else.
Rents have been subtly rising since 2000, whereas
incomes have not kept pace, which is why some say
we may be facing a rental crisis.
The rational response to this potential problem is
to use the GSEs for their proper purpose—to support
homeownership for those who can afford it and to
support the development of affordable multifamily
housing. It would also be rational to put an end to the
government’s use of Fannie’s and Freddie’s profits
as a slush fund.
The fate of the GSEs and the US housing market is too important to be left to special interests
to decide behind closed doors in Washington, DC.
Starting a public discussion would be a meaningful
improvement over the current situation.
Conclusion
In a speech in the House of Commons in 1947, Winston
Churchill described democracy as “the worst form of
government except for all those other forms that have
been tried from time to time.” Similarly, the GSEs may
be the ugliest way possible of financing homeownership—except for all those other ways.
CE Qualified
Activity
0.5 CE credit
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Q&A: McLean
Question and Answer Session
Bethany McLean
Question: If we are not willing to get rid of the
30-year fixed-rate mortgage, is there any hope of
changing the structure of the GSEs?
McLean: Multiple alternatives are floating around
about ways to have a government backstop other than
Fannie and Freddie. The conversation can become a
philosophical debate about the role of government.
Most people agree that if a government backstop
does not exist, the 30-year fixed-rate mortgage will not
be available for most people, but we do not know that
for certain. Fannie Mae has been around for 80 years, so
we have no experience of a mortgage market without
it. Given the lack of interest in credit risk among most
large investors, the market is likely to be dramatically
different without a government backstop.
One possibility is to nationalize the system
around Fannie and Freddie. But those who believe
strongly in free markets are not likely to embrace
that idea. Besides, we have seen what happens to
Fannie’s and Freddie’s profits. It was proposed that
the profits be used to fund the highway infrastructure bill. Instead, they were used to fund the payroll tax credit by hiking guarantee fees. The cost of
mortgages being used as a political instrument that
can be raised when the government needs money
for one thing and reduced when the government
wants to adjust credit is not a very attractive idea. As
conflicted as Fannie’s and Freddie’s original structure was with their social mandate and significant
profits, it is questionable whether there is a better
way to do it.
We could make the GSEs like utilities. Raines
talked about a race to the bottom among financial
services companies when the market is going into
a bubble. They start to engage in riskier behavior to
keep up with everybody else. We certainly saw that
among the banks, the mortgage lenders, and Fannie
and Freddie in the run-up to the crisis. Perhaps the
structure of a utility or a cooperative would help prevent that behavior, along with some kind of countercyclical measures embedded in its regulation.
Question: Do any other countries have a template
for mortgage finance that might work in the United
States?
McLean: Many have said that the United States
is the only country other than Denmark that has
a 30-year fixed-rate mortgage. One suggestion is
to structure the housing market like Europe’s or
Canada’s. European governments are not involved
in the mortgage market because the banks finance
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mortgages through covered bonds. But Europe’s
banks are as much GSEs as Fannie and Freddie.
Europe had to bail out its banks in the financial crisis,
in part because the banks financed homeownership.
Another suggestion is to broaden the rental
market. Countries in Europe have many more rental
products than the United States. But countries in
Europe also have a much bigger social safety net than
the United States. Homeownership has traditionally been the way that the lower and middle class
have earned financial stability and been able to get
leverage to work in their favor. That purpose did
not work in the run-up to the crash, but it failed
for a very specific reason—the use of homes as a
credit card. The underlying failure was not that of
homeownership itself.
People who write about the financial crisis
sometimes trace it back to the Clinton administration, when Clinton began to push homeownership,
as if it were somehow a modern phenomenon.
Homeownership is engrained in the US psyche.
It goes back to the 1800s, when many believed
that a nation of landowners would be a stronger
nation. This belief certainly prevailed in the Great
Depression. To say that all of a sudden the United
States is going to become a nation of renters and get
homeownership out of its collective psyche would
require a bigger change than people realize.
Commentators often point to Canada’s big banks
as a system we might emulate. But the United States
is wary of big financial institutions. We fear their
power, so we do not have megabanks like Canada
does. Canada’s megabanks finance the homeownership market, and they did not need to be bailed out
in the crisis. Canada came through that just fine. But
every crisis is different, and institutions that do well
in one may do poorly in another.
Question: What do banks hope will happen?
McLean: Big banks are not uniform in their outlook. Some, like Wells Fargo, very much want the
GSEs destroyed and would like to control more of
the mortgage market.
Small banks, on the other hand, want Fannie and
Freddie kept alive because they fear that without
Fannie and Freddie to buy their mortgages, the big
banks would take over, which would be the end of
small banks and community bankers.
The Obama administration itself has been erratic
on the subject of private capital. On the one hand, it
has said repeatedly that it wants private capital to
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bear the risk of the mortgage market. On the other
hand, it has done everything it can to discourage
private capital from entering the mortgage market.
As a result, big banks say they want nothing to
do with mortgages made to people with less than
perfect credit. It is unprofitable, it is bad for their
reputation, and it can result in exorbitant fines.
Question: How would you describe the relationship between cash-out refinancings and helping
middle-class families buy a home for the first time?
McLean: Many market participants knew all along
about the relationship between homeownership and
credit creation. The interconnectedness was quite
deliberate.
In 2004, a New Century executive told Congress
that two-thirds of New Century’s loans were cashout refinancings. He said that people need such loans
to help pay their bills or go on vacation and that the
government needed companies like New Century
because they bring a lot more money to the government than GSEs. He said that the GSEs are very
stringent with their credit standards but the private
market is more relaxed and will loan people much
more money than the GSEs.
So, it was not a secret that most of these loans
were for cash-out refinancings and credit creation.
That paints a darker picture of the US economy
because it shows how much of it was driven by credit
creation, which is something that people do not want
to acknowledge. In fairness, it may not be as much of
an issue going forward because interest rates cannot
go much lower. Thus, the giant waves of refinancing
and cash-out refinancings that have been driven by
lower interest rates are probably at an end.
Nonetheless, this issue should be addressed.
If we are going to encourage homeownership, we
should not encourage loading homes with debt and
thus creating the danger that homeowners might
lose their homes.
Question: Do you see parallels between Fannie
and Freddie and the Enron scandal?
McLean: During Fannie’s big accounting scandal,
its regulator referred to Fannie and Freddie as a
government-sponsored Enron.
Arrogance and hubris have been the cause
of downfalls since classical times. Fannie’s and
Freddie’s executives—Fannie’s in particular—were
incredibly arrogant in the 1990s. They really did ride
roughshod over everyone in Washington, DC. Of
course, their existence depended on the government,
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and they knew that some in the government wanted
to shut them down, so it is no surprise that they lobbied aggressively. But the way they treated people
created many enemies.
Some companies are feared and admired; others
are feared and disliked. When companies are disliked
in their industry, it eventually becomes a problem.
Enron was disliked. Other companies in the industry thought of Enron and its executives as arrogant.
Dislike among a company’s peers is a useful warning
sign for investors; such dislike can eventually come
into play, and the end is always bitter and far more
severe than it might otherwise have been.
Looking back, I cannot see any particular rationale in the government’s treatment of various companies during the financial crisis. In fairness, the
government had no playbook. It was not like this sort
of crisis had happened before and everybody knew
what they were doing. But clearly, some companies
were liked and others were disliked, and that had
something to do with the very different treatment
they received during the crisis. Fannie Mae and
Freddie Mac were very disliked.
Question: Can you discuss the tax deduction for
mortgage interest and its effect on the US housing
market?
McLean: The tax deduction creates many wrong
incentives, but it is an untouchable item that reflects
the lobbying power of realtors and home builders.
It helps fairly wealthy people who do not need the
subsidy.
For government policy to encourage homeownership, it would need to encourage the buildup of
equity in a home instead of subsidizing the creation
of debt. The tax deduction for mortgage interest is
antithetical to the notion of homeownership, which
is one reason for thinking about homeownership
more creatively rather than focusing narrowly on
Fannie and Freddie.
We should think more clearly about the role of
government in the housing market. We should analyze the 30-year fixed-rate mortgage and determine
whether it makes sense. We should think about refinancings and the laws surrounding them.
But I see no appetite for a serious conversation
about these issues, and I fear that decisions will be
made once again in dark rooms by special interest
groups or by a court decision that forces a lurch in
housing policy that is not in anyone’s interest or is
determined in such a complex way that none of us will
understand the mousetrap until it snaps on our noses.
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