This article was sent to me by a friend and AMD.com follower.  It serves as a stark and realistic counterpoint to Barney Frank's recent letter written to Fannie and Freddie ("Barney the Underwriter"). 

I have excerpted the section that deals with the "Folly" of Past Lending Practices.  Link to full article on National Real Estate Investor (6/22/09).  


Learning from mistakes

However, although the Obama administration supports multifamily and affordable housing programs in general, the conservator warns that certain lending practices of the past amounted to “folly” and the government needs to avoid them as it seeks to stabilize the nation’s housing market.

The problem is that The Department of Housing and Urban Development set affordable housing goals that were unworkable for the government-sponsored enterprises, says Lockhart. The agencies need a well-defined and consistent mission based on the secondary mortgage market, but it has to be one that doesn’t require them to take excessive risk, he says.

“The affordable housing goals that HUD set in retrospect were too high, and frankly caused them to do some things that they shouldn’t have done. Freddie for instance was a very big buyer of subprime, private label securities, because they got affordable housing goal credit for that.”

Freddie and Fannie also made the mistake of guaranteeing loans on the secondary mortgage market that were highly leveraged, Lockhart told a gathering of the National Association of Real Estate Editors in Washington, D.C. “It was really a folly to let them be able to write mortgages at 100 to one leverage. In fact, their mortgage-backed services could have done it at 200 to one leverage.”

Regulators are targeting better minimum capital levels and risk-based capital to develop a counter-cyclical approach to financing, so that when housing prices rise too high, capital charges can rise, and when prices decrease, capital charges can also be lowered. “We need to figure out how to dampen some of the boom and bust."


AMD.com Commentary

The Conservator has correctly identified the cause of Fannie Mae's/Freddie Mac's failure and an origin of the Housing Bubble as "affordable housing goals that HUD set".  The Government overtly directed the GSEs to meet arbitrary, expanding and distortive housing goals, not behave reasonably or responsibly. 

The last paragraph highlights the need for minimum capital levels and risk management tools.  It is interesting that Congress forced Fannie Mae and Freddie Mac to abandon both during February and March of 2008 in a panicked and futile attempt to prop up housing prices.  (Case Study: Predicting the Collapse of Fannie Mae and Freddie Mac)

Finally, the following chart has been overused by this venue, but it definitively demonstrates the roots of the Housing Bubble.  The origin was Government intervention in the mortgage market which wildly distorted Homeownership rates.  Rapidly rising and record-level Homeownership levels caused subsequent unsustainable housing price appreciation which began in 1997.