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Fannie & Freddie: Turning the ‘American Dream’ into a Nightmare

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Who’s responsible for the housing and foreclosure crisis?

In 2011, The Financial Crisis Inquiry Commission, a 10-member panel created by Congress in  2009 to investigate the cause of the financial crisis, concluded that Fannie and Freddie “contributed to the crisis but were not a primary cause,” blaming instead everybody else — federal regulators, Wall Street investment banks, subprime lenders and irresponsible borrowers.

But Oonagh McDonald, author of Fannie Mae and  Freddie Mac: Turning the American Dream Into a Nightmare, (Bloomsbury 2012) places blame squarely on government housing policy, namely Fannie and Freddie’s “affordable housing ideology” that triggered the housing bust and subsequent  financial crisis.

McDonald, a widely respected expert in financial regulation and a former member of the British  Parliament, deftly traces the origins of the foreclosure crisis to the mid-1990s, when President Bill Clinton launched the National Home Ownership Strategy in June 1995. The strategy stressed the need to “make it easy for people to own a home,” setting a quota of 8 million low-to-moderate income homeowners by 2000. And in 2002, when  President George W. Bush unleashed his American Dream Down Payment Initiative whose goal was to bridge the “home ownership gap” among minorities.

“The affordable housing ideology dominated the American housing market for 13 years  and ultimately destroyed it,” muses McDonald, a British scholar of financial  markets in her thoroughly researched and footnoted study. “Clinton set the wheels in motion; Bush did little to stop the juggernaut of ‘affordable’ or ‘subprime lending,’ which rolled on without any obstacles in its way. But when housing prices began to fall and interest rates began to rise, almost half of  the outstanding mortgages were revealed as subprime. When it all went wrong, politicians both in the U.S. and elsewhere, sought to deflect attention from their own actions by the ever-popular sport of attacking and blaming the banks. Of course, many of the banks played their part as well, but the prime responsibility is a political one of seeking to increase home ownership at any  price.”

McDonald argues that “politicians of every hue” and many other players — including lenders, borrowers and regulators — failed to see the risks involved in jettisoning  proper underwriting standards, despite the warning signs. She spends much of the book tracing the evolution of prevailing attitudes toward government’s  involvement in home ownership from the 1990s to the present day. Along the way she delivers a good institutional history of the modern federal housing  industrial complex (Fannie Mae, Freddie Mac, Federal Housing Administration and  the U.S. Department of Housing and Urban Development (HUD), concentrating not only on failed leaders like Fannie chairman James A. Johnson, one of the  architects of promoting home ownership while enriching himself, and Fannie chairman Franklin D. Raines, one of the architects who left under the cloud of an accounting scandal in 2004.

“Politicians supported Fannie and Freddie as they thought this was the best way of making sure that the banks had the funds to lend and reducing the costs of mortgages for poor families,” she writes. “They refused to see the dangers of low  deposits, low or non-existent credit scores and no or low documentation of incomes or incomes consisting of welfare payments. Fannie and Freddie were grossly mismanaged, weakly regulated, while senior executives made millions,”  she writes.

But it all ended in September 2008, when millions of American borrowers, whose  loans were guaranteed by Fannie and Freddie, started defaulting and the government had to step in and rescue Fannie and Freddie, costing U.S. taxpayers  some $142 billion.

From President Clinton’s announcement of the National Home Ownership Strategy in 1995 to Fannie and Freddie’s collapse in 2008, this book skillfully traces the disastrous results in housing when government intervention, bailout capitalism and social engineering take hold.

Politicians, regulators and banks, argues McDonald, still have much to learn from a period  dominated by “affordable housing” ideology. She believes Fannie and Freddie should be phased out over a set period of years. And regulators should turn their attention to ending bad lending. Sound underwriting practices should be reintroduced and enforced.

But that’s easier said than done. Fannie, Freddie and the Federal Housing Administration, another government agency, currently back 90 percent of all newly originated mortgages.

This is an important book, but it does have a few flaws. The book would have benefited by having an American editor, who would have certainly known that  President Clinton’s home town is Little Rock, Ark., not San Antonio, Texas (page  56). Moreover, the book’s price tag — at $85 — will keep many readers from purchasing it.

Surprisingly, however, the nation appears to have learned remarkably little from the foreclosure crisis, McDonald claims. She says that the grand social experiment to “democratize” homeownership through reduced lending standards has turned into a nightmare, triggering millions of foreclosures. Yet there is no evidence that the lessons have been learned by the political  class in Washington, D.C.

To the contrary, the same people that steered the economy into this foreclosure crisis are back in power, tasked with cleaning up the mess they themselves made, warns McDonald. Even more worrisome, they want to expand the role of the  federal government in housing to “fix” the foreclosure crisis. Beltway politicians would be well advised to read this detailed history of how not to meddle with housing.

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