Part II - Defending the Government by Misrepresenting the Facts
In just two steps President Clinton's housing secretaries used executive fiat and the affordable housing mandate to greatly increase the volume of mortgages being issued to low and moderate income borrowers. In December 1995, Secretary Cisneros established a target of 42% of GSE loans to be issued to low and moderate income borrowers for 1997-1999. (1) While this was a huge increase from the 30-34% level the GSEs were operating with before President Clinton's housing central plan, it was mere child's play compared to what Andrew Cuomo had in mind.
Like some villain in a James Bond movie pressing the start button on a doomsday machine, Andrew Cuomo sealed the fate of the US economy on October 31, 2000. It was then that Cuomo announced a new affordable housing mandate target - fully 50% of GSE mortgages must go to low and moderate income borrowers. Cuomo acknowledged this goal would require the GSEs to purchase $2.4-trillion in mortgages over the next ten years. (2) The significance of the 50% target should not be underestimated. It essentially required Fannie and Freddie - and their multi-trillion dollar loan portfolios - to navigate an economic environment previously unexplored or even imagined. Earlier that year, in March, when the 50% goal was still just a gleam in Andrew Cuomo's eye, Fannie CEO Franklin Raines stated of the 50% target, "We have not been a major presence in the subprime market, but you can bet that under these goals we will be." (3)
As the housing bubble advanced, the affordability housing mandate forced Fannie and Freddie deeper and deeper into the uncharted waters of lower lending standards. Not only did the housing affordability mandate lead to lower lending standards throughout the mortgage industry, the mandate also increased the already dominant position of Fannie and Freddie in the mortgage market. As Fannie and Freddie expanded their definition of mortgages that were considered conforming and met their underwriting standards, it was possible for Fannie and Freddie to securitize more mortgages.
It naturally followed that the privileges Fannie and Freddie enjoyed over their private competitors - chiefly an implied government guarantee and access to cheap government capital - would lead to an increasingly dominant position in the mortgage market for Fannie and Freddie. Not only did this dynamic increase the credit risk to Fannie and Freddie, it also increase the credit risk of their private-label competitors. As the GSEs purchased mortgages that until recently would not have met the requirements for a conforming loan, their private competitors were forced to move even further out on the risk curve. Often the private competitors to the GSEs purchased even dodgier loans than those purchased by Fannie and Freddie.
Many defenders of Fannie and Freddie refuse to recognize the role Fannie and Freddie played in the enormous losses suffered in the mortgage market. These defenses do not have their roots in any sort of rigorous analysis of the facts or understanding of markets. Rather these defenses are purely political and partisan in nature. It is clear; people in positions of authority and influence do not have the integrity to address the obvious facts surrounding the GSEs or the government in the housing bubble dispassionately and objectively. That people of great power and influence choose to ignore these obvious facts to protect a political agenda is almost as distressing as all the losses the GSEs and the government caused during the crisis.
Given the path of incompetence, ignorance and destruction trod by HUD Secretaries Cisneros and Cuomo, it is hardly surprising that one person refusing to accept the obvious role of the government in causing the crisis is President Obama's first HUD secretary, Shaun Donovan. Donovan does admit that the affordable housing goals weren't "particularly effective," but defends Fannie, Freddie and the affordable housing mandate by claiming they played no role in the housing bubble. As proof of this he cites the fact the private-label mortgages suffered just as many loses as Fannie and Freddie.
"The vast majority of mistakes that were made - poor underwriting standards, underpriced risk and insufficient capital with inadequate regulatory or investor oversight - closely mirror those made in the private label securities market where affordability goals were simply not a factor." (4)
This argument has been echoed by Paul Krugman of the New York Times and Princeton. (5) Krugman identifies the housing bubble's "point of maximum inflation" as the middle years of what he calls the "naughties," starting well into 2005. Krugman identifies the peak of the housing bubble as the time period with the largest price increases. Unfortunately for Krugman's argument prices are a lagging factor in the development of any bubble, and home ownership actually peaked in April 2004, well before the largest increases in home prices.
Apparently, as the law of supply and demand is taught at Princeton it is only after prices go up the most that demand will start to follow prices up. In the real world - which apparently doesn't include the Princeton economics department or the New York Times - it is prices that follow demand up. Prices will always peak after demand has peaked. The highest prices in any market are always accompanied by reduced sales volumes. Indeed, technicians and "chartists" in the stock and commodity markets routinely use volume to confirm what prices are doing. When prices reach record highs in declining volume - as they did with housing in 2005 - it is a classic sell signal. Short of a company building a new corporate headquarters, there is no better sell signal in a market than higher prices in lower volumes. What Krugman identified as the housing bubble peak is well after the peak, and by the time of the "Krugman peak" the housing bubble had been deflating for well over a year.
It was not out of standard, run of the mill economic ignorance of prices following demand that Krugman conveniently chose the time period beginning in 2005 as the peak of the housing bubble. During the time Krugman identifies as the housing bubble peak, the GSEs were "only" responsible for securitizing about 40% of all mortgages while private label companies were responsible for about 55%. Because Ginnie Mae was responsible for another 5% of mortgages during this period, the government's role in the mortgage market - 45% - was still enormous, but not as large is it had been. Indeed, just a few years earlier the market position position of the GSEs was absolutely dominant. For example, in 2003 the GSEs securitized about 70% of mortgages while private label companies only securitized about 20%. (6) What had caused the GSEs to have a smaller share of the mortgage securitization market in 2005? Krugman - in purely political partisan fashion - attributed this reduced presence in the market to "pressure" from congress.
As with most of Krugman's arguments, what he leaves out of them is more revealing than what he includes in them. The "pressure" from congress was not random but was well-founded. This pressure was the result of a $6-billion accounting fraud at Fannie Mae that was exposed in September 2004. In addition, it should be noted that - the GSE's relatively reduced market presence starting in 2005 notwithstanding - one estimate held that by 2008 the government - via Fannie, Freddie, Ginnie Mae and the Federal Housing Administration (FHA) held or insured fully 74% of the 28-million non-prime mortgages in the United States! (7) Krugman makes it seem like the government and the GSEs were bit players in the mortgage market when nothing could be further from the truth.
Krugman's defense of the GSEs and the government makes it clear he is a political hack first and an economist a distant second. In advancing his argument that seeks to minimize the role played the GSEs in the housing collapse, Krugman makes no mention of the essentially criminal behavior of Fannie Mae being the reason for the reduced GSE presence in the housing market during the time period he conveniently identifies as the housing bubble peak. In attempting to highlight the role played by the private mortgage market, he consciously attempts to obscure what was by anyone's fair reckoning the absolutely dominant mortgage market position held by the government sponsored enterprises, Fannie and Freddie.
Moreover, in conveniently selecting the approximate two-year period beginning in 2005 as the peak of the housing bubble, Krugman claims Fannie and Freddie couldn't have had much to do with the housing bubble. The reason being, when the housing bubble was at its worst, the market share of the GSEs in mortgages was at its lowest. It has been shown that the housing bubble peaked before 2005, and the market presence of the GSEs in the mortgage market - their reduced presence post-2005 notwithstanding - was absolutely dominant. Of course Prof. Krugman is completely silent - and his silence here is deafening - on the reason for the reduced presence of the GSEs in the post-2005 mortgage market. The reason was a $6-billion accounting scandal at Fannie Mae! Regrettably, for everyone studying economics at Princeton or reading his New York Times editorials - and getting dumber in the process - these are not the only mistakes Prof. Krugman makes while defending the GSEs. These other mistakes will be discussed in Part III.
September 2, 2018
(1) U.S Housing Market Conditions Summary: HUD Prepares to Set New Housing Goals, https://www.huduser.gov/periodicals/ushmc/summer98/summary-2.html
(2) HUD News Release 00-317, October 31, 2000, https://archives.hud.gov/news/2000/pr00-317.html
(3) Kathleen Day, "Fannie Mae Chief Defends Record," Washington Post, March 3, 2000 https://www.washingtonpost.com/archive/business/2000/03/03/fannie-mae-chief-defends-record/46d555ad-12b6-4af5-b0c5-58f1671a35a7/?noredirect=on&utm_term=.9c5f21c82cdb
(4) Nick Timiraos, "HUD Secretary: Fannie, Freddie Housing Goals Didn't Work," Wall Street Journal Blogs, March 03, 2011 https://blogs.wsj.com/developments/2011/03/03/hud-secretary-fannie-freddie-housing-goals-didnt-work/
(5) Paul Krugman, "The Conscience of a Liberal: Things Everyone in Chicago Knows," New York Times, June 03, 2010 https://krugman.blogs.nytimes.com/2010/06/03/things-everyone-in-chicago-knows/?_php=true&_type=blogs&_r=0
(6) "Fannie and Freddie- The Saga in the Charts," Wall Street Journal MarketBeat, February 11, 2011 https://blogs.wsj.com/marketbeat/2011/02/11/fannie-and-freddie-the-saga-in-charts/
(7) Peter J. Wallison and Edward J. Pinto, "Free Fall: How Government Policies Brought Down the Housing Market," American Enterprise Institute, April 26, 2012 http://www.aei.org/publication/free-fall-how-government-policies-brought-down-the-housing-market/