How Fannie and Fed Caused the Crash

Economist John B. Taylor reviews Reckless Endangerment by Gretchen Morgenson and Joshua Rosner:

The book focuses on two agencies of government, Fannie Mae and the Federal Reserve. The mutual support system is better explained and documented in the case of Fannie, the government‐​sponsored enterprise that supported the home mortgage market by buying mortgages and packaging them into marketable securities which it then guaranteed and sold to investors. The federal government supported Fannie Mae — and the other large government‐​sponsored enterprise, Freddie Mac — by implicitly backing up those guarantees and by providing favorable regulatory treatment and protection from competition. These benefits enabled Fannie to rake in excess profits — $2 billion in excess, according to a 1995 study by the Congressional Budget Office.


The book then gives examples where Fannie’s executives — Jim Johnson, CEO from 1991 to 1998 [and also top aide to Vice President Walter Mondale, campaign manager for Mondale, head of vice presidential selection for both John F. Kerry and Barack Obama, and chairman of both the Kennedy Center and the Brookings Institution], is singled out more than anyone else — used the excess profits to support government officials in a variety of ways with plenty left over for large bonuses: They got jobs for friends and relatives of elected officials, including Rep. Barney Frank, who is tagged as “a perpetual protector of Fannie,” and they set up partnership offices around the country which provided more jobs. They financed publications in which writers argued that Fannie’s role in promoting homeownership justified federal support. They commissioned work by famous economists, such as Nobel Prize‐​winner Joseph Stiglitz, which argued that Fannie was not a serious risk to the taxpayer, countering “critics who argued that both Fannie and Freddie posed significant risks to the taxpayer.” They made campaign contributions and charitable donations to co‐​opt groups like the community action organization ACORN, which “had been agitating for tighter regulations on Fannie Mae.” They persuaded executive branch officials — such as then Deputy Treasury Secretary Larry Summers — to ask their staffs to rewrite reports critical of Fannie. In the meantime, Countrywide, the mortgage firm led by Angelo Mozilo, partnered with Fannie in originating many of the mortgages Fannie packaged (26 percent in 2004) and gave “sweetheart” loans to politicians with power to affect Fannie, such as Sen. Chris Dodd of Connecticut. The authors write that “Countrywide and Fannie Mae were inextricably bound.”

But don’t ignore the role of the Fed:

Early on the authors take on the Boston Fed, and in particular its research director Alicia Munnell, for using a study documenting racial discrimination in mortgage lending to justify the relaxation of credit standards, even though the study’s findings were found to be flawed by other researchers. And they criticize the very low interest rate set by the Fed when Alan Greenspan was chairman and Ben Bernanke was a Fed governor, saying it “contributed mightily to the mortgage lending craze,” adding that “with the Fed on a rate‐​cutting rampage, demand for adjustable‐​rate mortgages with relatively low initial interest costs had become incendiary.”

If you watched the HBO movie Too Big to Fail, you wouldn’t get much sense that government actions — easy money, the homeownership mania, HUD and Fannie’s push to lend to non‐​creditworthy borrowers — played a major role in the housing bubble and subsequent financial crisis. Sounds like this book would make good supplemental reading for viewers, along with Johan Norberg’s Financial Fiasco.