It wasn’t that Fannie and Freddie made a prescient strategic decision to stay clear of the housing frenzy. They couldn’t have participated even if they had wanted to. The two agencies had committed various accounting irregularities earlier in the decade, and their regulator forced them to rein in their growth.
Moreover, Fannie and Freddie couldn’t compete with rapaciously expanding private lenders. Securitization was in full swing, enabling private lenders to offer low rates and increasingly aggressive terms to borrowers. In 2006, almost half the loans made by private lenders required no down payment and no documentation. Fannie and Freddie simply couldn’t play in that league, even though Congress had given them aggressive lending targets to help boost homeownership among lower-income and minority households.
Fannie and Freddie did play a significant part in the financial panic. As financial conditions began to weaken in 2007 and the private mortgage industry pulled back, the agencies partially filled the void. This was their chance to get back in the game. The memory of their accounting scandals had faded, and policymakers hoped the agencies could keep the housing market from unraveling. Fannie’s and Freddie’s originations of sketchy loans actually peaked near $160 billion in 2008, the year regulators placed them into conservatorship. The two agencies had jumped back into the housing market at precisely the wrong time.
The government’s takeover of Fannie and Freddie arguably ignited the global financial panic. The Treasury Department’s decision to wipe out shareholders of Lehman Brothers and Bear Stearns, two of the largest financial institutions on the planet, sent a shock wave through markets as it became apparent that no institution was safe any longer. Investors ran for the door, sending Lehman Brothers into bankruptcy one week later; a string of failures at other venerable institutions followed.
Despite Fannie and Freddie’s role in the panic, it is wrong to blame them for creating it; that distinction belongs rightly to the private mortgage market. Understanding this is critical to creating a stable, efficient mortgage finance system for the future. While Fannie and Freddie themselves deserve to pass from the scene, given their numerous past missteps, it is equally clear that the government needs to remain an important player in housing finance, providing consistent regulatory oversight and a backstop in case the private market collapses again.
Mark Zandi is chief economist at Moody’s Analytics, a subsidiary of Moody’s Corp. He is the author of “Financial Shock,” an book about the financial crisis. His column will appear regularly.