Fed's seek further control...

[mookiemookie]

Originally Posted by UnderseaLcpl

If there had been no Fannie Mae or Freddie Mac there would be no significant subprime mortgage market and there would have been no house of cards to topple.

This is absolutely false. Suprime lending didn't exist until the early 1990s.

Fannie and Freddie were actually losing market share to non-bank lenders in the subprime market during the runup to the crisis (2003-2007). And remember, the credit bubble extended to more than just home mortgages - commercial real estate, student loans, credit card receivables and other forms of debt that Wall Street had an insatiable appetite for. None of which involved Fannie and Freddie (hereafter referred to as government sponsored entities or GSEs).

The primary sources of the credit bubble and resulting economic collapse were the abandonment of traditional lending standards - banks didn't care if loans were going to pay, as they were moving them off their books to Wall Street within 30, 60, 90 days after closing anyways - and a Federal Reserve that brought rates to historic lows and kept them there for an extended period of time, all the while ignoring the bad behavior of the loan originators. Again, none of this is directly a fault of the GSEs. They did purchase loans from banks, and they did lower their requirements for the loans that they would purchase, but the majority of the garbage loans were securitized by private label issuers, and not the GSEs. Indeed, by the time that the GSEs had relaxed their rules, the die had already been cast and the housing boom was in full swing.

The GSEs were not the first to fall. They were not even government agencies - they were government SPONSORED entities. The important difference being that they could borrow from the Treasury at more attractive rates than others. They were private sector, publicly traded firms.

According to http://www.nytimes.com/2008/10/05/bu.../05fannie.html

From 2001 to 2004, the subprime loan market grew from $160 to $540 billion. And also, by 2004 FNMA had lost 56% of its business to Wall Street firms. the GSEs relaxed their loan buying standards in attempt to play catchup to the greed of the private label securitizers who cared not about the quality of the loans they securitized, just so long as they could get them into a mortgage backed security and out the door.

The "blame Freddie and Fannie" argument even fails in terms of time and space....FNMA's been around for 70-odd years and just now they cause a collapse of the financial system? It makes no sense - especially given that the entire world experienced a housing boom during the early to mid 2000s. UK, France, Spain, Australia, Ireland - if the entire cause of the crisis could be laid at the GSEs doorstep, then how did they cause the runup internationally?

As I said before - blame the GSEs for taking part in the whole mess, but to say they were the cause and start of it is just not true.

Stealth Hunter - I agree with your list! I would add a couple culprits:

The credit rating agencies - rating junk paper as "AAA" and thus giving the green light for asset managers to purchase it based on their investment policy was a huge cause of the crisis.

The repeal of Glass Steagall - allowing depository banks, who are by definition supposed to be risk averse, to be co-mingled with investment banks who by definition take on risk is a recipe for disaster.

The 2004 SEC leverage exemption - in 2004, the SEC allowed just 5 firms - Goldman Sachs, Merrill Lynch, Morgan Stanley, Bear Stearns and Lehman Brothers - to boost their debt-to-net-capital ratio from 12-1 up to 30 or 40 to 1. This allowed for the losses to be magnified. For a testament to how destructive this decision was - look at the names on that list and see which ones still exist today.

[FIREWALL]

And don't leave out VA loans which had almost a 100% default rate.

[UnderseaLcpl]

Originally Posted by mookiemookie

This is absolutely false. Suprime lending didn't exist until the early 1990s.

Negative. The term "subprime" may not have existed until then ( I wouldn't know) but Fannie Mae was created with the intent of providing a secondary mortgage market through purchasing risky loans, thus setting the groundwork. A rose by any other name still has thorns.

Fannie and Freddie were actually losing market share to non-bank lenders in the subprime market during the runup to the crisis (2003-2007). And remember, the credit bubble extended to more than just home mortgages - commercial real estate, student loans, credit card receivables and other forms of debt that Wall Street had an insatiable appetite for. None of which involved Fannie and Freddie (hereafter referred to as government sponsored entities or GSEs).

Yeah, because Wall Street thought it had a backup plan in the security promised to GSEs by the Fed. You're missing a key point here, and that is that this whole industry is a reflection of what it is built on. Like dollars themselves, it was only worth anything because people thought other people thought it was. A whole industry was built, and then expanded upon the premise that the state would buy debt, and there was a killing to be made while high- interest payments came in. It didn't take long for a whole trading system to grow up around that system, but the system itself was bound to collapse. If there had been no Federal housing initiatives of this type banks wouldn't usually lend to high-risk customers and there would be no crisis.

The primary sources of the credit bubble and resulting economic collapse were the abandonment of traditional lending standards - banks didn't care if loans were going to pay, as they were moving them off their books to Wall Street within 30, 60, 90 days after closing anyways - and a Federal Reserve that brought rates to historic lows and kept them there for an extended period of time, all the while ignoring the bad behavior of the loan originators.

And why didn't they care? Why was there a way to trade bad loans in the first place? Government made it happen. It's just another unintended side-effect of screwing around with the market.

Again, none of this is directly a fault of the GSEs. They did purchase loans from banks, and they did lower their requirements for the loans that they would purchase, but the majority of the garbage loans were securitized by private label issuers, and not the GSEs. Indeed, by the time that the GSEs had relaxed their rules, the die had already been cast and the housing boom was in full swing.

Like I said, they laid the groundwork. They created a market where none existed before, and where one should not yet have existed.

The GSEs were not the first to fall. They were not even government agencies - they were government SPONSORED entities. The important difference being that they could borrow from the Treasury at more attractive rates than others. They were private sector, publicly traded firms.

I've made my argument, but I'd like to address this point. GSEs are no different from government agencies in my mind, as they are backed by a fitness guarantee and operate much in the same way government does, which is to say the same way any guaranteed industry does, which is to say stupidly. They are only private firms in the nominal sense in that respect.

Furthermore, they may not have been the first to fall out of everyone, but that's splicing hairs and disregarding the Federal backing they recieved. They were definetly the first dominoes to fall, though. When they went, the market built on top of them went.

The "blame Freddie and Fannie" argument even fails in terms of time and space....FNMA's been around for 70-odd years and just now they cause a collapse of the financial system? It makes no sense - especially given that the entire world experienced a housing boom during the early to mid 2000s. UK, France, Spain, Australia, Ireland - if the entire cause of the crisis could be laid at the GSEs doorstep, then how did they cause the runup internationally?

You've got me on that one. I don't know for sure. It could be any number of things, but I suspect that if the GSE's were to blame then the world runup would have something to do with everything being tied to the US economy and perhaps other nations following suit with respect to housing policies.

As far as the time element is concerned, that's a non factor. Times change, and when these agencies were established there was not a great demand for home-ownership from people who couldn't afford it. There was a moderate crisis in the late 70's, as I mentioned, which just happened to come right after an immigration spike, so this has happened before.

As I said before - blame the GSEs for taking part in the whole mess, but to say they were the cause and start of it is just not true.

Perhaps, but this crisis reminds me of a lot of earlier economic crises where everything under the sun was blamed except for government, or rather, particular policies embraced by persons in office at the time, and all that turned out to be BS. As such I am inclined to believe that the simplest explanation is the correct one.

Take, for instance, the gas crisis of the 70's, as one of the most severe in recent history. The shortage and inflation of the time were blamed on everything from the weather to OPEC to speculation to greedy oil tycoons, but those things have always been around. What caused the shortage was the government price-fixing gasoline. As Milton Friedman put it (paraphrased)"Economists may not know much, but we know how to create a surplus or a shortage. Want a surplus? Set prices above the market rate. Want a shortage? Set prices below the market rate."
He was right, and the whole truckload of BS that followed was blamed on everything except the bulls.

I see the same thing here. Affordable housing is a popular political stance, and it comes with all the trappings of similar failed initiatives of the past. You can blame anything on anything if you try hard enough, but you can't deny empirical evidence unless you are blind.

[mookiemookie]

Originally Posted by UnderseaLcpl

Negative. The term "subprime" may not have existed until then ( I wouldn't know) but Fannie Mae was created with the intent of providing a secondary mortgage market through purchasing risky loans, thus setting the groundwork. A rose by any other name still has thorns.

You misunderstand what FNMA/FHLMC actually did. They were bound by charter to only buy conforming (i.e. not subprime) mortgages. This only changed in the mid-2000s when they began losing market share of the mortgage market to private securitizers.

Yeah, because Wall Street thought it had a backup plan in the security promised to GSEs by the Fed. You're missing a key point here, and that is that this whole industry is a reflection of what it is built on. Like dollars themselves, it was only worth anything because people thought other people thought it was. A whole industry was built, and then expanded upon the premise that the state would buy debt, and there was a killing to be made while high- interest payments came in. It didn't take long for a whole trading system to grow up around that system, but the system itself was bound to collapse. If there had been no Federal housing initiatives of this type banks wouldn't usually lend to high-risk customers and there would be no crisis.

No. The ace in the hole "backup plan" was the fact that the originating lender did not need to keep the loan on their books. they could make any loan at all, as they knew that there would be someone on Wall Street would would buy it and securitize it. The voracious demand for securitized debt can be traced back to the decisions of the Fed - with rates as low as they were, the reach for yield led asset managers to take on other assets than traditional bonds and Treasuries. Mortgage backed securities were yielding much higher rates than any other security out there - coupled with the fact that defaults were low due to housing boom, and credit rating agencies putting their stamps of approval on all of it. It was a great deal.

It was a system of passing the buck and shortsightedness. Loan originators didn't care about the quality of the loans they made, as they could sell it to a Wall Street securitizer. Wall Street securitizers didn't care about the quality of the loans they bought, as the risk of any individual loan would be mitigated (or so they thought) by pooling it with other loans and selling it to investors. The investors didn't care, as they were earning great yields and the credit rating agencies had rated this stuff AAA. Everyone wins.

And why didn't they care? Why was there a way to trade bad loans in the first place? Government made it happen. It's just another unintended side-effect of screwing around with the market.

Ah, ah - be careful there. Did government MAKE it happen? Or did government LET it happen? It's the latter - the Federal Reserve completely failed to reign in banks making liar loans (loans with no income verification) or NINJA (No Income, No Job or Assets) loans. And why was there a market for these kind of loans? FNMA/FHLMC were forbidden by charter to purchase these in the early years of the credit bubble? Where were they going? To the private label securitizers!

Like I said, they laid the groundwork. They created a market where none existed before, and where one should not yet have existed.

Are you blaming securitization? The process of pooling mortgages into a security? If you are, then you should realize that the first mortgage backed security was issued in 1981. That's way before the crisis, and thus cannot be a cause of it.

FNMA and FHLMC were rife with fraud and poor risk management practices. but they did not create the market for mortgage backed securities. The private label securitization market had developed on its own by the 1990s. Wall Street was securitizing all sorts of debt - as I said before, auto loans, credit card debt, student loans, etc.

Let's do a little experiment. Imagine that the GSEs had been taken out of the picture during the mid to late 1990s (imagine they went bankrupt, or swallowed up by a black hole, or whatever). What happens? It changes nothing! The Fed still lowers rates to historic lows, asset managers still search for yield, loan originators still make crappy loans to satisfy that yield and earn a hefty profit, the credit rating agencies still stamp it all AAA, the Wall Street firms still get heavily into derivatives and still overleverage themselves. None of that relies on the GSE's existence or non-existence to happen.

[UnderseaLcpl]

Originally Posted by mookiemookie

You misunderstand what FNMA/FHLMC actually did. They were bound by charter to only buy conforming (i.e. not subprime) mortgages. This only changed in the mid-2000s when they began losing market share of the mortgage market to private securitizers.

That's news to me. IIRC there were several initiatives passed concerning affordable housing well before 2000 that Fannie Mae and Freddie Mac were governed by.

But let's say that they did buy only conforming mortgages. Why did they exist? By that token alone they are interfering with the market by creating demand where there was none before. The private sector creates artificial demand as well, but it doesn't have a state to back it up, so the damage is minimized. What happens when a GSE has state backing?

No. The ace in the hole "backup plan" was the fact that the originating lender did not need to keep the loan on their books. they could make any loan at all, as they knew that there would be someone on Wall Street would would buy it and securitize it. The voracious demand for securitized debt can be traced back to the decisions of the Fed - with rates as low as they were, the reach for yield led asset managers to take on other assets than traditional bonds and Treasuries. Mortgage backed securities were yielding much higher rates than any other security out there - coupled with the fact that defaults were low due to housing boom, and credit rating agencies putting their stamps of approval on all of it. It was a great deal.

Of course it was a great deal. The government made it that way. The Fed was to blame, yes, but the whole structure never should have existed in the first place. FNMA was the beginning of the first national "housing project", and like every other housing project it failed utterly and was ruinously expensive because it went against the grain of market forces.

It was a system of passing the buck and shortsightedness. Loan originators didn't care about the quality of the loans they made, as they could sell it to a Wall Street securitizer. Wall Street securitizers didn't care about the quality of the loans they bought, as the risk of any individual loan would be mitigated (or so they thought) by pooling it with other loans and selling it to investors. The investors didn't care, as they were earning great yields and the credit rating agencies had rated this stuff AAA. Everyone wins.

Everyone wins, because the system was federally guaranteed, or at least it was until it failed. I think you look too much into the symptoms and not enough into the cauases.

Ah, ah - be careful there. Did government MAKE it happen? Or did government LET it happen? It's the latter - the Federal Reserve completely failed to reign in banks making liar loans (loans with no income verification) or NINJA (No Income, No Job or Assets) loans. And why was there a market for these kind of loans? FNMA/FHLMC were forbidden by charter to purchase these in the early years of the credit bubble? Where were they going? To the private label securitizers!

I'd say both. We still come down to the essential problem of a market existing where it should not. A market that is not truly governed by market forces is no market at all, and it will eventually collapse. We see this all the time in the form of subsidies and legislation and trade restrictions - ever evolving, never "just right", always requiring more and more capital expenditure and legislative adjustment. This time the bubble happened to be a little too big for the market to bear.

Are you blaming securitization? The process of pooling mortgages into a security? If you are, then you should realize that the first mortgage backed security was issued in 1981. That's way before the crisis, and thus cannot be a cause of it.

No, I am not blaming securitization. If I did I'd be after insurance and every other securitized asset as well, which I'm not. What I am blaming is state interference in natural market mechanisms... especially price mechanisms. That's it.

FNMA and FHLMC were rife with fraud and poor risk management practices. but they did not create the market for mortgage backed securities. The private label securitization market had developed on its own by the 1990s. Wall Street was securitizing all sorts of debt - as I said before, auto loans, credit card debt, student loans, etc.

There was no secondary mortgage market to speak of before 1938. No supply. FNMA created it.
I'd be interested in hearing your explanation of the housing crisis in the late 70's.

Let's do a little experiment. Imagine that the GSEs had been taken out of the picture during the mid to late 1990s (imagine they went bankrupt, or swallowed up by a black hole, or whatever). What happens? It changes nothing! The Fed still lowers rates to historic lows, asset managers still search for yield, loan originators still make crappy loans to satisfy that yield and earn a hefty profit, the credit rating agencies still stamp it all AAA, the Wall Street firms still get heavily into derivatives and still overleverage themselves. None of that relies on the GSE's existence or non-existence to happen.

One key thing is missing, the fitness guarantee that created the problem in the first place. Granted, rates at historic lows would have created a bubble, but nothing like what you get when investors think there's a safety.

I can see your points, Mark, but I don't think you're getting to the heart of the issue. It is true that private companies often seek maximum profit, as do investors, but they aren't stupid. If they bought into the scenario you presented there would have been an explosion of investment in everything from commodities to crops. I still see a missing factor, and that missing factor is most likely the fitness guarantee. At least, that's my opinion now. I'll have to look into it more, but this whole thing is disturbingly familiar, so I'm wary of it.