The Role of Fannie & Freddie
A very good description of Fannie/Freddie, via Doug Diamond and Anil Kashyap, posting at the Freakonomics blog:
"The Fannie and Freddie situation was a result of their unique roles in the economy. They had been set up to support the housing market. They helped guarantee mortgages (provided they met certain standards), and were able to fund these guarantees by issuing their own debt, which was in turn tacitly backed by the government. The government guarantees allowed Fannie and Freddie to take on far more debt than a normal company. In principle, they were also supposed to use the government guarantee to reduce the mortgage cost to the homeowners, but the Fed and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits and squeeze the private sector out of the “conforming” mortgage market. Regardless, many firms and foreign governments considered the debt of Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly.
Fannie and Freddie were weakly supervised and strayed from the core mission. They began using their subsidized financing to buy mortgage-backed securities which were backed by pools of mortgages that did not meet their usual standards. Over the last year, it became clear that their thin capital was not enough to cover the losses on these subprime mortgages. The massive amount of diffusely held debt would have caused collapses everywhere if it was defaulted upon; so the Treasury announced that it would explicitly guarantee the debt.
But once the debt was guaranteed to be secure (and the government would wipe out shareholders if it carried through with the guarantee), no self-interested investor was willing to supply more equity to help buffer the losses. Hence, the Treasury ended up taking them over."
That's about as cogent an explanation as I have come across . . .
And to repeat what I have written ad nauseum, Fannie/Freddie were cogs in the great housing mess, but they were not the proximate cause of either the boom or bust, or the eventual credit collapse.
>
Source:
Diamond and Kashyap on the Recent Financial Upheavals
Steven D. Levitt
Freakonomics, September 18, 2008, 10:04 am
http://freakonomics.blogs.nytimes.com/2008/09/18/diamond-and-kashyap-on-the-recent-financial-upheavals/
Sunday, October 19, 2008 | 03:30 PM | Permalink
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It is stuff like this that makes me want to vomit on our politicians in Washington - they all knew this crap was happening years ago, but no one fixed it. I know it is childish to even ask the question but is there really no virtue in our nations capital??? No wonder Christ said let the children come to me.
Posted by: ConcernedCitizen | Oct 19, 2008 4:46:06 PM
The "big picture" lesson in the whole GSE mess is that it's better to make subsidies explicit. If a government wants to support homeownership, just cut a check to the beneficiary.
Posted by: Estragon | Oct 19, 2008 4:46:53 PM
enough already with all this bullshit about what happened and why and how. this is all you need to know.
http://www.newsoftheworld.co.uk/news/article43510.ece
Posted by: taxman | Oct 19, 2008 4:57:25 PM
did he describe FNM & FRE or the TARP program?
"They had been set up to support the housing market.
...were able to fund these guarantees by issuing their own debt, which was in turn backed by the government. The government guarantees allowed {the TARP} to take on far more debt than a normal company.
In principle, they were also supposed to use the government guarantee to reduce the mortgage cost to the homeowners...
{The TARP} was weakly supervised and strayed from the core mission. They began using their subsidized financing to buy mortgage-backed securities which were backed by pools of mortgages that did not meet their usual standards."
Posted by: m3 | Oct 19, 2008 5:17:33 PM
The birth of the bailout: http://www.youtube.com/watch?v=dk47saogI8o&feature=related
Posted by: Winston Munn | Oct 19, 2008 5:27:16 PM
trouble signs at ING
http://www.marketwarnings.com/2008/10/ing-and-financial-crisis-credit-crunch.html
Posted by: pitu | Oct 19, 2008 5:37:04 PM
you got the ad nauseum right....
Posted by: Patrick Neid | Oct 19, 2008 5:50:37 PM
Fannie/Freddie were cogs in the great housing mess, but they were not the proximate cause of either the boom or bust, or the eventual credit collapse.
No, of course not. To think otherwise would be so intolerant, racist and non-PC. Only NRA member or tobacco smoker could think that. We cannot possible accept that they are arguing in good faith, could we?
Lets call them names!
~~~
BR: Only is they are asstards.
Posted by: mik | Oct 19, 2008 6:11:50 PM
mik,
Why don't you support the idea with facts that fannie and freddie are a cause of the Bush depression rather than dissembling about main street Wassilla?
Posted by: ilsm | Oct 19, 2008 6:24:16 PM
http://news.yahoo.com/s/ap/20081019/ap_on_bi_ge/the_influence_game_housing
"Freddie Mac secretly paid a Republican consulting firm $2 million to kill legislation that would have regulated and trimmed the mortgage finance giant and its sister company, Fannie Mae, three years before the government took control to prevent their collapse.
In the cross hairs of the campaign carried out by DCI of Washington were Republican senators and a regulatory overhaul bill sponsored by Sen. Chuck Hagel, R-Neb. DCI's chief executive is Doug Goodyear, whom John McCain's campaign later hired to manage the GOP convention in September."
Posted by: babycondor | Oct 19, 2008 6:50:55 PM
"They had been set up to support the housing market."
Had been? They still are. Why is our government still taking bad debt and adding it onto their balance sheets?
Posted by: Pat G. | Oct 19, 2008 8:28:25 PM
Don't forget that FanFred's own Chief Risk Officer (a hilarious position, can you say Court Jester) Warned the CEO multiple times they were on the path to destruction as far back as 2004 I believe.
Why didn't the CEO listen to his own CRO? Was he just plain stupid or pressured elsewhere to follow the path to oblivion?
Posted by: oulous | Oct 19, 2008 8:28:57 PM
"Had been? They still are. Why is our government still taking bad debt and adding it onto their balance sheets?"
As far as I can tell, they have been doing this for the last couple of years. The Bush administration has been using them as a dumping ground for securities from private banks as a way of trying to stave off a meltdown.
Posted by: OhNoNotAgain | Oct 19, 2008 10:08:41 PM
"trouble signs at ING"
Something has to go. This weekend was awful quiet, in a calm before the storm kind of way.
I can't imagine that Paulson's 250B$ is going to save anything other than Goldman/Sachs.
Posted by: Blackhalo | Oct 20, 2008 12:06:22 AM
why does everyone try to simplfy this into one cause, and thus discount everything from having any sort of impact. It seems like very simple minded thinking to me. why can't many factors have played a role, with prolonged, artificially low interest rates being the main fuel? It gauls me that fannie/fredie have been horrible run (presideing over multibillion dollar accounting scandal, etc) and have turned out to be nothing but a political patronage mill with a whole host's of congressional enablers.
Posted by: pkut | Oct 20, 2008 12:54:15 AM
There's certainly enough blame to go around for the on-going financial mess. Chris Cox, as head of the SEC, should have taken action against 30-40 to 1 leveraging but didn't.
And the Dems should have stopped using Fannie/Freddie as a piggy bank to advance their social agendas.
Check out the Dems fighting against reform in '04...
http://thepoliticalpage.wordpress.com/2008/10/02/democrats-refuse-to-reform-fanniefreddie-video/
Posted by: thepoliticalpage | Oct 20, 2008 1:08:54 AM
Then answer one question - if Fannie and Freddie did NOT have the implicit Gov't backing to fund, at a much cheaper rate, the demand for the lower credit quality mortgages, would as much debt have been floated. That is, if F&F were not the buyers of such large amounts, would the lower demand have slowed the issuance of such debt and slowed the supply of sub prime mortgages?
If F&F did not provide that great sucking sound for sub-prime collateralized mortgages less would have been issued. Much less as their gov't backed ability to turn junk into Aaa was what kept the originators capital flow possible to issue yet more crappy mortgages.
F&F was the linch-pin as the market would have not found a place for so much junk paper without demanding much higher yields thereby driving up the costs of sub prime to the borrower, decreasing their ability to borrow.
F&F created demand and a magical wand to turn junk into Aaa thereby greatly increasing the ability of the market to supply more funds to issue more and more sub-prime junk.
This is a very simple concept I guess you are having a difficult time grasping.
Posted by: Robert NYC | Oct 20, 2008 9:51:38 AM
"F&F created demand and a magical wand to turn junk into Aaa"
Please explain how this happened. My understanding is that F&F bought securities that were already AAA-rated, and the ratings were provided by the ratings agencies.
Posted by: OhNoNotAgain | Oct 20, 2008 1:38:23 PM
«Treasury announced that it would explicitly guarantee the debt.»
As far as I know this has never actually been said or written by the Treasury. They have been very careful to avoid saying that, and the result has been massive selloff of GSE debt for buying actual Treasury paper.
Posted by: Blissex | Oct 20, 2008 4:19:52 PM
«This is a very simple concept I guess you are having a difficult time grasping.»
Any "asstard" can make up concepts that are difficult to grasp, especially concepts that are based based on fantasy rather than numbers.
The undisputable numbers show that the GSE subprime and other problems are relatively small percentwise, much lower than those of fully private banks, and that the reason why the GSEs had trouble was not that they have had particularly large losses, but that they had even less capital and higher gearing than the investment banks, in order to give an even larger return on investment to their shareholders and bonuses to their executives.
The GSEs have been indeed a remarkable example of Republican (and Democrat) corporate fascism, where private investors and executives have been earning amazing returns thansk to government support. Just like Bear Stearns, Lehman, JPM, GS, who have been able to also have enormous gearing ratios and have been bailed out with LOTS OF FREE MONEY from ordinary citizens.
Posted by: Blissex | Oct 20, 2008 4:41:11 PM
Please vote for Bob Barr, the Libertarian Party's candidate for president.
Only Bob Barr opposed the bailout and the use of US government money to invest in banks, which is Socialism.
Both McCain and Obama were in favor of the bailout and the use of US government funds to buy equity in large banks.
And Bob Barr opposes Fannie and Freddie even more than McCain. Bob Barr wants to shut down Fannie and Freddie.
With the election probably lost by Republicans, it is a good time to vote on principle. Send a message to both parties that we oppose the bailout and oppose Fannie and Freddie!
Please vote for Bob Barr for President on Election Day.
Posted by: d | Oct 20, 2008 5:17:07 PM
Please vote for Bob Barr, the Libertarian Party's candidate for president.
Only Bob Barr opposed the bailout and the use of US government money to invest in banks, which is Socialism.
Both McCain and Obama were in favor of the bailout and the use of US government funds to buy equity in large banks.
And Bob Barr opposes Fannie and Freddie even more than McCain. Bob Barr wants to shut down Fannie and Freddie.
With the election probably lost by Republicans, it is a good time to vote on principle. Send a message to both parties that we oppose the bailout and oppose Fannie and Freddie!
Please vote for Bob Barr for President on Election Day.
Posted by: d | Oct 20, 2008 5:17:15 PM
Rack up huge profits and squeeze the private sector out are mutually exclusive. Now they did make huge profits, but not so huge the private sector entertained entering, which is to say, not huge at all.
Posted by: Lord | Oct 20, 2008 5:54:49 PM
Lets call them names!
~~~
BR: Only is they are asstards.
And definition of asstard is the one who does not share my, oh so pure and correct, opinion?
Posted by: mik | Oct 20, 2008 6:52:57 PM
Why don't you support the idea with facts that fannie and freddie are a cause of the Bush depression
If Jorge Boosh is as dense as I think he is, he cannot cause boom or depression. All he can do is just stand there.
And we don't have depression, not yet.
But more importantly I don't think Fannie/Freddy caused this crisis.
Initially I guessed that CRA in combination with Fan/Fred political bribes and loose standards caused crisis.
After longer look I changed my mind.
CRA/Fanny/Freddy were catalyst for a blow-up in an unstable world-wide mix of derivatives. Sort-of like overheating water in a perfect jar, a tiny grain of sand will cause rapid boil.
So, even in absense of CRA, Fan/Freddy, liar loans, etc we whould have had blow-out. Something would have gotten even slightly wrong and boil would have started.
It seems it should be possible to construct a math model to show inherent instability of CMOs, CMOs squared, CMOs qubed and credit swaps.
Posted by: mik | Oct 20, 2008 7:10:35 PM
