Part3
The Politicization of Mortgage Lending
As publicly traded corporations, the GSEs faced the obligation of all corporations – to
maximize the value of shareholders’ equity. This meant seeking out profitable
opportunities to invest in housing and, to the maximum extent possible, pushing the
envelope of innovation in mortgage finance to compete for market share. However,
unlike any other publicly traded corporation, Fannie Mae and Freddie Mac also answered in a very direct way to the federal government and elected officials in a manner reminiscent of the “crony capitalism” of countries such as Russia or China, which preserve a large state-owned enterprise sector. Fannie and Freddie answered to the Department of Housing and Urban Development (“HUD”), which set quotas for GSE investment in affordable housing, as well as to Congress and the White House, which sought to use them as vehicles to advance the politically popular goal of increasing the national homeownership rate. This was done directly through legislation and regulation.
The “Big Three” are Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings.
which mandated affordable housing lending and indirectly through political pressure
from politicians and advocacy groups. This created incentives for Fannie and Freddie to curry political favor with Congress and necessitated a massive lobbying effort which GSE executives termed “political risk management.” As the New York Times
summarized it:
“Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.”
In the early 1990s, Fannie and Freddie began to come under considerable pressure to
lower their underwriting standards, particularly on the size of down payments and the
credit quality of borrowers. A deeply flawed 1992 study published by the Federal
Reserve Bank of Boston, purporting that minorities faced discrimination in mortgage
lending, was particularly influential at the time. This study has since been shown to have been based on inaccurate data, including loans which were supposedly made to borrowers with a negative net worth. When researchers ran the models again after correcting the flawed data, the discrimination that had been the study’s central finding disappeared. Yet the damage had been done and Congress seized on the study as part of a major legislative reorganization of the GSEs’ function. In 1992, Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act, which created an “affordable housing mission” for Fannie Mae and Freddie Mac. This legislation directed HUD to establish three separate quotas requiring the GSEs to set aside a certain percentage of their yearly mortgage purchases to loans with affordable characteristics. These quotas were expressed as the minimum share of
mortgages that Fannie and Freddie purchased every year which had to be made to “low-and moderate-income families … low-income families in low-income areas and very low-income families,” as well as borrowers in “central cities, rural areas, and other
underserved areas.” Congress granted HUD the authority to adjust these three
affordable housing quotas for the GSEs over time, allowing both Democratic and
Republican Administrations to consistently make campaign promises to boost
homeownership through government intervention in the market. Consequently, under
both the Clinton and Bush Administrations, HUD dramatically increased these quotas,
which reached their zenith when the Bush Administration raised them to 56 percent, 27 percent and 39 percent, respectively.
HUD’s affordable housing quotas represented major departures from the GSEs’ prior commitment to underwriting only sustainable mortgages. congressional charter acknowledged the risks involved in low down payment loans because it allowed Fannie to purchase loans with less than a 20 percent down payment only in concert with certain mitigating factors such as private mortgage insurance or a repurchase agreement with the mortgage originator.10 The establishment of the HUD quotas broke this convention and set the stage for the dramatic politicization of mortgage
lending.
In 1994, Fannie Mae CEO Jim Johnson announced the company’s first affordable
housing initiative, the $1 trillion “Opening the Doors to Affordable Housing” program.
Johnson, a long-time friend of both President Clinton and Treasury Secretary Robert
Rubin, took the helm of Fannie in 1991 after a stint at Lehman Brothers. In an article
entitled “Fannie Mae’s Trillion-Dollar Giveaway,” written about this initial affordable
housing initiative, the Los Angeles-based Family Savings Bank criticized Fannie Mae’s
past practices for relying too heavily on borrowers’ income and debt levels when
underwriting loans. Although some would consider using such metrics to be prudent, the article stated that these guidelines “must have been written sometime in the 1800s.” It praised Mr. Johnson’s $1 trillion commitment because it would introduce “qualifying flexibility,” for low-income borrowers, allowing them to reduce their down payments to as little as 3 percent. The article cited “pressure from President Clinton’s
administration,” as the primary influence on Fannie Mae’s decision to lower its lending
standards. The GSEs also allowed politicians to claim credit for earmark-like affordable housing initiatives in their districts without having to appropriate the money in Congress. In 1994, Johnson opened Fannie Mae’s first “partnership office” in a congressional district. These partnership offices “issued thousands of press releases” featuring Members of Congress assisting Fannie Mae with affordable housing initiatives.12 They also had a reputation for hiring relatives of Members of Congress as employees.13 This political strategy won Fannie and Freddie allies on Capitol Hill who would prove invaluable in fending off calls to rein in their risky borrowing and lending practices. In 1995, Johnson seeded the Fannie Mae Foundation with $350 million of Fannie stock. The company used this foundation to spread millions of dollars around to politically-connected organizations like the Congressional Hispanic Caucus Institute. It also hired well-known academics to write papers that gave an aura of academic rigor to policy positions favorable to Fannie Mae. For example, one paper coauthored by now-Director of the Office of Management and Budget Peter Orszag, concluded that the chance was minimal that the GSEs were not holding sufficient capital to cover their losses in the event of a severe economic shock. The authors suggested that “the risk to the government from a potential default on GSE debt is effectively zero,” and that “the expected cost to the government of providing an explicit government guarantee on $1 trillion in GSE debt is just $2 million.”15 As of May 14, 2009, the taxpayers had already been exposed to $700 billion of GSE bailouts, including $59.8 billion of capital injections by the U.S. Treasury, $73 billion of GSE debt purchases by the Federal Reserve, and $567.3 billion of direct purchases of GSE mortgage-backed securities by both the Fed and Treasury.
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