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The Fanny Mae and Freddie Mac Debacle

Written by Aaron Rodriguez

Fanny Mae and Freddie Mac Were Too Large to Fail

Throughout the years, Fannie Mae and Freddie Mac have come to play a dominant role in the housing market by buying up mortgages and reselling them to investors. With approximately 5 trillion dollars of investment portfolios, Fannie Mae and Freddie Mac together owned or guaranteed about 70% of the U.S. mortgage market making these banks simply too large to fail.

For years, financial experts, economists, and regulators warned Congress that Fannie Mae and Freddie Mac have grown too large, have become too risky in their lending practices, and ultimately lacked the sufficient capital to protect itself against inevitable losses. Since 2001, the Bush Administration issued 34 warnings to Congress about the need to reform Fannie Mae and Freddie Mac before it caused substantial economic turmoil in the financial markets. However, they met continual opposition by Congressional Democrats who feared that tighter regulations on lenders would disqualify low-income applicants from affordable housing.

Congress Failed to Respond to Fannie Mae and Freddie Mac's Symptoms of Collapse

The detailed time-line of events below demonstrates that the collapse of Fannie Mae and Freddie Mac was preventable if Congress were more receptive and responsive to the warnings of expert analysis.

In 1938, Fannie Mae was established by an act of Congress to provide liquidity to the mortgage market during an economic crisis known as the Great Depression. (Fannie history)

In 1970 (three decades later), Freddie Mac was established by an act of Congress to counteract the growing monopoly of Fannie Mae over the secondary mortgage market. (Freddie history)

In 1977, the Carter Administration passed the Community Reinvestment Act (CRA) that required banks to offer an even disbursement of credit throughout the financial market in an attempt to curb past lending practices that targeted more desirable markets. At the time, Republican critics charged that such an act would impose unnecessary regulatory burdens on lending institutions and distort credit markets by forcing banks to offer loans to under-qualified applicants.

In 1995, the Clinton Administration pushed even harder to increase the supply of affordable housing to low-income families by offering performance-based incentives (Lowered Standards) . According to economist Stan Liebowitz, these developments led to a loosening of lending standards that required no verification of income or assets, little consideration of the applicant's ability to make payments, and no down payment payments. The net effect was an inevitable collapse of Fannie Mae and Freddie Mac at the cost of its investors.

In April of 2001, the Bush Administration first red flagged Fannie Mae and Freddie Mac stating that "financial trouble of a large GSE could cause strong repercussions in financial markets, affecting Federally insured entities and economic activity."

On September 10th of 2003, Treasury Secretary John Snow recommended to the House Financial Services Committee that Congress enact "legislation to create a new Federal agency to regulate and supervise the financial activities of our housing-related government sponsored enterprises" and set prudent and appropriate minimum capital adequacy requirements.

The new agency was a recommendation from the Bush Administration for a serious regulatory overhaul in the housing finance industry. The plan was an acknowledgment of two things. First, more oversight was necessary for Fannie Mae and Freddie Mac that have managed to accumulate over 1.5 trillion dollars in outstanding debt - averaging a 20% increase in residential debt per year. And second, the supervisory system in place did not have the tools to deal effectively with the size, scope, and complexity of Fannie Mae and Freddie Mac. Subsequently, the recommendation was staunchly opposed by Congressional Democrats and National Association of Home Builders who thought that tighter regulation of Fannie Mae and Freddie Mac would reduce their commitment to financing low-income and affordable housing.

In response to the Bush's regulatory overhaul proposal, Barney Frank, a ranking Democrat on the Financial Services Committee, defended Fannie Mae and Freddie Mac saying,


These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis, the more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing . . . I think it is clear that Fannie Mae and Freddie Mac are sufficiently secure so they are in no great danger. . . I don't think we face a crisis; I don't think that we have an impending disaster. . . . Fannie Mae and Freddie Mac do very good work, and they are not endangering the fiscal health of this country.

At a Congressional Hearing in 2003, Rep. Maxine Waters, Democrat of California objected to the proposal of stricter regulations on Fannie Mae and Freddie Mac stating,


I have sat through nearly a dozen hearings where, frankly, we were trying to fix something that wasn't broke. [sic] ...These GSEs have more than adequate capital for the business they are in: providing affordable housing. As I mentioned, we should not be making radical or fundamental change... If there is anything to fix or improve, it is the [regulators].

Rep. Gregory Meeks, Democrat of New York, agreed with Rep. Waters and rabidly stated,


...I have to go to another hearing, I will try to be just real quick... I am just pissed off at [the regulator] because if it wasn't for you I don't think that we would be here in the first place. ...we are faced with is maybe some individuals who wanted to do away with GSEs in the first place, you have given them an excuse to try to have this forum [to change the] mission of what the GSEs had, which they have done a tremendous job... There has been nothing that was indicated is wrong, you know, with Fannie Mae... The question that then presents is the competence that your agency has with reference to deciding and regulating these GSEs.

Rep. Melvin L. Watt, Democrat of North Carolina said, "


I don't see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing.

Rep. Artur Davis, Democrat of Alabama, went a little further in his statement. Instead of defending Fannie Mae and Freddie Mac like his colleagues, he tried turning the tables on the regulatory agency saying,


A concern that I have... is you are making very specific... broad and categorical judgment about the management of this institution, about the willfulness of practices that may or may not be in controversy. You have imputed various motives to the people running the organization... That sounds to me as if you have gone from being a dispassionate regulator to someone who is very much involved and has a stake in this controversy... And I will follow up on Ms. Waters's point because I think it is very well taken: Her observation is that the political context surrounding your investigation was that serious doubts were being raised about OFHEO... In fact, frankly, doubts were raised about your leadership of OFHEO. And all of a sudden, the response to that is to produce an enormously critical report.

Rep. Lacy Clay, Democrat of Missouri, followed suit by shifting the burden saying equating tighter regulations on Fannie Mae and Freddie Mac to racism,


This hearing is about the political lynching of Franklin Raines.

And ranking Democrat Barney Frank committed himself to stability of Fannie Mae and Freddie Mac concluding,


But I have seen nothing in here that suggests that the safety and soundness are at issue, and I think it serves us badly to raise safety and soundness as kind of a general shibboleth when it does not seem to me to be an issue.

In October of 2003, less than a month later, Fannie Mae disclosed 1.2 billion dollars in accounting errors.


In November of 2003, the Bush Administration upgraded their warning to a "systemic risk" that could very well extend beyond the confines of the housing market. In a July report, written by external investigators, it concluded that Freddie Mac manipulated its accounting to mislead investors. And other critics pointed out that Fannie Mae did not adequately hedge against rising interest rates.

In November of 2003, Council of the Economic Advisers, Chairman Greg Mankiw, argued that "legislation to reform GSE regulation should empower the new regulator with sufficient strength and credibility to reduce systemic risk." And in order to do such, the regulator would have "broad authority to set both risk-based and minimum capital standards" and "receivership powers necessary to wind down the affairs of a troubled GSE." (Remarks of Dr. N. Gregory Mankiw Chairman Council of Economic Advisers at the Annual Meeting of the National Association of Business Economists)

In February of 2005, President Bush's Budget plan emphasized the risk posed by the explosive growth of the GSEs and their sub-par levels of capital. The Bush's plan called for the creation of a new, world-class regulator saying, "The Administration has determined that the safety and soundness regulators of the housing GSEs lack sufficient power and stature to meet their responsibilities, and therefore…should be replaced with a new strengthened regulator.

On February 17th of 2005, Alan Greenspan, at the behest of President Bush, suggested that Congress limit the growth of Fannie Mae and Freddie Mac saying, "Enabling these institutions to increase in size - and they will once the crisis in their judgment passes - we are placing the total financial system of the future at substantial risk."

On April 6th of 2005, Chairman Alan Greenspan told the Committee on Banking, Housing, and Urban Affairs, U.S. Senate (Greenspan's Testimony).

The strong belief of investors in the implicit government backing of the GSEs does not by itself create safety and soundness problems for the GSEs, but it does create systemic risks for the U.S. financial system as the GSEs become very large. Systemic risks are difficult to address through the normal course of financial institution regulation alone and, as I will stipulate shortly, can be effectively handled in the case of the GSEs by limiting their investment portfolios funded by implicitly subsidized debt . . . When these institutions were small, the potential for such risk, if any, was small. Regrettably, that is no longer the case. From now on, limiting the potential for systemic risk will require the significant strengthening of GSE regulation and the GSE regulator . . . The GSEs will have increased facility to continue to grow faster than the overall home-mortgage market; indeed since their portfolios are not constrained, by law, to exclusively home mortgages, GSEs can grow virtually without limit. Without restrictions on the size of GSE balance sheets, we put at risk our ability to preserve safe and sound financial markets in the United States, a key ingredient of support for homeownership.

On April 6th of 2005, Democrat Senator Chuck Schumer disputed Greenspan's warnings about Fannie Mae and Freddie Mac stating,


I think Fannie and Freddie have done an incredibly good job and are an intrinsic part of making America the best-housed people in the world…. if you look over the last 20 or whatever years, they’ve done a very, very good job.

In April 13th of 2005, Treasury Secretary John Snow called for GSE reform, saying "Events that have transpired since I testified before this Committee in 2003 reinforce concerns over the systemic risks posed by the GSEs and further highlight the need for real GSE reform to ensure that our housing finance system remains a strong and vibrant source of funding for expanding homeownership opportunities in America… Half-measures will only exacerbate the risks to our financial system." (Snow's Testimony)

In May of 2006, Senator McCain co-sponsored the Federal Housing Enterprise Regulatory Reform Act of 2005 (found here), a legislation introduced by Republicans in the Senate Banking Committee, which intended to introduce more oversight on Fannie Mae and Freddie Mac. However, the bill never made it to the Senate floor for a vote. Republicans believed a party line vote wouldn't survive a Democrat filibuster. And despite McCain's endorsement, the bill designed to increase regulation on Fannie Mae and Freddie Mac died in the Senate.

In June of 2005, Deputy Secretary of Treasury, Samuel Bodman, highlights the risk posed by the increasing GSEs and subsequently called for reform. He said, "We do not have a world-class system of supervision of the housing government sponsored enterprises (GSEs), even though the importance of the housing financial system that the GSEs serve demands the best in supervision to ensure the long-term vitality of that system. Therefore, the Administration has called for a new, first class, regulatory supervisor for the three housing GSEs: Fannie Mae, Freddie Mac, and the Federal Home Loan Banking System."

On May 25th of 2006, Senator John McCain made his statement,

For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac–known as Government-sponsored entities or GSEs–and the sheer magnitude of these companies and the role they play in the housing market. OFHEO’s report this week does nothing to ease these concerns. In fact, the report does quite the contrary. OFHEO’s report solidifies my view that the GSEs need to be reformed without delay. I join as a cosponsor of the Federal Housing Enterprise Regulatory Reform Act of 2005, S. 190, to underscore my support for quick passage of GSE regulatory reform legislation. If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.

In August of 2007, President Bush calls upon Congress to push through a reform package for Fannie Mae and Freddie Mac, saying "First things first when it comes to those two institutions. Congress needs to get them reformed, get them streamlined, get them focused, and then I will consider other options."

In December of 2007, President Bush warns Congress to pass legislation reforming GSEs, saying "These institutions provide liquidity in the mortgage market that benefits millions of homeowners, and it is vital they operate safely and operate soundly. So I've called on Congress to pass legislation that strengthens independent regulation of the GSEs – and ensures they focus on their important housing mission. The GSE reform bill passed by the House earlier this year is a good start. But the Senate has not acted. And the United States Senate needs to pass this legislation soon."

In March of 2008, President Bush calls on Congress to "move forward with reforms on Fannie Mae and Freddie Mac. They need to continue to modernize the FHA, as well as allow State housing agencies to issue tax-free bonds to homeowners to refinance their mortgages."

In April of 2008, President Bush urges Congress to "modernize Fannie Mae and Freddie Mac. [There are] constructive things Congress can do that will encourage the housing market to correct quickly by … helping people stay in their homes."

On May 3rd of 2008, George Bush pleads with Congress to make legislation before Fanny Mae and Freddie Mac start to collapse. In his radio address, Bush says, "Americans are concerned about making their mortgage payments and keeping their homes. Yet Congress has failed to pass legislation I have repeatedly requested to modernize the Federal Housing Administration that will help more families stay in their homes, reform Fannie Mae and Freddie Mac to ensure they focus on their housing mission, and allow State housing agencies to issue tax-free bonds to refinance sub-prime loans."

On May 19th of 2008, President Bush pleads with Congress again with his radio address saying, "The government ought to be helping credit-worthy people stay in their homes. And one way we can do that – and Congress is making progress on this – is the reform of Fannie Mae and Freddie Mac. That reform will come with a strong, independent regulator."

On May 31st of 2008, President Bush makes yet another radio address saying, "Congress needs to pass legislation to modernize the Federal Housing Administration, reform Fannie Mae and Freddie Mac to ensure they focus on their housing mission, and allow State housing agencies to issue tax-free bonds to refinance sub-prime loans."

In June of 2008, President Bush told Congress, "We need to pass legislation to reform Fannie Mae and Freddie Mac."

In July of 2008, Congress finally passed a reform bill addressing Fannie Mae and Freddie Mac only after it became clear that the institutions were failing.

On September 10th of 2008, after the economic turmoil set in, Democrat Senator Christopher Dodd sat down for an interview with Bloomberg. In an astounding display of conspicuous hypocrisy, Senator Dodd said,

Why weren't we doing more, why did we wait almost a year before there were any significant steps taken to try to deal with this problem? I have a lot of questions about where was the administration over the last eight years.

However, Senator Dodd failed to mention that the Bush Administration had warned Congress 34 times about the economic risk that Fannie Mae and Freddie Mac posed on our financial systems, while in 2008, the Bush Administration pressed Congress harder than ever by issuing 17 warnings in just 6 short months about Fannie Mae and Freddie Mac.

On September 30th of 2008, shortly after Rush Limbaugh had played on his radio program an 8 minute audio of Congressional Democrats obstructing the regulatory efforts of the Bush Administration and Congressional Republicans (Limbaugh Transcript), Congressman Artur Davis of Alabama (featured in the youtube video defending Fannie Mae and Freddie Mac) issued an apology on Fox News saying,


Like a lot of my Democratic colleagues I was too slow to appreciate the recklessness of Fannie and Freddie. I defended their efforts to encourage affordable homeownership when in retrospect I should have heeded the concerns raised by their regulator in 2004. Frankly, I wish my Democratic colleagues would admit when it comes to Fannie and Freddie, we were wrong.

I think something ought to be said about Congressman Artur Davis. It takes intellectual honesty and political courage to admit a mistake concerning the regulation of Fanny Mae and Freddie Mac, especially when it can be linked to the economic downturn that has lead to an unprecedented bailout. We hope that his Congressional colleagues, featured in the 2004 Congressional Hearings video above, are noble enough to come forward and fess up to their mistakes as well.

Concluding Thoughts on Fannie Mae and Freddie Mac

Although it's fairly clear that Fannie Mae and Freddie Mac aren't the only reason our economy is in the toilet, their excessive mortgage debt, less than stringent credit and down-payment requirements, and their eventual spread of risk throughout the financial system certainly contributed to our current mess. Couple this with legislation like "The Community Reinvestment Act" that forced banks to lend to consumers who lacked credit-worthy qualifications and the "moral hazard" that encouraged lenders to make high-risk loans due to the expectation of federal bailout, Congressional Democrats played a significant role in today's economic crisis by their refusal to recognize the troublesome signs and symptoms of the Fannie Mae and Freddie Mac demise.

Here is a comprehensive analysis on the decline of Fannie Mae


Comments (2)
  • Anonymous

    Very good aritcial, should make everyone angry

  • Realtor  - yet...

    yet Obama has tried to pin every single problem he has had while in office on Bush, when the root of the problem was democrats trying to hold onto their own seats, then they try to blow smoke and blame it on Bush.

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