Amid the current financial turmoil, the causes of the crisis that just preceded it—the bursting of the housing bubble—are being badly distorted. Some analysts, including the authors of the book under review, are arguing that the housing and financial crises of 2007 and 2008 were the direct result of federal guarantees of mortgages, a program first created in the 1930s, and therefore less so the result of the aggressive creation of mortgages by private business than has been widely reported.
In particular, the authors accuse two quasi-public but profit-making companies, Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation), of adding risks to the mortgage markets that resulted in disaster. Much the same criticism has been made by Peter Wallison, a fellow of the American Enterprise Institute, who wrote an angry dissent to the findings of the Financial Crisis Inquiry Commission (FCIC), which was appointed by Congress to investigate the causes of the crash.1 Contrary to Wallison, the nine other members of the commission, including three others appointed by Republicans, concluded that Fannie and Freddie were not the main causes of the crisis.
Along with many other experts, the nine members pointed to considerable evidence that, despite large losses, these government-sponsored enterprises (GSEs), as they are known, bought or guaranteed too few highly risky loans, and did so too late in the 2000s, to cause the crisis. But in their new book, Reckless Endangerment, the New York Times reporter Gretchen Morgenson and mortgage securities analyst Joshua Rosner try to revive the issue of their responsibility.
The book boldly and passionately asserts that the risk-taking of Fannie Mae and Freddie Mac was a major element in causing the housing bubble. In particular, the authors blame the crisis on the goals set by the Clinton administration in the early 1990s to make lending “affordable” to more middle- and low-income home buyers. These goals were raised several times over the next dozen years so as to include more people, with the result that loans became cheaper. The authors write, “The homeownership drive helped to plunge the nation into the worst economic crisis since the Great Depression.” They add, “How Clinton’s calamitous Homeownership Strategy was born, nurtured, and finally came to blow up the American economy is a story of greed and good intentions, corporate corruption and government support.”
This bold claim, however, is not substantiated by persuasive analysis or by any hard evidence in the book. The GSEs did generate large losses, but their bad investments in housing loans followed rather than led the crisis; most of those investments involved purchases or guarantees made well after the subprime and housing bubbles had been expanded by private loans and were almost about to burst.
Even then, the GSEs’ overall purchases and guarantees were much less risky than Wall Street’s: their default rates were one fourth to one fifth those of Wall Street and other private financial firms, a fact not made clear by the authors. A further review of other literature shows that Clinton’s goals to increase “affordable lending” had little to do with the risks the GSEs took. The FCIC, for example, argued that in several years these goals were largely met by the GSEs’ standard loans with traditional down payments.
Although they were set up originally by the federal government, the GSEs have been private companies for roughly the last forty years. They are traded on the stock market and were on a hunt for profits like much of Wall Street, in part because their executives’ bonuses were linked to earnings per share. Even so, by comparison with other companies they restrained their risk. Private firms on Wall Street and mortgage companies across the nation, uncontrolled by adequate federal regulation, unambiguously caused the crisis as they expanded in the 2000s. They were the ones who “came to blow up the American economy.”
This is not to say that the GSEs’ way of doing business was sensible or that their losses—up to $230 billion—can be justified. The hybrid business model of a quasi-public but profit-making company, whose bonds were treated in the financial markets as if they were guaranteed by the federal government, was likely to lead to abuse and careless investment. Financial markets assumed that the GSEs were relatively safe partly because they were regulated by a federal agency, the Office of the Federal Housing Enterprise Oversight (OFHEO) and were subject to a web of rules. They also had a long record of backing safe mortgages. The authors describe well how, beginning in the 1990s, Fannie in particular betrayed its responsibilities. It aggressively minimized federal regulation of its activities and it fought off attempts to tax its profits, partly through extravagant favors to influential lawmakers. This is a story that needed telling. Reform of the GSEs should be an urgent part of a new federal housing agenda.
But the book’s unjustified thesis that Fannie and Freddie were major causes of the financial crisis is being used by politicians and pundits to soften criticism of private business and by lobbyists and others who would water down the new regulations passed by Congress under the Dodd-Frank Act. The book is also being exploited by those who believe the federal government should have little if anything to do with support for the mortgage market, a view we find unfounded.
Reviving the housing market was a high priority for Franklin Delano Roosevelt when he took office in 1933. In 1934, he created the Federal Housing Administration, which guaranteed mortgage payments, and provided insurance for savers’ deposits in the thrift institutions that then were the nation’s leading mortgage writers. He had also created a government bank, the Home Owners’ Loan Corporation, to make new loans to distressed home owners and buy bad mortgages from failing financial institutions. Finally, in 1938, he established Fannie Mae to guarantee mortgages that met adequate standards or buy them outright from private financial institutions; it issued its own debt to major investors to support its practices. The goal was to maintain a stable mortgage market with reasonable borrowing rates in all regions of the country.
For roughly fifty years, Fannie Mae did its job. Home ownership rates rose from about 40 percent in the 1920s to about 60 percent and, in contrast to earlier, far more volatile history, the mortgage market was mostly stable. Freddie Mac was created in 1970 as a private company to package mortgages into securities that could be sold to institutional investors like pension funds.
That the GSEs were private began to draw increasing criticism as they grew larger. The implied federal guarantee of the debt of these private, profit-making companies, which lowered their borrowing rates, made it easier for them to grow and make new and riskier loans. Some urged that the GSEs be fully privatized and stripped of any advantage they might have because of federal regulation. Wall Street and mortgage firms wanted for themselves the business Fannie and Freddie were doing, including the packaging of mortgages into securities.
In the early 1990s, Congress recognized that Fannie and Freddie, which were growing rapidly, required closer regulation. President Clinton and Congress also were eager to channel more loans to lower-income Americans. Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, which established a new agency to oversee the GSEs and set affordable lending goals.
From the beginning, the new oversight agency—OFHEO—was weak. And this is essentially where Reckless Endangerment begins, with sordid details about how James Johnson, Fannie’s chief executive and an influential Democratic insider, fended off control by OFHEO during its first seven years. Johnson established an expensive twelve-person lobbying office, gave campaign money to powerful politicians, and made contributions to the favorite charities of influential congressmen. He opened local development offices in congressional districts as a public relations campaign to show how congressmen were helping their local constituents get mortgages.
By means of such measures, Johnson won congressional support and repeatedly resisted attempts by a handful in Congress to rein Fannie in, as did his successor in 1999, Franklin Raines, President Clinton’s former budget director. Perhaps most important, Johnson tied his own CEO bonuses and those of other executives to the earnings of the company.
Morgenson and Rosner make a strong if one-sided case against Johnson. We never hear from any of his defenders, and he refused, the authors write, to be interviewed. But as they make clear, Johnson, partly by his egregious self-promotion, made Fannie virtually untouchable politically. Above all, he exploited the Fannie mandate to lend to lower-income Americans in order to expand the company’s reach, and in the process increase both its earnings and his personal wealth.
They also note that Democrats ranging from Congressman Barney Frank, who got his partner a job with Fannie, to former Clinton adviser Lanny Davis were strong supporters of Fannie Mae. William Daley, a high-level adviser to President Obama, was on Fannie’s board. They cite Republicans who were Fannie supporters or executives as well, including Newt Gingrich, Senator Christopher Bond, and Robert Zoellick, legal counsel of Fannie and currently head of the World Bank.
The authors make no serious charges of outright fraudulent corruption on the part of these people, however. The one potential exception is Angelo Mozilo, the flamboyant head of Countrywide Financial, the nation’s largest mortgage originator, who offered beneficial mortgage rates to some influential politicians. But the authors add nothing new here. The “friends of Mozilo,” who got cut-rate VIP loans, included Johnson, Senators Chris Dodd and Kent Conrad, and the late Ambassador Richard Holbrooke, among others. But while Mozilo did favors for them, Morgenson and Rosner cite no specific favors returned to Mozilo by Dodd, Conrad, Holbrooke, or the others mentioned.
In these and other cases, the authors tar with a broad brush. They write that they conducted interviews over more than a decade and amassed a “mountain of notes,” but many sources quoted are anonymous and the book does not cite references in footnotes so there is no way to assess many of their assertions. They almost never deal with counterarguments to their many claims, if only to show them wrong.
They make some odd errors as well, such as stating that Walter Mondale was “sitting out” the 1980 presidential election, when as vice president he ran again as Jimmy Carter’s running mate. Their scathing criticism of a Federal Reserve Bank of Boston study published in 1992, which demonstrated prejudice against minorities in the distribution of mortgages in the Boston area, is an especially disturbing example of their one-sided reporting. They assert that this study, which they say influenced Congress’s adoption of affordable lending goals, was deeply flawed. They mock the primary author of the study, the economist Alicia Munnell, and state that the Boston Fed made “a fool of itself.”
1 Peter J. Wallison, " Dissent from the Majority Report of the Financial Crisis Inquiry Commission, " American Enterprise Institute, 2011. ↩
Peter J. Wallison, ” Dissent from the Majority Report of the Financial Crisis Inquiry Commission, ” American Enterprise Institute, 2011. ↩