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March 21, 2011 1:03 am
Guaranteed to Fail: Fannie Mae, Freddie Mac and the Debacle of Mortgage Finance, by Viral Acharya, Matthew Richardson, Stijn van Nieuwerburgh, Lawrence J White, Princeton, RRP£16.95, $24.95
It is comforting to think of the late, calamitous bubble in US subprime real estate as having been caused by greed. If greed were the culprit, Americans could become better people as they grew more solvent. Unfortunately, there is a strong case that sentimentality and social conscience did as much to drive the US economy into a ditch as hard-headedness and lust for profit. Four New York University finance professors make a version of that case in Guaranteed to Fail.
The US real estate market is more heavily supported by government than any other in the west. Big tax breaks – from deductions for mortgage interest to exemptions from capital gains – subsidise homeowning over apartment-dwelling. But the jewels in the crown of US housing policy are the government-sponsored enterprises (GSEs), which by 2009 guaranteed or owned $5,390bn worth of mortgages. The Federal National Mortgage Association (Fannie Mae), which dates from the New Deal of the 1930s, and the more recent Federal Home Loan Mortgage Corporation (Freddie Mac) are not quite government agencies, since executive salaries there used to run into the tens of millions. But neither are they real private companies, since the US president appoints board members. Rather they are corruption-sowing hybrids, profitmaking groups that carry an implicit guarantee of government support – or did, until their bail-out in September 2008 made it perfectly explicit. The authors believe the GSEs will cost as much as $350bn and will net out as the most costly part of the federal banking rescue.
Fannie and Freddie purchase, guarantee and securitise home loans, issuing trillions in debt to do so. They create a deep secondary market in mortgages, making possible that beautiful product – the 30-year mortgage at a low, fixed rate – on which rests the privileges of the US middle class. Politicians’ attempts to broaden those privileges spelt the system’s doom. The GSEs suffered from a dramatic drop in housing prices starting five years ago. But even the mildest slowdown would have done them in, the authors show.
Fannie and Freddie went bad in stages. In 1968, Lyndon Johnson, trying to fix a budget bloated by the Vietnam war and various domestic follies, “privatised” the GSEs. Most investors understood this as a fiction, meant only to take the government’s housing debts off balance sheet. They assumed, correctly, that the government would guarantee the GSEs’ debt in a crisis. And their statutory advantages (including lower capital requirements) gave them “incentives to ramp up risk on the taxpayer’s dime”.
In 1992 came what the authors refer to as a crossing of the Rubicon. On the eve of presidential elections, George HW Bush greatly expanded the GSEs’ “mission goals”. Fannie and Freddie would now seek to supply “affordable housing”, particularly in “underserved areas” – the government’s euphemism for ethnic minority neighbourhoods. Suddenly the government had “wiggle room” to deal in dangerous mortgages – ones with suspect borrowers and high loan-to-value ratios. President Bill Clinton crusaded against what he called “redlining” – the dearth of housing credit in poor, black, urban neighbourhoods – and President George W Bush went further, insisting on an ever-rising low-income component to GSE lending.
Explaining credit and finance in a way that brings pleasure to the reader is a rare skill, and the authors of Guaranteed to Fail do not have it. (Either that or four cooks are enough to spoil the broth.) But while their book is turbid in places, it is more multi-dimensional and nuanced than most other books on the bloody crossroads where real estate and banking meet. We should therefore take seriously the authors’ warnings that the Federal Reserve’s holdings of $1,400bn in GSE debt constitutes “a massive problem for the future”.
The authors do not object to low-income housing programmes. But they are sceptical that stimulating mortgage lending is a good way to go about it. By 2007, risky mortgages made up 22 per cent of the GSEs’ portfolio, up tenfold from a decade before. It took a long time before the consequences of the 1992 act made themselves felt. Rising home prices disguised how ill-advised many of the loans had been. But the authors show convincingly that the GSEs’ subprime lending was not a noble idea that eventually went wrong or drifted into excesses – it was a fool’s errand from the beginning. “The moment that the GSEs lowered their underwriting standards, there was no turning back,” they write, “and as soon as housing prices started falling, their fate was sealed.”
The writer is an FT columnist
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