The Big Lie

First, a personal anecdote. One day in September or October of 2008, a time when it looked like the world was about to end, one of my colleagues--a stanch conservative and Rush Limbaugh devotee--came to my office and offered the unsolicited observation that Fannie Mae and Freddie Mac were responsible for the financial meltdown we were witnessing.

I found this observation odd at the time and I said so. As I pointed out, Fannie and Freddie were not mortgage originators. My view at the time, before I entirely understood the role Wall Street played in this mess, was that the primary culprits were private non-bank mortgage originators, such as Countrywide, Ameriquest, New Century, and IndyMac which made a practice of providing sub-prime mortgages (both new homes and refinancing of existing homes) to people who could clearly not afford them. They were able to do this because they did not keep the loans. They sold them off to investors, who would bundle together as mortgage-backed securities. Since they weren't on the hook if the mortgages went bad, they had no personal stake in sound underwriting principles. In short, they blew up the economy because they could make a lot of money doing it.

In any case, my colleague's view was that Fannie and Freddie--quasi government institutions--created the crisis because they "forced" lenders to lend to the undeserving poor.

This view has been widely repeated in conservative media outlets. Even Michael Bloomberg has repeated this story. Gretchen Morgenson, a highly-respected New York Times financial reporter, has also endorsed one version of this story.

Quite simply, this story is wildly at odds with the facts. It was cooked up by conservative ideologues who cannot abide the notion that a catastrophic financial collapse was brought on by people working in the private enterprise system and motivated by a desire for ever larger profits.

The government created a commission whose goal was to document and explain the causes of the 2008 meltdown. The official Financial Crisis Inquiry Report was predictably unable to achieve bipartisan agreement. The main report was endorsed by Democratic members and a minority report was endorsed by Republican members. This is not surprising. What was surprising is that there were TWO minority reports, one representing the views of all of the Republican members, except one. The second reflected the views of Peter Wallison, an American Enterprise Institute scholar, and it was only this dissent-from-the-dissent report that pushed the Fannie/Freddie-did-it line. Even the great majority of the partisan Republicans on the commission could not bring themselves to endorse a position that was so clearly inconsistent with the historical record.

How does Wallison support that which all of his colleagues rejected? Apparently, he relied on research by AEI consultant Ed Pinto that basically redefines "sub-prime" in such a way as to implicate the GSEs. For a detailed analysis of the Pinto research, see the work of Center for American Progress's David Minn. This graphic summaries it fairly well.

As you can see, the default rate of Pinto's "high-risk" loans look much more like the national average than actual sub-prime mortgages.

For a fair and comprehensive treatment of the financial crisis for those who don't want to wade through the government report, I would recommend All the Devils are Here by Bethany McClean and Joe Nocera. The basic story they and others tell is that, yes, Fannie and Freddie did get into the sub-prime mortgage business, but they were followers, not leaders. Fannie and Freddie entered this business fairly late in the crisis as an attempt to recapture some of the market share they had lost to the private market which had been originating sub-prime loans and selling them to Wall Street for years.

In his extremely negative review of Morgenson's book on the crisis, Robert Kuttner, though no apologist for GSEs, outlines who he sees as the worst offenders in the crisis in order of culpability.

1. Alan Greenspan's Federal Reserve, which lowered interest rates without increasing regulation, refused to enforce a 1994 law requiring prudent underwriting standards and turned a blind eye to abuses in the process of loan securitization.
2. The Office of Thrift Supervision, which let savings banks under its supervision engage in outlandishly risky practices.
3. The Wall Street firms that bankrolled subprime lenders and turned their high-risk loans into securities.
4. The credit-rating agencies that blessed toxic subprime securities with Triple-A ratings.
5. The SEC's failure to police those agencies
6. And, of course, the subprime lenders themselves.

This seems about right to me. The financial crisis, the effects of which we are still living through, was caused by a failure of government, but not the type of failure the Right would have you believe.