The Role of the Bush Administration Homeownership Policy

In All the Devils are Here, McLean and Nocera recount how as “Fannie’s market share dropped, the company’s investors grew restless—so restless that Fannie hired Citigroup to look at what Citi called “strategic alternative to maximize long-term Phineas [the code name the Citi team gave Fannie] shareholder value.” One of Citi’s primary recommendations was that “Fannie should begin to guaranteeing “non-conforming residential mortgages”—i.e. subprime.” At first Fannie and Freddie purchase and placed into their portfolios the safest subprime securities in the marketplace: the triple-A rated tranches of residential mortgage-backed securities. “Eventually, the Street began designing a special GSE tranche that was packed with loans that satisfied the affordable housing requirements.” According to McLean and Nocera, the triple-A tranches offered Fannie and Freddie an effortless means to achieve their affordable housing goals.

Presidential candidate George W. Bush made increasing home ownership rates a major plank of his election platform. Described as a “compassionate conservative,” the Bush Administration pursued an even more ambitious agenda of encouraging home ownership. Bush used the expression “ownership society” to refer to his new domestic agenda and framed home ownership as the best source of economic “self-reliance and individualism.” Once elected, the Bush administration offered the blueprint for an expanded homeownership agenda called, “A Home of Your Own: Expanding Opportunities for All Americans”. During a 2002 Conference on Minority Home Ownership President Bush called for increasing “the number of minority homeowners by at least 5.5 million.” Bush added that “some may think that’s a stretch, I don’t think it is. I think it is realistic.”

The Bush Administration ownership society agenda included a five-year initiative to provide homebuilders with $2 billion in tax credits as well as increased funding for down payment assistance, home buying education, and affordable housing. As part of this effort, the Bush Administration increased Fannie and Freddie affordable housing goals and their purchases of subprime-related products. Fannie and Freddie purchased and held in their portfolios an increasing volume of subprime securities without taking into account their poor quality or default risk that would have disqualified them as “conforming mortgages.” According to Inside MBS & ABS, a trade publication used by the Federal Reserve researchers, by June of 2008, Fannie and Freddie held $114 billion of subprime and $71 billion in Alt-A mortgage securities which counted towards HUD affordable housing goals.

As noted by McLean and Nocera, Fannie and Freddie did not determine or control the quality of mortgages packaged into subprime securities, therefore “they lost the opportunity to enforce any standards on the lenders.” In the end, “putting triple-A subprime securities on its books was, like some of Fannie’s other methods of meeting its housing goals, a stupid pet trick. It didn’t help low-income Americans buy homes.” Robert Levin, the former chief business officer of Fannie, told the FCIC that buying private-label mortgage-backed securities “was a moneymaking activity—it was all positive economics…There was no trade-off between making money and hitting goals. It was a very broad-bushed effort: that could be characterized as “win-win-win: money, goals, and shares.”

A net consequence was a shift in mortgage products away from moderately conservative and standardized conventional mortgage underwriting guidelines, promulgated for decades, in favor of appreciably looser standards. According to Congressional Budget Office estimates, Fannie and Freddie’s $5 trillion mortgage exposure and market position resulted in their insolvency, costing taxpayers hundreds of millions, and counting.  The dual mission of promoting homeownership and maximizing profits for shareholders led to the demise of Fannie and Freddie. As outlined in FCIC final report, Chapter 17: September 2008: The Takeover of Fannie Mae and Freddie Mac. “From the fall of 2007 until Fannie Mae and Freddie Mac were placed into conservatorship on September 7, 2008, government official struggled to strike the right balance between the safety and soundness of the two government-sponsored enterprises and their mission to support the mortgage market.”

Public policy failures to curtail the under-regulated explosion of high-risk mortgage products resulted in Fannie and Freddie holding and exporting enormous portfolios of housing-related assets and debt into global economy with the implicit, and often treated as explicit, guarantee of the U.S. Treasury. In July of 2008, Congress enacted the Housing and Economic Recovery Act of 2008 (HERA). Section 1103 of HERA, authorizes the abolishment of OFHEO and transfers regulatory oversight of Fannie and Freddie to the newly created Federal Housing Finance Agency.

Former Treasury Sectary Henry Paulson described Fannie and Freddie, owing and guaranteeing $5.3 trillion of mortgage with capital of less than 2 percent, as a disaster waiting to happen.  Paulson portrayed Fannie and Freddie as causing huge dislocations in the global marketplace. “Try to go around the world and explain to one leader after another what this implicit-not-explicit government was about. To me, if there’s a guarantee, they should be a utility—why should people get wealthy off a government guarantee? Paulson said that when the credit crisis hit in the summer of 2007 with housing at its epicenter, all of the flaws that have been brought to the surface by the credit crisis – of the appallingly bad underwriting standards and the kinds of subprime loans beings made-when the crisis came those stopped… Lending essentially shut down on the private side….Essentially the only game in town was Fannie and Freddie. He continued, “I knew they were very big and had the flawed structure. And if we can’t change structure, let’s at least get a real regulator there….it’s not a partisan issue because there were people of both sides who advocated on behalf of Fannie and Freddie.

On July 15, 2008, Treasury Secretary Henry Paulson, in testimony before Senate Committee on Banking, Paulson introduced a three-prong legislative strategy for Fannie and Freddie to ensure “on a temporary basis, access to both liquidity and capital, while also ensuring that the GSEs can fulfill their mission.”

First, as a liquidity backstop, the plan includes an 18-month temporary increase in Treasury’s existing authority to make credit available for the GSEs. Given the difficulty in determining the appropriate size of the credit line we are not proposing a particular dollar amount. Flexibility is the best means of increasing market confidence in the GSEs, and also the best means of minimizing taxpayer risk…

Second, to ensure the GSEs have access to sufficient capital to continue to fulfill their mission, the plan gives Treasury an 18-month temporary authority to purchase – only if necessary – equity in either of the two GSEs. …

Third, to help protect the financial system from future systemic risk, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by providing the Federal Reserve authority to access information and perform a consultative role in the new GSE regulator’s process for setting capital requirements and other prudential standards…As I have said for some time, the Fed already plays the role of de-facto market stability regulator and we must give it the authorities to carry out that role. This role for the Federal Reserve with respect to the GSEs is consistent with the recommendation made in Treasury’s Blueprint for a Modernized Financial Regulatory Structure.

According to documents released by the FCIC, Fannie regulator “admonished management and the board for their imprudent decision to purchase or guarantee high-risk loans to ‘increase market share, raise revenue and meet housing goals, and for attempting to increase market share by competing with Wall Street firms that purchased lower-quality securities. On August 22, the FHFA informed Fannie that it was “seriously concerned about the current level of capital.

A month later, in what the FCIC described as “blistering midyear reviews,” the FHFA informed the CEOs of Fannie and Freddie that they had been downgraded to “critical concerns” FHFA letter to Fannie expressed the fact that “even after internal reports pointed to market problems, Fannie continued to purchase riskier subprime mortgage products. According to the FHFA, “Despite signs in the latter half of 2006 and 2007 of emerging problems, management continued activity in risky programs, and maintained its higher eligibility program for Alt-A loans without establishing limits.” Two days later, FHFA sent memos to Fannie and Freddie proposing appointment of FHFA as conservator. Losses for Fannie were estimated between $18 billion and $50 billion. Losses for Freddie were projected at between $11 and $32 billion. On September 7, 2008, in order to restore the balance between safety and soundness and mission, FHFA placed Fannie Mae and Freddie Mace into conservatorship.