part8
REFORM OF FANNIE AND FREDDIE THWARTED: FOR A PRICE
The GSEs’ political risk management succeeded in thwarting congressional and Bush
Administration attempts at reform. In 2004, Senators Hagel, Sununu, Dole, and McCain, took up Fed Chairman Alan Greenspan’s call to create stronger regulatory oversight of the GSEs and limit the amount of leverage GSEs could use to invest in risky mortgage lending. While this would not have interfered with the GSEs’ role in providing a secondary mortgage market, it would have reduced their ability to fund high-risk lending with borrowed money and cut into the companies’ fabled profit margins and executive compensation. However, when the Senate Banking Committee took up the legislation, S.1508, Democrats and some Republicans opposed it as originally drafted. For example, the legislation was approved by the Committee only after Senator Robert Bennett, whose son was employed by the Fannie Mae partnership office in Utah, attached an amendment that stripped the provision which would have allowed a new regulator to limit the GSEs’ leverage. This led the Bush Administration to withdraw its support from the weakened legislation, which ultimately failed to pass the full Senate. A similar scenario unfolded in 2005 when the Senators reintroduced their GSE reform language. Once again the bill, S.190, failed to get a single Democratic vote in the Banking Committee. Among the Democrats who voted against the bill were Senator Christopher Dodd, who received a sweetheart mortgage from Countrywide, and Senator Charles Schumer, who had so prominently advertised a $100 million Freddie Mac affordable housing program in his state. Without any Democratic support, the legislation failed to garner sufficient support for a vote on the Senate floor and was never enacted.
The House of Representatives also took up GSE reform in 2005 with the passage of H.R.
1461. However, the legislation did not allow the new federal regulator it would have
created to limit the size of the GSEs’ portfolio. As a result, the Bush Administration,
citing Fed Chairman Alan Greenspan’s insistence on the need for such a measure, once again withdrew its support and the bill died.
In return for political protection from oversight and reform, however, Fannie Mae and
Freddie Mac were forced to placate their congressional protectors with an ever-increasing commitment to high-risk lending. That Fannie and Freddie felt such political pressure is made clear in an email exchange at Freddie Mac regarding the company’s decision to not place an upper limit on the number of defaulting affordable loans the company was underwriting. Freddie Mac’s senior vice president in charge of its affordable housing mission admitted that the higher default rates typical of lower-quality affordable mortgages could do serious
“[h]arm to households and neighborhoods.” This grim reality notwithstanding, “[t]ipping the scale in favor of no cap [on defaults] at this time was the
pragmatic consideration that [it] would be interpreted by external critics as additional
proof that we are not really committed to affordable lending.”70 Clearly the GSEs feared a backlash from powerful advocates of looser mortgage standards so much that they could not even agree to place limits on how many defaults they would tolerate for one of their more risky loan products, irrespective of the obvious damage this lending was doing to families and neighborhoods.
Politicians who favored reduced lending standards in the name of increasing the
homeownership rate among their constituents cheered on these efforts. For example,
members of the Hispanic Caucus in the U.S. House of Representatives formed a special housing initiative called Hogar to encourage increased lending to Latino borrowers in their districts through reduced standards. These lawmakers received financial and policy support from the subprime lending industry as well as from Fannie Mae and Freddie Mac, which in return received congressional support for their drive to make low-quality loans. According to one report, for $150,000 in campaign contributions a year, subprime lenders could supply a research fellow to produce studies for Hogar that would in turn be used by industry lobbyists to push low-quality mortgage lending among Latino borrowers. For $100,000 a year in donations, the congressional group “offered to provide news releases from the Hispanic Caucus promoting a lender’s commercial products for the Latino market.” Freddie Mac partnered with Hogar to produce a study of Latino homeownership in 63 congressional districts which found that Latino homeownership had increased thanks to “new flexible mortgage loan products” and recommended “further easing of down-payment and underwriting standards.”71 Indeed, according to the U.S. Census Bureau, Latino homeownership increased by 47 percent during the housing bubble, from 4.1 million to 6.1 million between 2000 and 2007. This was an astonishing
rate of increase at a time when the national homeownership rate rose by just 8 percent.
Along with political pressure from Congress for more low-quality affordable housing
loans, Fannie Mae and Freddie Mac also caved in to the temptation to lower their
standards in an attempt to take market share away from Wall Street. This pressure
amplified the effect of the push by politicians to lower their underwriting standards in
order to do more risky affordable lending. These dual pressures were noted in an email
from Freddie Mac’s chief risk officer:
[T]he push to do more affordable business and increase share means more
borderline and unprofitable business will come in. The best credit enhancement is a profit margin and ours is likely to get squeezed as we respond to these market pressures.
But even as Fannie and Freddie acted to placate political allies who they needed to help thwart reforms, some GSE employees were beginning to develop a new fear. A Fannie Mae presentation obtained by the Committee explicitly acknowledged conditions indicative of a housing bubble, including an overheated market and the proliferation of increasingly risky mortgages. Yet when faced with the choice of “staying the course” or “meeting the market where it is,” the presenters recommended developing “underground” efforts to delve into subprime and “alternative” markets in order to avoid becoming “less of a market leader.”
One case study that illustrates the dual pressures of the politicization of mortgage lending and the push for market share is the internal debate at Freddie Mac over its purchase of No-Income, No-Asset (NINA) mortgages, a type of Alt-A loan. These risky loans did not verify a borrower’s income or assets. The company’s chief risk officer warned his fellow executives in 2004 that the mortgages in question would prove to be dangerously risky and that Freddie Mac would likely give in to the temptation to continue lowering its standards to attract market share. “In 1990 we called this product ‘dangerous’ and eliminated it from the marketplace,” he wrote to his colleagues. He also warned that these mortgages were “disproportionately targeted towards Hispanics,” making “[t]he potential for the perception and the reality of predatory lending with this product…great”. He also predicted that these loans were going to “borrowers who would have trouble qualifying for a mortgage if their financial position were adequately disclosed,” with first-year delinquency rates ranging from 8 percent to 13 percent. However, according to another executive, the company pushed ahead, buying billions of dollars worth of these loans “to ensure we hit share objectives and continue to diversify our customer base.” Freddie Mac executives sought to control the risk of these junk mortgages by implementing certain minimum parameters such as only buying loans made to borrowers with at least a 680 credit score. However, in a nod to the competitive pressures of the market, the chief risk officer warned that “we have already had requests from [J.P.Morgan] Chase and Wells [Fargo] to allow this offering to go to 660 [credit scores],” and that competition between Fannie and Freddie “will likely compete the borrower profile [down] to a level where understanding income and assets really does matter. I don’t know how to put the genie back in the bottle.
”He continued: I know this is where the market is evolving…Having said that, we did no-doc lending [in the late 1980s and early 1990s], took inordinate losses and generated significant fraud cases. I’m not sure what makes us think we’re so much smarter this time around.
Another Freddie Mac executive admitted that pressure to reduce underwriting quality and purchase these loans was “largely driven by a need to allow lenders to compete” with reduced documentation mortgages at Countrywide and Bank of America.80 At the same time, the chief risk officer also acknowledged that, “the push to do more affordable business and increase share means more borderline and unprofitable business will come in.”
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