02 Oct Origins of the Fannie Mae/Freddie Mac Crisis
While the collapse of Fannie Mae and Freddie Mac seemed to come from nowhere, the seeds of the collapse of the nation’s mortgage system were fairly obvious to those of us who represented bankruptcy debtors during the past ten years. Time and time again, I would meet with honest, sincere and hardworking debtors who found themselves in bankruptcy in an attempt to save a home that was well beyond their means. On numerous occasions I would ask myself how could a person with an unstable job history and very modest income qualify for a mortgage loan that clearly exceeded his means.
The answer is fairly simple. Ten years ago, the Clinton Administration directed Fannie Mae and Freddie Mac to underwrite loans to people of modest means, and people with damaged credit. The goal was noble – expand home ownership and thus expand the middle class – but the numbers just did not add up. Here is a quote from a New York Times article dated September 30, 1999 entitled “Fannie Mae Eases Credit to Aid Mortgage Lending” by Steven A. Holmes:
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 addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates — anywhere from three to four percentage points higher than conventional loans.
”Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements,” said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer. ”Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”
Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.
In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.
”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ” If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”
Banks and mortgage companies are in business to make money. The government basically came in and encouraged mortgage lenders to bypass their standard lending procedures and issue loans to individuals who were not credit worthy, with the risk of loss absorbed by the federal government. For all the talk about not trusting the market to solve an economic problem, I say that this mortgage crisis never would have happened but for the initial interference with that market in the first place.
Jonathan Ginsberg, Esq.
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