Fannie mae freddie mac caused housing crisis

Recovering those basic facts will lead us to a better understanding of what went wrong and why. The debate over the origin of the mortgage crisis comes down to a simple question: What makes a mortgage "high risk"? To many observers, a risky mortgage is one that deviates in any way from the traditional, year fixed-rate prime mortgage loan. In this view, the spike in mortgage default volumes and the failures of Fannie and Freddie are easily explained by the sizeable growth of "non-traditional" mortgages between and The problem with this interpretation is that non-traditional mortgages often have very little in common with one another.

A subprime loan made to a borrower with no equity and a long history of unpaid bills is quite different from an interest-only mortgage made to a high-income borrower with a solid credit score and larger-than-average down payment. The mere fact that neither is a year fixed-rate loan does not mean they resemble each other. If such dissimilar mortgages were to default at the same frequency, those defaults would have to be explained by some common factor that actually unites them.

Because the first wave of defaults in involved subprime mortgages with adjustable interest rates, many economists and policymakers blamed the crisis on these mortgages' non-traditional payment features. The initial policy response to the crisis therefore focused on facilitating mortgage-contract renegotiations for borrowers experiencing payment shocks as their low initial payment rates expired. Analysts began to pay special attention to the schedule of mortgage payment resets, assuming that future waves of defaults would be tied to the timing of subprime-mortgage resets.

This initial misdiagnosis continues to confuse the public regarding the cause of the mortgage crisis in two damaging ways. First, the exotic nature of these mortgages focused the public's attention on the mortgage products' designs, leading observers to conclude that any variation in default rates could be explained by unusual payment types, the waiving of documentation requirements like proof of income or assets , and peculiar amortization schedules.

But as we shall see, in most cases, these non-traditional mortgage features were merely a symptom of the underlying disease. Second, the focus on payment shock has fostered the sense that the crisis stemmed from mortgage payments becoming so high that borrowers could no longer afford them. While monthly payments obviously cannot exceed the borrower's monthly income, affordability — as commonly understood — was not the cause of the crisis. Homes were suddenly worth far less than the mortgage debt issued against them. The impact of house-price trends soon became clear when subprime fixed-rate mortgages defaulted at roughly the same rate as subprime adjustable-rate mortgages.

It is perfectly easy to show why unaffordable payments should not by themselves cause mortgage defaults. A household with equity in its home — a house worth more than the mortgage — does not default when job loss, divorce, or payment shock causes its income to fall below the level required to meet its monthly mortgage payment. Instead, the home is sold to convert its equity into cash to pay off the unpaid principal.

Since the mortgage lender is the first in line to get paid in the event of the home's sale, the home's equity creates a buffer that ensures the lender suffers no loss. A mortgage default occurs only in situations where the unpaid principal balance on a mortgage exceeds the market value of the home. A systemic mortgage crisis like the one in can therefore occur only when the level of house prices overall falls dramatically relative to the amount of mortgage debt outstanding, causing the value of many homes to fall below their corresponding mortgage balances, and therefore causing many borrowers to default at once.

Mortgage-credit risk is therefore inextricably tied to house-price dynamics. When house prices are expected to rise continuously, the income and payment history of borrowers are of secondary importance when lenders determine credit worthiness. Expectations of continuous increases in house prices also bias household financial decisions, causing household portfolios to be overexposed to housing-market risk.

Years of rising prices improve the performance of otherwise questionable mortgages, which encourages progressively looser lending terms and speculation by buyers. Speculative purchases push prices up further, which confirms the expectations of eternal increases in value and generates more positive feedback. This cycle ends only when house prices stop rising, which causes lenders and borrowers to revise expectations of future price changes downward, leading to a contraction in credit and a reduction in demand. The problem that came to a head in and , in other words, was that too many people — lenders as well as borrowers — expected house values to continue rising forever and acted accordingly.

When those values stopped rising — even before they actually began to fall — the speculative bubble became untenable and a crisis became increasingly likely. All of this had next to nothing to do with the qualifications of homebuyers or the particular terms of mortgage financing. It had to do with an explosion in home prices that eventually proved to be unsustainable, and unmoored from real values.

If the true cause of the housing crisis was an unsustainable explosion in home prices, the next question we must ask is clear: How do we determine how much a home should cost? Like an automobile or a dishwasher, a house is a durable good; it is valuable because it generates a flow of services over a long period of time. The fundamental value of a house, then, is the value of the shelter services it provides over its useful life.

Fannie Mae, Freddie Mac and the 2008 Credit Crisis

The value of these shelter services can be evaluated monetarily with a measure called the "owners' equivalent rent," which is the rental income an owner could obtain if he moved out of the house and rented it to a third party at current market rates. As we have seen, mortgage default rates are not a function of a disjunction between the monthly income of a borrower and the monthly mortgage obligations he incurs.

Rather, what matters is the disjunction between the price of a home and the income it generates. And that income is best measured in terms of rental value. Unless a household possesses sufficient liquidity to buy a home outright, it is a renter. The question is whether it rents directly from a landlord in the rental market or whether it rents the capital necessary to buy the home in the mortgage market. Whether it is preferable to rent the capital or the home depends on the expected trajectory of house prices.

If house prices rise, it is better to rent the capital and so buy the home since a mortgage's principal balance is fixed, which means homeowner equity increases with house prices on a dollar-for-dollar basis. Conversely, if house prices decline, the renter is better off because he avoids the decline in household net worth that occurs when the value of the home falls relative to the fixed principal balance on the mortgage, and so avoids the risk of going "underwater.

During the house-price boom of the last decade, this two-sided nature of housing-market risk was ignored. Many mistook the fortuitous capital gains people made as the values of their homes increased as something inherent to homeownership. Renters were ridiculed for throwing their money away, and homeownership rates rose to record levels. Unfortunately, households were accumulating exposure to housing market risk at precisely the time when a price reversal became most likely.

The relationship between home prices and owners' equivalent rents can give us a sense of when the risk of such a reversal is high. When house prices rise faster than equivalent rents over a sustained period, house prices become fragile and susceptible to huge declines.

The figure below depicts change relative to January in the ratio between house prices and equivalent rents for the Miami and Cleveland metro areas, as well as the entire United States. A level above one for any given date means house prices had risen more than owners' equivalent rents between January and that date; a level below one means rents had outpaced house prices. Between and , the relative price of owning rather than renting in the Miami metro area more than doubled, as house prices increased at an annually compounded average of Growing at this pace, it would have taken equivalent rents 16 years to reach the level of house prices.

Although soaring house prices caused many to worry about housing "affordability," the annual increase in equivalent rents 4. Housing services were not becoming unaffordable, only buying a house through the mortgage market was. As the meteoric rise in house prices came to an end, it became clear that recent home buyers had overpaid, as the same housing services could be obtained at less than half the price in the rental market.

House prices collapsed, and the price-to-rent ratio returned to parity in less than three years. This boom-bust cycle occurred in much the same way in Tampa, Las Vegas, Phoenix, and parts of California. For the nation as a whole, the "bubble" was about one-fifth smaller than it was in these so-called "sand states," as some areas of the country — like Cleveland, along with much of the South and Midwest — experienced almost no housing bubble at all.

The bubble itself, rather than the growth in the volume of high-risk mortgages, was the cause of the crash. And in fact, the bubble was also the cause of the explosion of risky borrowing. To avoid "throwing their money away" on rent as house values were skyrocketing, many people who would have been much better off in the rental market instead took out non-traditional mortgages, and it was these mortgages that accounted for almost the entirety of Fannie and Freddie's losses.

But these loans — known colloquially as "affordability products" — did not default at high rates because the loans were extraordinarily risky. They defaulted because they were concentrated in geographic regions that saw high rates of mortgage default in general — areas where the house-price bubble was most inflated.

It is important to distinguish these non-traditional mortgages from subprime loans and the subprime market's development.

In addition, housing bubbles appeared in several European countries at the same time, although U. Only 1 of the 10 FCIC commissioners argued housing policies were a primary cause of the crisis, mainly in the context of steps Fannie Mae and Freddie Mac took to compete with aggressive private sector competition. Failure to regulate the non-depository banking system also called the shadow banking system has also been blamed. Many of these institutions suffered the equivalent of a bank run , [5] with the notable collapses of Lehman Brothers and AIG during September precipitating a financial crisis and subsequent recession.

The government also repealed or implemented several laws that limited the regulation of the banking industry, such as the repeal of the Glass-Steagall Act and implementation of the Commodity Futures Modernization Act of The former allowed depository and investment banks to merge while the latter limited the regulation of financial derivatives. Note: A general discussion of the causes of the subprime mortgage crisis is included in Subprime mortgage crisis, Causes and Causes of the — global financial crisis.

This article focuses on a subset of causes related to affordable housing policies, Fannie Mae and Freddie Mac and government regulation. Deregulation, excess regulation, and failed regulation by the federal government have all been blamed for the lates decade subprime mortgage crisis in the United States.

Did Fannie and Freddie Cause Mortgage Crisis?

Conservatives have claimed that the financial crisis was caused by too much regulation aimed at increasing home ownership rates for lower income people. Liberals have claimed that GSE loans were less risky and performed better than loans securitized by more lightly regulated Wall Street banks.

The Financial Crisis Inquiry Commission issued three concluding documents in January 1 The FCIC "conclusions" or report from the six Democratic Commissioners; 2 a "dissenting statement" from the three Republican Commissioners; and 3 a second "dissenting statement" from Commissioner Peter Wallison. Both the Democratic majority conclusions and Republican minority dissenting statement, representing the views of nine of the ten commissioners, concluded that government housing policies had little to do with the crisis.

The majority report stated that Fannie Mae and Freddie Mac "were not a primary cause of the crisis" and that the Community Reinvestment Act "was not a significant factor in subprime lending or the crisis. This tells us to look to the credit bubble as an essential cause of the U. It also tells us that problems with U. However, Commissioner Wallison's dissenting statement did place the blame squarely on government housing policies, which in his view contributed to an excessive number of high-risk mortgages: " I believe that the sine qua non of the financial crisis was U.

If the U. This comparison clearly indicates that adherence to the CRA led to riskier lending by banks. Additionally it was criticized for not considering an alternate explanation: "that bank officers deliberately make bad loans. The sentries were not at their posts, in no small part due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves.

More than 30 years of deregulation and reliance on self-regulation by financial institutions, championed by former Federal Reserve chairman Alan Greenspan and others, supported by successive administrations and Congresses, and actively pushed by the powerful financial industry at every turn, had stripped away key safeguards, which could have helped avoid catastrophe. This approach had opened up gaps in oversight of critical areas with trillions of dollars at risk, such as the shadow banking system and over-the-counter derivatives markets.

In addition, the government permitted financial firms to pick their preferred regulators in what became a race to the weakest supervisor. Among the new mortgage loan types created and gaining in popularity in the early s were adjustable-rate, option adjustable-rate, balloon-payment and interest-only mortgages. These new loan types are credited with replacing the long-standing practice of banks making conventional fixed-rate, amortizing mortgages.

Among the criticisms of banking industry deregulation that contributed to the savings and loan crisis was that Congress failed to enact regulations that would have prevented exploitations by these loan types. Subsequent widespread abuses of predatory lending occurred with the use of adjustable-rate mortgages. This legislation established an "affordable housing" loan purchase mandate for Fannie Mae and Freddie Mac, and that mandate was to be regulated by HUD. This encouraged "subprime" mortgages.

See HUD Mandates, below. It separated commercial banks and investment banks, in part to avoid potential conflicts of interest between the lending activities of the former and rating activities of the latter. Economist Joseph Stiglitz criticized the repeal of the Act. Rivlin , who served as a deputy director of the Office of Management and Budget under Bill Clinton, said that GLB was a necessary piece of legislation because the separation of investment and commercial banking 'wasn't working very well.

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It aligned the formerly competing investment and commercial banking sectors to lobby in common cause for laws, regulations and reforms favoring the credit industry. Economists Robert Kuttner and Paul Krugman have supported the contention that the repeal of the Glass—Steagall Act contributing to the subprime meltdown [21] [22] although Krugman reversed himself several years late saying that repealing Glass-Steagall is "not what caused the financial crisis, which arose instead from ' shadow banks. The vast majority of failures were either due to poorly performing mortgage loans, permissible under Glass-Steagall, or losses by institutions who did not engage in commercial banking and thus were never covered by the act.

Peter J. Wallison points out that none of the major investment banks that were hit by the crisis, "Bear, Lehman, Merrill, Goldman, or Morgan Stanley — were affiliated with commercial banks" but were stand-alone investment banks allowable by Glass-Steagall. The mortgage banks, Wachovia, Washington Mutual, and IndyMac, were also independent banks existing before the repeal of Glass. Capital requirements refer to the amount of financial cushion that banks must maintain in the event their investments suffer losses. Depository banks will take deposits and purchase assets with them, assuming not all deposits will be called back by depositors.

The riskier the assets the bank selects, the higher the capital requirements to offset the risk. Depository banks were subject to extensive regulation and oversight prior to the crisis. Deposits are also guaranteed by the FDIC up to specific limits. However, depository banks had moved sizable amounts of assets and liabilities off-balance sheet, via complex legal entities called special purpose vehicles. This allowed the banks to remove these amounts from the capital requirements computation, allowing them to take on more risk, but make higher profits during the pre-crisis boom period.

When these off-balance sheet vehicles encountered difficulties beginning in , many depository banks were required to cover their losses. Unlike depository banks, investment banks raise capital to fund underwriting, market-making and trading for their own account or their clients; they are not subject to the same oversight or capital requirements. Large investment banks at the center of the crisis in September , such as Lehman Brothers and Merrill Lynch, were not subject to the same capital requirements as depository banks see the section on the shadow banking system below for more information.

FDIC Chair Sheila Bair cautioned during against the more flexible risk management standards of the Basel II accord and lowering bank capital requirements generally: "There are strong reasons for believing that banks left to their own devices would maintain less capital—not more—than would be prudent.

The fact is, banks do benefit from implicit and explicit government safety nets. Investing in a bank is perceived as a safe bet. Without proper capital regulation, banks can operate in the marketplace with little or no capital. And governments and deposit insurers end up holding the bag, bearing much of the risk and cost of failure. History shows this problem is very real … as we saw with the U. The final bill for inadequate capital regulation can be very heavy.

In short, regulators can't leave capital decisions totally to the banks. We wouldn't be doing our jobs or serving the public interest if we did.

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The non-depository banking system grew to exceed the size of the regulated depository banking system. However, the investment banks, insurers, hedge funds, and money market funds within the non-depository system were not subject to the same regulations as the depository system, such as depositor insurance and bank capital restrictions. Many of these institutions suffered the equivalent of a bank run with the notable collapses of Lehman Brothers and AIG during September precipitating a financial crisis and subsequent recession.

Yet, over the past plus years, we permitted the growth of a shadow banking system—opaque and laden with shortterm debt—that rivaled the size of the traditional banking system. Key components of the market—for example, the multitrillion-dollar repo lending market, off-balance-sheet entities, and the use of over-the-counter derivatives—were hidden from view, without the protections we had constructed to prevent financial meltdowns. We had a 21st-century financial system with 19th-century safeguards. In a June speech, U.

Treasury Secretary Timothy Geithner , then President and CEO of the NY Federal Reserve Bank, placed significant blame for the freezing of credit markets on a "run" on the entities in the "parallel" banking system, also called the shadow banking system. These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls.

Further, these entities were vulnerable because they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would make them subject to rapid deleveraging , selling their long-term assets at depressed prices. Economist Paul Krugman described the run on the shadow banking system as the "core of what happened" to cause the crisis.

Influential figures should have proclaimed a simple rule: anything that does what a bank does, anything that has to be rescued in crises the way banks are, should be regulated like a bank.

No, But Here's What Did

For example, investment bank Bear Stearns was required to replenish much of its funding in overnight markets, making the firm vulnerable to credit market disruptions. When concerns arose regarding its financial strength, its ability to secure funds in these short-term markets was compromised, leading to the equivalent of a bank run. The securitization markets started to close down in the spring of and nearly shut-down in the fall of More than a third of the private credit markets thus became unavailable as a source of funds.

The Economist reported in March "Bear Stearns and Lehman Brothers were non-banks that were crippled by a silent run among panicky overnight " repo " lenders, many of them money market funds uncertain about the quality of securitized collateral they were holding. Mass redemptions from these funds after Lehman's failure froze short-term funding for big firms. The Commission found GSE loans had a delinquency rate of 6. The GSEs participated in the expansion of subprime and other risky mortgages, but they followed rather than led Wall Street and other lenders.

The three [41] wrote:. Government entities held or guaranteed Wallsion publicized his dissent and responded to critics in a number of articles and op-ed pieces, and New York Times Columnist Joe Nocera accuses him of "almost single-handedly" creating "the myth that Fannie Mae and Freddie Mac caused the financial crisis". Critics contend that Fannie Mae and Freddie Mac affected lending standards in many ways - ways that often had nothing to do with their direct loan purchases:. In Fannie and Freddie introduced automated underwriting systems, designed to speed-up the underwriting process.

These systems, which soon set underwriting standards for most of the industry whether or not the loans were purchased by the GSEs greatly relaxed the underwriting approval process. An independent study of about loans found that the same loans were 65 percent more likely to be approved by the automated processes versus the traditional processes.

In a paper written in January , OFHEO described the process: "Once Fannie Mae and Freddie Mac began to use scoring and automated underwriting in their internal business operations, it was not long before each Enterprise required the single-family lenders with which it does business to use such tools. Some analysts believe that the use of AVMs, especially for properties in distressed neighborhoods, led to overvaluation of the collateral backing mortgage loans. In some mainstream banks told the Wall Street Journal that Fannie and Freddie were promoting small, thinly capitalized mortgage brokers over regulated community banks, [51] by providing these brokers with automated underwriting systems.

The Wall Street Journal reported that the underwriting software was "made available to thousands of mortgage brokers" and made these "brokers and other small players a threat to larger banks. Many of the loan products sold by mortgage lenders, and criticized for their weak standards, were designed by Fannie or Freddie.

For example, the "Affordable Gold " line of loans, designed by Freddie, required no down payment and no closing costs from the borrower. The closing costs could come from "a variety of sources, including a grant from a qualified institution, gift from a relative or an unsecured loan.

Countrywide, a company reported to have financed 20 percent of all United States mortgages in , had a close business relationship with Fannie Mae. Estimates of subprime loan purchases by Fannie and Freddie have ranged from zero to trillions of dollars. For example, in Economist Paul Krugman erroneously claimed that Fannie and Freddie "didn't do any subprime lending, because they can't; the definition of a subprime loan is precisely a loan that doesn't meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.

Critics claim that the amount of subprime loans reported by the two GSEs are wildly understated. The highest estimate was produced by Wallison and Edward Pinto, based on amounts reported by the Securities and Exchange Commission in conjunction with its securities fraud case against former executives of Fannie and Freddie.

The discrepancies can be attributed to the estimate sources and methods. The lowest estimate Krugman's is simply based on what is legally allowable, without regard to what was actually done. Other low estimates are simply based on the amounts reported by Fannie and Freddie in their financial statements and other reporting. As noted by Alan Greenspan, the subprime reporting by the GSEs was understated, and this fact was not widely known until "The enormous size of purchases by the GSEs [Fannie and Freddie] in — was not revealed until Fannie Mae in September reclassified a large part of its securities portfolio of prime mortgages as subprime.

The estimates of Wallison, Calomiris, and Pinto are based upon analysis of the specific characteristics of the loans. For example, Wallison and Calomiris used 5 factors which, they believe, indicate subprime lending. Those factors are negative loan amortization, interest-only payments, down-payments under 10 percent, low-documentation, and low FICO credit scores.

When Fannie or Freddie bought subprime loans they were taking a chance because, as noted by Paul Krugman, "a subprime loan is precisely a loan that doesn't meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income. However, some loans were so clearly lacking in quality that Fannie and Freddie wouldn't take a chance on buying them.

Nevertheless, the two GSEs promoted the subprime loans that they could not buy. He said that Freddie could usually find a way to buy and securitize their affordable housing loans 'through the use of Loan Prospector research and creative credit enhancements …. Miller added: 'But what can you do if after all this analysis the product you are holding is not up to the standards of the conventional secondary market? The GSEs had a pioneering role in expanding the use of subprime loans: In , Franklin Raines first put Fannie Mae into subprimes, following up on earlier Fannie Mae efforts in the s, which reduced mortgage down payment requirements.

At this time, subprimes represented a tiny fraction of the overall mortgage market. From forward, private lenders increased their share of subprime lending, and later issued many of the riskiest loans. However, attempts to defend Fannie Mae and Freddie Mac for their role in the crisis, by citing their declining market share in subprimes after , ignore the fact that the GSE's had largely created this market, and even worked closely with some of the worst private lending offenders, such as Countrywide.

In , one out of every four loans purchased by Fannie Mae came from Countrywide. Joseph Stiglitz [72]. Countering Krugman's analysis, Peter Wallison argues that the crisis was caused by the bursting of a real estate bubble that was supported largely by low or no-down-payment loans, which was uniquely the case for U. Sanders reported in December : "We find limited evidence that substantial deterioration in CMBS [commercial mortgage-backed securities] loan underwriting occurred prior to the crisis. Business journalist Kimberly Amadeo reports: "The first signs of decline in residential real estate occurred in Three years later, commercial real estate started feeling the effects.

Gierach, a real estate attorney and CPA, wrote:. In other words, the borrowers did not cause the loans to go bad, it was the economy. In their book on the crisis, journalists McLean and Nocera argue that the GSEs Fannie and Freddie followed rather than led the private sector into subprime lending. Just one year later, it dropped to There was no question about why this was happening: the subprime mortgage originators were starting to dominate the market. They didn't need Fannie and Freddie to guarantee their loans As Fannie's market share dropped, the company's investors grew restless Among its key recommendations for increasing In a article on Fannie Mae, the New York Times describes the company as responding to pressure rather than setting the pace in lending.

By , "competitors were snatching lucrative parts of its business. Congress was demanding that [it] help steer more loans to low-income borrowers. Lenders were threatening to sell directly to Wall Street unless Fannie bought a bigger chunk of their riskiest loans" [78]. According to Journalist McLean, "the theory that the GSEs are to blame for the crisis" is a "canard", that "has been thoroughly discredited, again and again.

The Government Accountability Office estimated a far smaller number for subprime loans outstanding than Pinto. Pinto stated that, at the time the market collapsed, half of all U. The GAO estimated in that only 4. Significantly, the SEC alleged and still maintains that Fannie Mae and Freddie Mac reported as subprime and substandard less than 10 percent of their actual subprime and substandard loans.

By contrast, the national average was 9. The Fannie and Freddie Alt-A default rate is similarly much lower than the national default rate. The only possible explanation for this is that many of the loans being characterized by the S. Still another criticism of Wallison is that insofar as Fannie and Freddie contributed to the crisis, its own profit seeking and not government mandates for expanded homeownership are the cause.

The GSEs were far more concerned to maximize their profits than to meet these goals; they were borrowing at low rates to buy high-paying mortgage securities once their accounting irregularities were behind them.


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Many readers might recall the periods of high inflation that resulted in the s, which are clearly shown in the first quartile of the Exhibit. That significant drop in inflation can be seen about a third of the way from the y-axis in Exhibit 1. What most readers including most economists do not know, however, is how long-term mortgage rates rose even higher than short-term rates during the early s, and then how subsequently long-term rates have tracked with inflation over time. Both Exhibit 1 and Exhibit 2 can be used to see how they have tracked, and they have not tracked well.

And that mistake of allowing mortgages rates to go to If there is anything we should learn from the past, it is that long-term rates should not be used to control inflation; unless of course, you believe current inflationary trends are expected to continue for the long-term also. Not only were long-term mortgage rates raised and mishandled in the early s, it is also noteworthy that it took a lot longer than it should have to lower long-term rates.

For the last years almost the full time for a year loan to mature , inflation as measured by the CPI has averaged 2. With mortgage-rates set so far above what they should have been set in , Fannie Mae and Freddie Mac were allowed to establish a policy that slowly lowered mortgage rates year after year, in effect allowing us to enjoy one refinancing cycle after another so that their mortgage portfolios could grow and grow and grow. Debt through refinancing meant nothing more than income to these Government Sponsored Enterprises. Not only did the GSEs have free reign on setting mortgage rate policy, they used that power to construct derivative REMIC-type products than enabled them to further outwit investors.

Hindsight you say? Considering technological productivity gains, the fall of the Berlin Wall, China-India-Brazil's development, and globalization in general, how long should it have taken our esteemed economists to understand that inflationary trends could be somewhat tame over the long haul? If you look at Exhibit 1 again, you will see that we have been experiencing the benefits of these factors and low inflation ever since the late s.

How did the GSEs get away with their strategy in light of oversight and investor supply and demand issues? There are two fundamental reasons why:. One, the Federal Reserve was asleep at the wheel. Even though we may revere our esteemed Reserve economists; the Federal Reserve never understood mortgage debt, nor did they ever question mortgage rate policy. Instead, the Fed simply received regular reports from Freddie Mac telling them what the current GSE mortgage rate policy was.