Hoisted from Comments: Risk Controls at Fannie Mae During the Mid-2000s
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Varieties and Alternative Definitions of the "Financial Crisis" Revisited...

Matthew Yglesias writes:

Fannie, Freddie, “The Crisis”: This, to me, is what “the financial crisis” is:

  1. There was a large run-up in property values.
  2. Many highly rated mortgage backed securities were created based on the assumption that that a systematic decline in property values was impossible.
  3. A lot of financial transactions were undertaken based on the assumption that the high ratings were deserved.
  4. Property values declined.
  5. Highly rated MBS lost their value.
  6. Financial panic!

I would add (3a) major Wall Street banks, especially, lost control of their derivatives books and lost their risk controls; (5a) the large size of the MBS that were not distributed by highly-leveraged financial firms but retained became known; and (5b) the investment community lost confidence in the safety, soundness, and competence of the major highly-leveraged money center banks.

Matthew goes on:

The part where unwise public policies to subsidize homeownership would seem to come into this is step (1), but we in fact see this happening in many markets (Spain, commercial real estate) where Fannie and Freddie weren’t players. Admittedly, about a hundred other terrible economic things have happened over the past four years. But this chain, to me, is the financial crisis. Before the financial crisis, I remember a number of people warning that the problem with Fannie and Freddie was that they could leave the taxpayers on the hook for a lot of money if something went wrong. And, indeed, something went wrong and Fannie and Freddie left taxpayers on the hook for a lot of money. That, to me, seems sufficient to make the case against Fannie and Freddie. But people want this fact to do some kind of ideological work that it won’t support. Banking activities need to be regulated or else asset price fluctuations will lead to macroeconomic instability.

[UPDATE] I don’t think I want to endorse Brad DeLong’s conclusion that Fannie and Freddie made the crisis better. American housing policy is really bad, along a number of dimensions, of which Fannie and Freddie were one and I don’t think that does much to help anything. But I see F&F’s critics as trying to make the problems with housing subsidies do ideological work regarding bank regulation in a way that doesn’t make sense.

Well, clearly I was not clear.

Fannie and Freddie created one variety of crisis, they made a second variety of crisis less damaging, and they were irrelevant to the third variety of crisis.

Fannie and Freddie's actions created crisis1: as organizations whose debts have an explicit or implicit government guarantee, they played heads-we-win-tails-the-government-pays, flipped tails, and the government had to pay out a lot of money.

Fannie and Freddie's existence greatly moderated crisis2: The really bad parts of the crisis--crisis2 and then the subsequent failures of political economy that have given us crisis3 started with the uncontrolled bankruptcy of Lehmann Brothers, in which it was all of a sudden no longer clear where the government stood and which financial assets had value. But people knew one thing at least: they knew that the government stood behind Fannie and Freddie. If every Fannie and Freddie bond and mortgage guarantee had suddenly dropped to the quality of Lehmann Brothers' liabilities--as would have happened if they had not been GSE's--things would have been much much worse. Crisis1 phenomena encourage overleverage during the boom, but they are a fountain of confidence and stability and make crisis2 much less severe when the crunch comes (as long as the government remains a high-quality debtor, at least).

And Fannie and Freddie seem to me to be irrelevant and orthogonal to our current crisis3: unemployment remaining at 9% even four years after 2007. That's a consequence of the Obama administration, the Federal Reserve, and the Congress--not of Fannie Mae.