21 September 2010

Fannie and Freddie Didn't Cause Housing Bubble

Karl Smith recaps the reasons why Fannie Mae and Freddie Mac, government chartered corporations that invested in the housing market, were not important causes of the housing bubble that caused the financial crisis.

Fact One: Fannie and Freddie’s primary business of subsidizing conventional loans was not a driver of the housing the bubble....

Fact Two: Fannie and Freddie lost market volume during the boom....

Fact Three: The major losses to Fannie and Freddie came through their expansion into guaranteeing non-traditional loans, not through their portfolio. That is, yes like every other financial entity Fannie and Freddie were buying subprime packages in the secondary market. However, these losses were relatively mild....

Fact Four: The key change in the Fannie / Freddie business model was their expansion in the types of loans they willing to guarantee. In particular moving into the Alt-A and Interest-Only categories....

Fact Five: The higher number of Alt-A and Interest Only loans combined with ultimately higher delinquency rates have meant that a plurality of losses have come from these two categories. These loans were vulnerable not because the borrowers were poor low-credit individuals that the government was taking pity upon but because the loan concepts were predicated on rising or at least stable housing prices.

Fact Six: Areas with the largest collapse in home prices have accounted for most of Fannie and Freddie losses. . . . This is further evidence that it was the collapse of the bubble and not betting on people who were poor credit risks that induced major losses at Fannie and Freddie....

The wave of housing price increases was kicked off by changes in private label securitization. These changes left Fannie and Freddie with a smaller market share and lower absolute level of securitizations. Fannie and Freddie attempted to adjust their basic business practices to stay competitive in bubble markets and among aggressive borrowers. These adjustment left Fannie and Freddie exposed to a large decline in housing prices.

The source supports the assertions above with tables, charts and analysis. I agree with the gist of the argument and have made it myself a couple of times over the last three years (for example, about two years ago.)

Federal Policy Was Not An Important Housing Bubble Cause

Karl Smith uses "Fact Six" to make the point that housing prices and not excessive lending to people with bad credits was the problem, but it has a corollary that broadly exonorates a wide variety of federal culprits from anti-redlining law enforcement, to Federal Reserve monetary policy, to Fannie and Freddie as candidates for primary causes of the housing bubble whose collapse led to the financial crisis.

This is that the housing bubble was not a national phenomena and was not even a phenomena found in all areas with growing economies.

This was a regional problem. The housing bubble was a big problem specific to certain kinds of loans, mostly in four states. About 58% of all credit losses at Fannie Mae and 61% of all credit losses at Freddie Mac came from California, Florida, Nevada and Arizona. Fannie Mae has 27% of its loans from those states; Freddie Mac has 25% of its loans from these states. Those losses in turn are overwhelmingly Alt-A and Interest-only loans from prior to 2008.

One striking example is that of Florida, Texas and Georgia. Florida had a huge housing bubble and was crushed when it collapsed. Texas and Georgia had similarly booming economies, but without anything near the housing bubble seen in Florida.

State law, and in particular, non-recourse mortgage laws in California and Florida (with spillover effects in Arizona and Nevada economies closely tied to California and Florida economically), explain the facts much better than any national cause.

Federal law may very well explain how a regional housing bubble collapse became a global problem. New York City orchestrated financial transactions and a lack of regulatory oversight in Washington D.C. explain how it could spread. But, federal law does not do much to explain the bubble itself. If federal policy caused the housing bubble, it would have been much more widespread. And, once the bubble appeared, its collapse was inevitable.

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