Seems that Heritage Foundation got it right.

[Dinner]

Let's face it. Fannie and Freddie where small players in the subprime market originating only a small single digit percentage of the subprime loans and then only buying at most 20% of the subprime loans. Of those it bought a lot of them were in the final months before the crisis in an attempt to help out troubled banks. The vast majority of the subprime lending was being done by private capital because interest rates where really low and money was cheap. So much money was sloshing around due to loose monetary policies that there was more cheap money then sound places to invest it.

It didn't help that the companies making sub prime loans thought they were protected by Credit Default Swaps and besides they could always resell the loans packed as Mortgage Backed Securities. The folks who bought MBS thought they were getting a safe well balanced portfolio of loans insured by CDS but it wasn't true. This crisis has exposed a lot of faulty assumptions and there are reforms which need to be done. It seems that (just as the nay sayers predicted) having the people selling complex financial assets owning the agencies who rate financial assets isn't a good idea because then the company has a conflict of interests to inflate ratings undeservedly making risky investments seem safer then they are. Also services which act like insurance should be regulated like insurance to make sure the company issuing CDS can actually pay claims if they have to.

The other thing I wonder about is if a company is to big to fail then maybe it is just to big. I mean if a company is so big its failure threatens the entire national economy then maybe it should be broken up and not be allowed to become so dominant.

[SlowwHand]

You probably don't like the Cartwright's and the Ponderosa, do you?

[KrazyHorse]

Originally posted by DanS
The Heritage Foundation

Fannie Mae and Freddie Mac are two institutions that started on a small scale, but have grown like a cancer since. It will be a hell of a time shutting them down, even though most agree that they are out of control.

We should get rid of all of these housing industry subsidies.

I agree. But the two FMs had only a tangential relationship to the current crisis.

[Naked Gents Rut]

But the two FMs had only a tangential relationship to the current crisis.

Much smarter people than you disagree.

[Jaguar]

Originally posted by Oerdin
Let's face it. Fannie and Freddie where small players

My god, this hurts me so much.

[Kidlicious]

Originally posted by Naked Gents Rut


Much smarter people than you disagree.

"First of all, there can be no death of the free market when the free market has never lived."

[KrazyHorse]

Originally posted by Naked Gents Rut


Much smarter people than you disagree.

a) If you're going to start with arguments from authority then I can find equally good (or better) arguments

b) I disagree with your hypothesis, though I do grant far lower understanding of economics

[Naked Gents Rut]

I disagree with your hypothesis, though I do grant far lower understanding of economics

This is the real problem. No one here knows enough about the subject to do much other than cite other people.

[KrazyHorse]

That's not true. Most thinking on economics is horribly muddled. There are a few people here (myself included) who can at least point out ridiculous inconsistencies in logic.

So while I don't doubt that you (or others) could come up with an argument to plausibly show that the FMs were a primary cause of the crisis which I couldn't refute, I do know enough to refute the naive arguments being promulgated through much of the media.

[Naked Gents Rut]

So while I don't doubt that you (or others) could come up with an argument to plausibly show that the FMs were a primary cause of the crisis which I couldn't refute, I do know enough to refute the naive arguments being promulgated through much of the media.

I could make such an argument, but I don't know if it's actually true or not. I simply don't know enough about the history of the subprime market to speak with any authority. I don't think anyone here can.

That being said, I think it's clear that Fannie and Freddie weren't merely "tangential" to the crisis. The question is whether they were a primary cause of the crisis or just a major contributing factor.

[DanS]

The problem is, those who have spoken with authority on this subject on Poly are clearly wrong too.

[KrazyHorse]

That being said, I think it's clear that Fannie and Freddie weren't merely "tangential" to the crisis. The question is whether they were a primary cause of the crisis or just a major contributing factor.

Here's my current understanding (which is open to correction):

1) The existence of the GSEs in the form of 90s-00s led to higher housing prices in general because the implicit gov't guarantees (and legislative exceptions? don't know) allowed higher leverage ratios than non-GSE companies could use.

2) (1) has the effect of distorting the debt market, directing some investment from non-housing to housing (much lower amounts than naively stating size of GSE mortgages would suggest, of course)

3) The GSEs maintained, AFAIK, significantly lower exposure to subprime/Alt-A loans than their total mortgage market share would suggest. They were also less exposed to "novel" debt instruments than mortgage market share would suggest and entered into both of these markets later than the private actors did

4) The leverage ratios are what killed the GSEs, not any sort of special exposure to subprime/CDO/MBS

5) (2) suggests to me that the GSEs made it easier for subprime borrowers to get unsustainable loans. (1) and (3) suggest to me that GSEs made it harder for subprime borrowers to get unsustainable loans. Is there any a priori argument which shows that (2) outweighs (1) and (3)?

6) (2) is the most pernicious effect of the GSEs. The most odious effect is that the GSEs represent a transfer from a poorer group (renters) to a richer group (homeowners)

[Naked Gents Rut]

The GSEs maintained, AFAIK, significantly lower exposure to subprime/Alt-A loans than their total mortgage market share would suggest. They were also less exposed to "novel" debt instruments than mortgage market share would suggest and entered into both of these markets later than the private actors did

I think looking at it this way is misleading.

Private lenders simply can't compete with the GSEs and as Fannie and Freddie moved into the upper-reaches of subprime, they forced the privates to either exit the housing market altogether or start lending to even riskier borrowers.

The privates might have gotten out if no one had been willing to take this increased risk off their hands, but the GSEs were there (with their government backing) to buy up the loans and securitize them. The GSEs pushed the privates into extremely risky lending and then made a market for those extremely risky loans

Of course Fannie and Freddie had a low exposure to subprime as compared to their total share of the mortgage market. How could they not, when they monopolize the prime mortgage sector? Their role in the subprime crisis goes beyond their own exposure to subprime, however.

[KrazyHorse]

Originally posted by Naked Gents Rut


I think looking at it this way is misleading.

Private lenders simply can't compete with the GSEs and as Fannie and Freddie moved into the upper-reaches of subprime, they forced the privates to either exit the housing market altogether or start lending to even riskier borrowers.

By showing a preference for better borrowers an actor increases the costs of worse borrowers relative to better borrowers. Period. Any other conclusion is mumbo-jumbo (as long as we assume upward sloping supply and downward sloping demand)

The privates might have gotten out if no one had been willing to take this increased risk off their hands, but the GSEs were there (with their government backing) to buy up the loans and securitize them.

Again, yes, the GSEs reduced the overall cost of borrowing. Most of this goes directly into a transfer to existing homeowners. Some of it diverts more investment to housing. But if the GSEs show a bias toward good borrowers (demonstrated by holding proportionally more debt of good borrowers) then they change the relative cost of borrowing in favour of good borrowers

The GSEs pushed the privates into extremely risky lending and then made a market for those extremely risky loans

This is nonsense. The GSEs didn't "push" anybody. There are other investment markets than housing. If other investment markets had offered better returns for private entities then they would have invested in them. By being dedicated mortgage buyers/guarantors the GSEs do shift the balance toward housing (offset somewhat by exit of private entities to other markets) but by demonstrating preference for good borrowers they shift the balance toward good borrowers. They drop the price of borrowing more for good borrowers than bad (relative to counterfactual of no GSEs). Both drops increase the price of housing (this is by far the biggest effect, by the way). This is offset somewhat by entry of additional investment. Now, subprime borrowers face a lower cost of borrowing but higher housing prices. Which one dominates? It is not unambiguous. Depends on actual elasticities and preference shown to good borrowers by GSEs relative to private entities.

[Naked Gents Rut]

The GSEs didn't "push" anybody.

Not in the sense that they forced anybody, no. However, they did take away part of the privates' market and then increased the incentives for the privates to move into a riskier portion of the subprime market.

If other investment markets had offered better returns for private entities then they would have invested in them.

The returns for the privates in riskier subprime wouldn't have been nearly as enticing if they had been forced to hold the risk from those loans themselves.

By being dedicated mortgage buyers/guarantors the GSEs do shift the balance toward housing

Obviously.

by demonstrating preference for good borrowers they shift the balance toward good borrowers.

You're going to have to explain this whole "good borrowers vs. bad borrowers" thing in a different way. I'm not grasping the relevance.