Fannie Mae and Freddie Mac
A Political Scandal?
Introduction to the Scandal
Fannie Mae and Freddie Mac were the two largest financial institutions on the planet,responsible for financing 80% of all new mortgages in the US. It is therefore no surprise thatwhen the US housing bubble burst in 2007 and their
subprime “junk loans” surfaced
, theyhad the potential to trigger a collapse in the global financial system (Wallison and Calomiris,2009, p76; Wood, 2009). The role of The Federal National Mortgage Association (FannieMae) and The Federal Home Loan Mortgage Corporation (Freddie Mac) is to buy mortgagesfrom mortgage providers and sell them as securities to afford banks and building societiesmore scope to lend to borrowers (Thompson, 2009). Privatised in 1968 Fannie Mae and later
Freddie Mac became “share
holder owned companies with a public mission” causing a
conflict of interest (Wallison and Calomiris, 2009, p72). Their government mission was tokeep mortgage interest rates low and increase support for affordable housing, while theirprivate mission was to fight increases in regulation that would raise costs, and reduce risk taking and profitability (Wallison and Calomiris, 2009).
After Fannie and Freddie’s
accounting scandals of 2003 and 2004, questions were raised about their activities of holdingportfolios of mortgages and mortgage backed securities exposing tax payers and the widereconomy to significant risks. In addition, it was argued that their activities did not have muchof a role to play in reducing mortgage interest rates (Wallison and Calomiris, 2009). Fearingthat these government sponsored enterprises
would lose political support, they madean agreement with Congress to increase their efforts on their affordable housing mission. In2004 the Department of Housing and Urban Development (HUD) requested that Fannie andFreddie significantly increase their amount of subprime and Alt-A mortgage loans. As a
result between 2004 and 2007, the two GSE’s were the largest buyers of these mortgage
-backed securities (MBS) but the HUD failed to state that the loans had to conform to goodlending practices (Wallison and Calomiris, 2009; Thompson, 2009). People with poor credithistories were lured into these loans by attractive low interest rates that would reset aftertwo/three years to a substantially higher percentage.Once Fannie and Freddie acquired these loans they were packaged together and divided intotranches, known as
collateralised debt obligations (CDO’s)
, of varying rates of risk and soldon financial markets as securities.
were held by hedge funds, pension fundsand governments around the world. Between 2004 and 2006, the Fed increased interest ratesby 4 percentage points, resulting in mortgage interest rates to climb on subprime loans.When the housing bubble burst and the teaser period interest rates reset many people couldnot afford their mortgage payments. In 2006, there was a steep increase in the number of defaults on subprime mortgages and foreclosures causing a number of subprime mortgagelenders to collapse (Financial Times, 2008a). By 2007, the delinquency rate on subprimemortgages in the US rose to 17% (Panitch and Konings, 2009). A wave of uncertaintyflowed through the financial markets causing the value of mortgage-backed securities toplummet and the seizing up of money markets (Langley, 2008). By August 2008 Fannie Maeand Freddie Mac had a combined unpaid principal balance exposures of $1.011trillion onsubprime junk loans (Wallison and Calomiris, 2009). In order to soften the blow OFHEO