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How Fannie Mae And Freddie Mac Sank In The Subprime Quicksand
In 2002, the George W. Bush administration urged Congress to pass the American Dream Downpayment Act, which subsidized the down payments of prospective homebuyers whose incomes were below a certain level.

After passage of that act, the president also urged Congress to pass legislation permitting the Federal Housing Administration to begin making zero-down-payment loans at low interest rates to low-income Americans.

In 2004, Federal Housing Commissioner John Weicher said, "the White House doesn't think those who can afford the monthly payment but have been unable to save for a down payment should be deprived from owning a home."

He added, "We do not anticipate any costs to taxpayers." Who, if not the taxpayers, would pay for these government subsidies — much less the defaults from making riskier loans — was not revealed.

For some homebuyers, the standards were relaxed to the point where there was no down payment at all required, contrary to a long-standing tradition that homebuyers should have some stake in the home, so as to reduce the risk of default on the mortgage. The reduction or elimination of traditional safeguards in mortgage lending entailed a rising riskiness of the mortgages acquired by Fannie Mae and Freddie Mac under the new and lower mortgage loan approval standards.

Under these political pressures, traditional mortgage loans with traditional safeguards began to decline and mortgage loans made under the "innovative" and "flexible" standards urged by government increased.

Traditional 30-year mortgages with a fixed interest rate, which were still 57% of all mortgages in 2001, fell to 33% of all mortgages by the end of 2006. Meanwhile, subprime loans rose from 7% of all mortgage loans to become 19% of such loans over the same span of years. Other nontraditional loans rose from less than 3% of all mortgage loans to nearly 14%.

Between 2005 and 2007, Fannie Mae and Freddie Mac acquired an estimated trillion dollars' worth of subprime and other nontraditional mortgages. This was approximately 40% of the value of all the mortgages they purchased from banks and other lenders during those years....

...Ordinarily, financial markets would become less willing to invest in an enterprise with ever-growing risks. But, although Fannie Mae and Freddie Mac are officially private, profit-making enterprises, their size and the federal government's involvement in both their creation and their ongoing operations led many investors to assume that the federal government would never allow them to fail.

Which is to say, the increasing riskiness of the assets of these two mortgage market giants was an increasing riskiness for the taxpayers, whether the taxpayers knew it or not.

Since more and riskier mortgages meant more profits to Fannie Mae and Freddie Mac, who could likewise rely on the federal government to cover any losses, it was perfectly rational for them to expand their purchases of riskier mortgages from the banks and other mortgage lenders.

Moreover, "creative" accounting within Fannie Mae and Freddie Mac themselves concealed the full extent of the risk until independent audits turned up discrepancies at both places, which led to the resignation of the heads of both institutions....

...Market criteria had long required such things as substantial down payments, as well as income and credit histories that made continuing payments likely. But all that was brushed aside in the political crusade for "affordable housing" and bigger homeownership statistics.

Both the unrealistic nature of policies pursued in the name of "affordable housing" and the serious dangers that such policies posed to the entire economy provoked many warnings from economists and others. But these warnings were repeatedly brushed aside by political leaders, often by shifting the focus to the supposed benefits of creating more homeownership through "affordable housing."...