Fannie Mae’s First Chief Credit Officer Blames Government for Sub-Prime Meltdown

In an insightful interview, Fannie Mae’s first Chief Credit Officer, Edward Pinto, corroborates our Research Fellow Stan Liebowitz‘s Independent Policy Report, Anatomy of a Train Wreck: Causes of the Mortgage Meltdown. Interviewed by Chip Hanlon, President of Delta Global Advisors, Pinto discusses how the affordable housing/lending lobby chipped away at lending standards until there were none, creating a gigantic and nonviable financial bubble that has triggered a global recession. Here is an excerpt:

Chip: So Congress created this mess with its desire to essentially throw caution to the wind, in the name of doing something good, and now they rail against Wall Street and fail to name themselves as movers in this issue.

Edward: Exactly. If you recall, in the late ’80s, the Congress was always complaining about there isn’t enough discretionary spending. We don’t have enough. We’re getting squeezed, we’re getting squeezed. Well, HUD and affordable housing was in the discretionary spending bucket.

So in effect Congress decided, well, if we can’t get it through spending that’s on-budget, what if we get to it with spending that’s off-budget. And Fannie and Freddie could put trillions into this. In fact, in 1994, Fannie Mae announced its first trillion-dollar affordable housing initiative, by Jim Johnson.

And then it was followed in 2001, I believe it is, that Frank Raines had a follow-on, a cumulative $2 trillion program. And Freddie Mac had a companion $2 trillion program that year. These were multi-year programs. But I’ve now named $5 trillion of initiatives.

That swamped anything Congress could have done through HUD.

Chip: Right. And only a government-ordained institution could go on and make such messy loans, throwing credit standards to the wind, in a way that no private institution that actually cared about getting its capital back would ever do. Correct?

Edward: Exactly. Because again, Fannie and Freddie had a dual personality. On one side it was a shareholder-owned company. On the other it had this charter that gave it basically a governmental aura. And they needed the support of Congress to keep that dual personality in place.

However they needed to raise their earnings in order to keep their shareholders happy, they needed to spend some of the earnings on the affordable housing to keep Congress happy, eventually it became a very insidious problem, because every time they’d meet these goals that HUD had set, and this was over about a 15- or 16-year period of this goal setting.

Every time they’d meet them, HUD would say, “Thank you very much.” They probably didn’t even say thank you. They’d say, “OK, we’re going to raise them.” So eventually the goals got to somewhere in the mid-50 percent range.

And when I say goals, they’re actually very complicated. There’s multiple goals, and their sub-goals, as only the government can do. And so Fannie Mae and Freddie Mac would end up with dozens of little boxes they had to fill, and quotas. And it was very much managed by HUD. HUD was the manager of this.

. . . .

Chip: On September 25, Mr. [James] Lockhart said he was going to try and force more bad loans through the system. Can you talk a little bit about what you’re seeing and where we’re heading?

Edward: James Lockhart is the conservator of Fannie and Freddie. He’s the regulator, he’s the one who put them into conservatorship and named himself conservator. I took that as a positive sign. In fact, he early on announced that there was a plan to reduce over time the size of Fannie and Freddie’s portfolio. Which is one place you have to start. There’s a lot that has to be done here relative to Fannie Mae, but that’s certainly a minimum place to start.

Well, I was astounded when I read his testimony of September 25, 2008. That’s two weeks ago! And it was before a committee chaired by Representative Barney Frank. The listeners may be aware of Barney Frank’s involvement in Fannie Mae for many, many years.

And here you know have the regulator/conservator in front of Barney Frank. And he told the committee and the chairman that A) he was fully cognizant of his dual authority of both safety and soundness regulator of Fannie and Freddie, and as mission regulator for their affordable housing mission, and he was not going to forget that.

Chip: Ugh.

Edward: Number one. And that was a change that had just been passed last year by Congress out of Barney Frank’s committee. Number two, he basically said that Fannie and Freddie, the old regime, the one that he put out, had tightened up on underwriting in order to protect themselves and protect homeowners.

However, they had gone too far in tightening up, and that he had instructed the new CEOs that he had named to review all of those tightenings and make sure that Fannie and Freddie’s affordable housing mission was not compromised. And of course make sure that of course their safety and soundness isn’t compromised. But we know...

Chip: They don’t mean that.

Edward: In 17 years, nobody has cared about their safety and soundness relative to affordable housing. Thirdly, and this is one of the really astounding pieces here, thirdly he goes on to say that Fannie Mae and Freddie Mac, he had to take them over not because they had created mayhem across the fruited plain with defaults and foreclosures and junk loans to the tune of $18.5 trillion. No, that wasn’t the reason.

The reason he had to take them over was because their ability to proceed with their affordable housing mission had been imperiled. How had they been imperiled? Well, lenders were no longer originating—in bureaucratese—”goal-rich loans.” Goal-rich loans are ones that meet affordable housing quotas.

And he turned the New York—the blame game, they’ve been blaming New York. All of the sudden the problem of Wall Street is that...

Chip: They’re not doing them.

Edward: That they’re not doing sub-prime loans. The sub-prime loans were goal-rich for Fannie and Freddie. So Fannie and Freddie have been hamstrung because Wall Street isn’t able to sell them sub-prime loans.

And thirdly, FHA’s volume has exploded because Congress has greatly expanded FHA’s abilities, and that is now competing with Fannie and Freddie. And therefore Fannie and Freddie have to redouble their efforts in order to compete with FHA. So you now have one government-owned entity, Fannie and Freddie, competing with another government-owned entity because they both need to do goal-rich loans.

The last point he made was he assured the committee that he had already started meeting with national housing advocacy groups to develop a plan to make sure that Fannie and Freddie would be able to implement and meet their affordable housing goals.

These are the same groups that have been pressuring congress, and congress has been willingly agreeing for the last 20 years.

David J. Theroux is Founder, President and Chief Executive Officer of the Independent Institute.
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