Wednesday, October 08, 2008

More on Fannie/Freddie

The Fannie/Freddie debacle from

In 1938, Fannie Mae was established by an act of Congress to provide liquidity to the mortgage market during an economic crisis known as the Great Depression. (Fannie history)

In 1970, over three decades later, Freddie Mac was established by an act of Congress to counteract Fannie Mae's growing monopoly of the secondary mortgage market. (Freddie history)

In 1977, the Carter Administration passed the Community Reinvestment Act (CRA) that required banks to offer an even disbursement of credit throughout the financial market in an attempt to curb past lending practices that targeted more desirable markets. At the time, republican critics charged that such an act would impose unnecessary regulatory burdens on lending institutions and distort credit markets by forcing banks to offer loans to under-qualified applicants.

In 1995, the Clinton Administration pushed even harder to increase the supply of affordable housing to low-income families by offering performance-based incentives (Lowered Standards) . According to economist Stan Liebowitz, these developments led to a loosening of lending standards that required no verification of income or assets, little consideration of the applicant's ability to make payments, and no down payment payments. The net effect was an inevitable collapse of Fannie Mae and Freddie Mac at the cost of its investors.

In April of 2001, the Bush Administration first red flagged Fannie and Freddie stating that "financial trouble of a large GSE could cause strong repercussions in financial markets, affecting Federally insured entities and economic activity."

On September 10th of 2003, Treasury Secretary John Snow recommended to the House Financial Services Committee that Congress enact "legislation to create a new Federal agency to regulate and supervise the financial activities of our housing-related government sponsored enterprises" and set prudent and appropriate minimum capital adequacy requirements.

In October of 2003, less than a month later, Fannie Mae disclosed 1.2 billion dollars in accounting errors.

In November of 2003, the Bush Administration upgraded their warning to a "systemic risk" that could very well extend beyond the confines of the housing market. In a July report, written by external investigators, it concluded that Freddie Mac manipulated its accounting to mislead investors. And other critics pointed out that Fannie Mae did not adequately hedge against rising interest rates.

In November of 2003, Council of the Economic Advisers, Chairman Greg Mankiw, argued that "legislation to reform GSE regulation should empower the new regulator with sufficient strength and credibility to reduce systemic risk." And in order to do such, the regulator would have "broad authority to set both risk-based and minimum capital standards" and "receivership powers necessary to wind down the affairs of a troubled GSE." (Remarks of Dr. N. Gregory Mankiw Chairman Council of Economic Advisers at the Annual Meeting of the National Association of Business Economists)

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