Tuesday, September 9, 2008

From back when subprimes looked good...

I found a bone-chilling article written in 2002, discussing the recent change in policy of Fannie Mae and Freddie Mac (otherwise known as GSEs – government sponsored enterprises), and their foray into the subprime mortgage market. The article starts off strong, with this laughably discredited statement explaining the GSEs' rationale for getting into the subprime market:

Subprime borrowers frequently pay higher points and fees and are saddled with more unfavorable terms and conditions, such as balloon payments, high prepayment penalties, and negative amortization. Lenders say the higher rates and charges reflect the additional costs and risks of lending to borrowers with less than perfect or nonconventional credit. However, research conducted by Freddie Mac suggests that the higher interest rates charged by subprime lenders are in excess of the additional risks these borrowers bear. Thus, increased competition would tend to reduce borrowing costs in the subprime market.

History proved them wrong: subprime loans became dramatically overvalued rather than undervalued. But the GSEs and their congressional overlords didn't have to be seers to realize that the market can always judge risk better than a government agency. And the consequences of the miscalculation weren't limited to just Fannie and Freddie: as the GSEs make up the majority of the American mortgage market, their downward estimation of the risk in subprimes forced other companies who wanted to compete with them to lower their subprime rates and make loans that they before considered risky. Blame who you will, but just consider that were it not for the GSEs sticking their fingers in the subprime pot, the bubble probably never would have formed, nor the painful bust.

The growth of subprimes started before GSEs got into the game, but as you may recall, there was no subprime mortgage bust in the late '90s, a few years after private banks started really investing in subprimes. The bust only seemed to come after Fannie and Freddie took the subprime industry by storm:

Interestingly, subprime market growth in the 1990s occurred largely without the participation of Fannie Mae and Freddie Mac. The GSEs started showing interest in this market toward the end of the decade and now purchase A-minus mortgages as a regular part of their business. National Mortgage News, a trade publication, estimates their combined market share in 2001 grew by 74 percent, representing about 11.5 percent of all subprime loan originations in that year. Some market analysts estimate that GSEs will soon be purchasing as much as one-half of all subprime originations.

In 2002, they didn't know that it was going to end with Fannie and Freddie taking huge losses amidst a recession-provoking subprime collapse. (Though they really should have seen it coming.) Today's politicians, however, have the benefit of hindsight, and yet it seems that there's no serious movement to abolish the quasi-governmental organizations. The NYT has an article reviewing the options for Fannie and Freddie in the future. It lays out a few positions that involve keeping the GSEs, but relegates "the free-market theorists" to Bushite neocon radicals who have no chance. The article doesn't however mention that Bush hasn't always been hostile to social engineering through government-run mortgage companies. Also, the article fails to mention any possibility that Freddie and Fannie caused their own meltdowns, and of course doesn't mention anyone with anything to say about their future that involves taking into account their failings during the mortgage crisis. The economic ignorance of the mainstream media and Congress is truly astounding.

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