Freddie and Fannie

FREDDIE AND FANNIE….The Washington Post has a pretty good piece today about Fannie Mae and Freddie Mac and how they managed to avoid some much-needed oversight for the past decade or so. But at the risk of tooting our own horn — ah, who am I kidding, I am tooting our horn here — you could have gotten the basic lay of the land four years ago right here in the Washington Monthly:

By the late 1980s, these two entities, which belong to the category known as Government Sponsored Entities (GSEs), were buying up and reselling 30 percent of new mortgages and packaging the mortgages to be sold as securities.

Fannie and Freddie’s market share was limited by their ability to attract investment capital. But in 1989, Congress instituted some modest-seeming technical changes that made Freddie and Fannie much more attractive to investors, and able to draw much more capital. The GSEs used the new capital to buy up every mortgage they could, and banks were only too happy to sell off the mortgage paper.

….This shift has had two crucial, if under-appreciated, consequences. First, in little more than a decade, Fannie Mae and Freddie Mac have gone from handling one trillion dollars in mortgages to four trillion, with virtually no changes in oversight. Second, their dominance of the mortgage market has profoundly undermined the discipline that once kept housing prices in check.

Once banks knew they could automatically hand off the mortgages they wrote to Fannie and Freddie with basically no risk, the old incentive system dissolved. “Banks and other mortgage lenders are not watching home prices carefully because they rarely hold onto the mortgage paper they create — they just sell it upstream to mortgage investors,” John R. Talbott, a housing researcher at UCLA’s Anderson School of Business, has argued. “It is a dangerous situation indeed when neither home buyers nor the institutions that finance them are concerned with the ultimate price being paid for the housing asset.”

The piece is called “There Goes the Neighborhood,” by Ben Wallace-Wells, and it’s still worth reading today. It’s about a lot more than just Freddie and Fannie — much to Alan Greenspan’s discomfort, I’m sure.