Did Fannie and Freddie Get a Slap on the Wrist?

Peter Wallison's 1-person Republican dissent from the FCIC complains that the report is not tough enough on Fannie Mae and Freddie Mac.

Let’s face it: You won’t read every page of the Financial Crisis Inquiry Commission report. But FrumForum will, over the next days. So let’s proceed together, page by page, identifying the key points.

Click here to read the entire series.

Peter Wallison's 1-person Republican dissent from the FCIC complains that the report is not tough enough on Fannie Mae and Freddie Mac. Yet the report makes a lot of tough points about the two government sponsored enterprises.  The report notes that the implied federal subsidy to Fannie and Freddie amounted to some $122 billion.

It links this huge subsidy to the huge profits earned by the two enterprises: returns on equity in the 1990s of 26% for Fannie and 39% for Freddie.

It points out the crazy risks the two enterprises were running: In 2000, they supported more than $2 trillion of loans with only $35.7 billion of shareholder equity.

And it draws attention to the role of lobbying and donations in sustaining the whole mess. (42)

Yet if critics of Fannie & Freddie want to suggest that the market for securitized mortgage would have been more stable if only it had been left as the domain of private-sector banks, the report contradicts that assertion too over pages 43-49.

Securitization is out of of fashion these days. The FCIC report has hard things to say about securitization over 43-45. It quotes former Federal Reserve governor Larry Lindsey:

"Securitization “was diversifying the risk,” said Lindsey, the former Fed governor. “But it wasn’t reducing the risk. . . . You as an individual can diversify your risk. The sys- tem as a whole, though, cannot reduce the risk. And that’s where the confusion lies."

But diversifying risks is no small thing! Before 1990, mortgage lending in the United States was dominated by the savings and loan industry. The S&Ls were local institutions, sensitive to local market conditions. If times were tough in California, and fewer deposits were made into California S&Ls, then fewer mortgages were written in California. (Here is the origin of one mistake  that would lead so many securitizers astray: the assumption that local mortgage markets could never slump all at the same time. Before securitization that was true. But securitization rendered the assumption obsolete, by creating for the first time a national market for mortgage purchasing. That would have been a good thing, if investors had appreciated that this new development rendered obsolete their old assumption that mortgage markets were inherently local markets. As so often, a financial innovation eliminated the market inefficiency which had initially made the innovation lucrative. See junk bonds, history of.

More to come...