A Book Length Account of Fannie and Freddie and Their Role in the Financial Crisis

Among the scores of books I’ve accumulated on the financial crisis, one always seemed to be missing: a book length account of the role of Fannie and Freddie in bringing about the financial crisis, following their rise and fall.  Many books had important sections devoted to the GSEs (e.g., Roger Lowenstein’s The End of Wall Street), but despite the outpouring of books on the crisis, until now we’ve lacked one that has both financial acumen and investigative journalism fused together, directly on Fannie and Freddie.  The appearance of Gretchen Morgenson and Joshua Rosner’s Reckless Endangerment fills an important void in the literature.

That said, it just arrived from Amazon, and I have not yet read it.  So meanwhile, here are links to the NPR interview and two reviews that I’ve found most interesting thus far.  One is Gretchen Morgenson’s appearance on NPR’s Fresh Air.  The interview is particularly striking for two things.  One is Barney Frank’s role in getting his partner a position at Fannie, and related issues that, one might have hoped, would long ago have raised questions of conflict of interest.  And done more than raise them.

The other striking part of the interview, at least for me, is that Morgenson is pretty blunt on the question of the role of political pressures to lend to poor people who were bad credit risks as social policy.  Every time this issue comes up here at Volokh or other places, one can count on a chorus of commenters who will cite various things to say that this wasn’t so, or it didn’t play a causal or important role, etc..  Maybe they’re right, but particularly coming from a leading business reporter for the Times, there is material in this book (even just glancing through it) that those arguing that HUD or CRA or other similar things weren’t important will have to confront.

There is a tendency, in my anecdotal experience, for academic writers to skip over, bracket, or otherwise marginalize and not want to deal directly with this issue, even when one knows that they think it was an important factor.  Why?  The political back and forth is shrill and highly partisan, and many people are out to defend a pre-owned position.  A very shrill debate immediately sidelines the rest of technical discussions, whether of derivatives, or capital adequacy, or what have you.  So it is easier to skate over those issues, and focus instead on less politically riven topics.  I recall a speaker in an academic setting a while back speaking on topics loosely related to this; there was a sizable chunk of the academics present who didn’t care, and pretty clearly didn’t understand, anything about what he was saying, but whose comments were aimed solely at testing whether the talk had anything bad to say about CRA.  The speaker quite plainly thought that it did – but it was only part of the explanation, and the speaker seemed to make a decision not to state a view, presumably in order not to risk losing the audience about other, much more technical issues.

My guess is that it’s not an infrequent reaction in presentations or articles on this topic.    Anyway, take my experience for what it’s worth – the NPR interview dances around this topic, but manages to get more directly to it than most other discussions of the financial crisis and housing policy.

The first review of this book that caught my attention is John Taylor’s, in the Washington Post, with the apt title, Why the Regulator and the Banker Can’t Be Friends.  Because the largest moral of the story is a public choice one – a positive feedback cycle in which political influence creates economic rents which creates more political influence creating more economic rents.  It’s enough to drive one to dig out the yellowing, undergraduate copy of Exit, Loyalty, and Voice and read it all over again!

That’s the primary incompatibility.  The secondary incompatibility is Fannie and Freddie doing their work under a rationale of having found the way to do good and do well at the same time.  I think the highly paid folks at Fannie truly believed that, and still do; I work out most days a week in the gym in the basement of Fannie’s building, and have listened to lots of conversations in the locker room and gym floor for over a dozen years now; in my experience the folks who worked at Fannie were remarkably sanguine about having squared that particular circle.  I haven’t heard anything in the last couple of years that makes me think that on the inside of the institution, it thinks any differently.  And yet for all the sweet goodness of mutually reinforcing profits and public mission, Taylor notes just how ruthless it was:

Fannie’s lobbying efforts were resisted by some government officials, who are the heroes of the book. CBO Director June O’Neill is praised for refusing to stop the release of the 1995 study by CBO staffer Marvin Phaup showing that federal support increased Fannie’s profits by $2 billion. O’Neill reported that Fannie executives “Frank Raines and Bob Zoellick came and met with me and the people from CBO. All of us had the same feeling — that we were being visited by the Mafia.”

My own feeling about Fannie has long been that it had successfully adopted to Washington DC the Mexican gangster approach – “plomo o plata.”   Taylor concludes:

The book certainly does not let the private sector off the hook, but it is very hard to imagine that heavily regulated banks could have engaged in such extreme risk-taking without the support of regulators. Nobel prize-winning economist George Stigler warned long ago about “regulatory capture” — the tendency for regulated firms to get protection from their regulators — and the authors provide considerable evidence of it in this book. Though they do not always give sources, it is important to take such claims and evidence seriously and to introduce government reforms as necessary. This, unfortunately, has not happened yet, as the authors emphasize in the conclusion, pointing to “the irony of having two of the nation’s most strident defenders of Fannie Mae sponsoring” the Wall Street Reform and Consumer Protection Act of 2010, which did not reform Fannie Mae.

Today’s WSJ also has a review by James Freeman, which stresses the breathtaking ease with which Fannie and Freddie bought politicians of both parties – though the GSEs ultimately became primarily Democratic Party machines of influence.  A bipartisan

parade of famous Washington movers-and-shakers appear in cameos to do some disservice (now largely forgotten) to taxpayers. There is Newt Gingrich lauding Fannie Mae at a corporate event. There is Larry Summers bullying his Treasury staff to water down a report critical of Fannie. There is current World Bank President Robert Zoellick as a Fannie executive in the 1990s lobbying on Capitol Hill.

Look at Rep. Barney Frank, responding in 2005 to the question of whether the government’s push to increase home-ownership rates might result in people buying more home than they could afford and putting themselves in dire straits. The authors report: “Frank brushed off the questioner. ‘We’ll deal with that problem if it happens,’ he barked.”

It happened all right, and perhaps the most amazing part of this tale is that so many of those responsible for the disaster remain in power. Mr. Frank got his name on a so-called financial-reform law that left Fannie and Freddie intact. Mr. Johnson remains on the board at Goldman. Like the bank, he is apparently too big to fail.

At the level of public policy, however, the largest question is the social value of home ownership.  It has been a staple of bi-partisan policy for many, many decades, obviously, whether in Frank’s “roll the dice” form or the Bush administration’s ownership society.  Freeman says:

This is a story, the authors say, “of what happens when Washington decides, in its infinite wisdom, that every living, breathing citizen should own a home.”  Encouraged by politicians to expand home lending—not least to minorities and to households with few assets—[Fannie] ignored reasonable standards of underwriting and piled up fugitive profits almost as fast as it increased risk to taxpayers.  The disaster is now measured in the hundreds of billions of dollars. As for the borrowers who were supposedly to benefit from Fannie’s mortgage-industrial complex, Ms. Morgenson and Mr. Rosner write that home ownership “put them squarely on the road to personal and financial ruin.”

These points have been made many times in the last few years, notably by Megan McArdle in the online business press, but it seems to me there is often something left out.  My own read of the bi-partisan effort to raise home ownership during the Clinton and Bush administrations emphasizes that it was more than some good-hearted, but ultimately misguided, effort to boost asset wealth, neighborhoods, social cohesion, what have you, through home ownership.  The effort to increase  home ownership at every income level was importantly driven, I speculate, by a deep-seated demographic concern shared among high officials in both administrations. The rational and profound fear by political leadership of the baby boom generation having little savings for retirement – but being able to vote themselves whatever entitlements they wanted, provided the money could be borrowed and later generations taxed.  Homes were seen as a way of inducing savings for a generation that was starting to see retirement down the road.  Home ownership would develop equity, assets, things that would see a generation through to the end.

There was a deep problem with that logic, of course, called supply and demand.  Baby boomers trying to cash out the same asset more or less at once would drive much of the market gain out of the asset.  And in any case, the savings were undermined, among other things, by the conversion of the house into a credit card.  But I would venture that one of the reasons for the press for home ownership policies for several decades was a belief on the part of responsible, sober, fearful policymakers that this was one of the few mechanisms available by which to induce savings by the baby boom generation.  It was fear of actuarial facts, not so much quixotic ideals, that drove the press for home ownership starting in the 1990s.  If that has some element of truth to it, it has come a cropper, and we are actually worse off than before; the equity has not just been withdrawn and spent, it was used as collateral to borrow still more.

Update: I think I’m going to call a moratorium on comments on this thread.  I’m don’t think there’s a lot of value in re-stating for the 25th time pre-set positions, when the point is that a new book is out that invites serious consideration; it would be more useful at least to read the book reviews and the NPR interview cited above before responding.  Otherwise, it’s just regurgitating things that have been said here a thousand times.  I’ll let you know what I think once I’ve finished the book and a discussion would be more useful then, but even reading the reviews and interviews would be a start.

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