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Wall Street's Gullible Occupiers
...Beginning in 1992, the government required Fannie Mae and Freddie Mac to direct a substantial portion of their mortgage financing to borrowers who were at or below the median income in their communities. The original legislative quota was 30%. But the Department of Housing and Urban Development was given authority to adjust it, and through the Bill Clinton and George W. Bush administrations HUD raised the quota to 50% by 2000 and 55% by 2007.

It is certainly possible to find prime borrowers among people with incomes below the median. But when more than half of the mortgages Fannie and Freddie were required to buy were required to have that characteristic, these two government-sponsored enterprises had to significantly reduce their underwriting standards.

Fannie and Freddie were not the only government-backed or government-controlled organizations that were enlisted in this process. The Federal Housing Administration was competing with Fannie and Freddie for the same mortgages. And thanks to rules adopted in 1995 under the Community Reinvestment Act, regulated banks as well as savings and loan associations had to make a certain number of loans to borrowers who were at or below 80% of the median income in the areas they served.

Research by Edward Pinto, a former chief credit officer of Fannie Mae (now a colleague of mine at the American Enterprise Institute) has shown that 27 million loans—half of all mortgages in the U.S.—were subprime or otherwise weak by 2008. That is, the loans were made to borrowers with blemished credit, or were loans with no or low down payments, no documentation, or required only interest payments.

Of these, over 70% were held or guaranteed by Fannie and Freddie or some other government agency or government-regulated institution. Thus it is clear where the demand for these deficient mortgages came from....

...Accordingly, by the mid-2000s, investors had begun to notice that securities based on subprime mortgages were producing the high yields, but not showing the large number of defaults, that are usually associated with subprime loans. This triggered strong investor demand for these securities, causing the growth of the first significant private market for MBS based on subprime and other risky mortgages.

By 2008, Mr. Pinto has shown, this market consisted of about 7.8 million subprime loans, somewhat less than one-third of the 27 million that were then outstanding. The private financial sector must certainly share some blame for the financial crisis, but it cannot fairly be accused of causing that crisis when only a small minority of subprime and other risky mortgages outstanding in 2008 were the result of that private activity...