“Under direction of its chair, James Johnson, Fannie Mae had seen the political value of lending to low-income borrowers. In 1991, even before the enactment of the GSE Act, Fannie had made a $10 billion pledge of support for low-income housing, adapting a vehicle for reduced underwriting standards…

…called the Community Homebuyer Program (CHBP)…..In 1993 alone, the percentage of Fannie’s business volume with loans that had loan-to-value (LTV) ratios over 90 percent had almost tripled, from 6.85 percent to 18.77 percent. A report to Fannie’s Credit Policy Committee in 1995 pointed out that “(p)erformance of the standard high-LTV community lending product is more than 50 percent worse than a control group for 1993…….Thus, even before the affordable-housing goals were fully in effect, Fannie had begun to experience the costs associated with nontraditional mortgages (NTMs)……But Johnson pushed ahead. In 1994, Fannie made its first “Trillion Dollar Commitment,” promising to spend this dramatic sum over ten years in support of low-income housing. Because the affordable housing goals were already in force, this promise was making a virtue of necessity. But it reflected Johnson’s view, again correct, that Fannie’s franchise would be bulletproof in Congress if it committed itself to financing homes for low-income and minority borrowers. A 1997 article in the New York Times reported, “Mr. Johnson has won the widespread admiration from advocacy groups working to expand home ownership among low-income people and others left out of the housing market.” “We all understood,” said Tim Howard, later to become Fannie’s chief financial officer, “that accomplishing the goals of the Trillion Dollar Commitment would require and easing of our credit standards, specifically for loans with lower down payments….and loans to borrowers with less than perfect credit.”

The year 1995 was pivotal in setting the pattern for the GSEs’ later development. In that year, HUD ruled that Fannie and Freddie could get affordable-housing goals credit for buying private mortgage-backed securities (PMBS) that were backed by loans to low- and moderate-income (LMI) borrowers. This ruling provided an opportunity for subprime lenders or securitization sponsors to create pools of subprime mortgages that were likely to be rich in loans that met the affordable-housing goals. These were then sold either directly or through Wall Street underwriters to Fannie and Freddie, which became by far the largest buyers of these high-risk PMBS. Between 1997 and 2007, Fannie and Freddie bought more than $700 billion in subprime PMBS…..about 30 percent of all PMBS issued during that period…..and an additional $154 billion in Alt-A PMBS, about 12.5 percent of the total issued. As will be shown later, these PMBS were bought not for profit or for market share, but to meet the affordable-housing goal quotas.

By creating a large market for PMBS backed by NTMs, Fannie and Freddie enabled Wall Street firms…which previously focused primarily on securitizing prime jumbo loans…..to get their start in the business of issuing and underwriting PMBS backed by NTMs.

Why such desperation (to meet HUD’s ever higher affordable housing goals)? It is important to recall Fannie Chair James Johnson’s original perception that Fannie’s franchise would be impossible to challenge if the firm were associated in Congress with assisting low-income housing. From that time forward, the first rule of Fannie’s management and employees was to preserve the franchise. That objective had become all the more compelling in 2003, when the Bush administration was beginning to propose tougher regulation of Fannie and Freddie to a Republican Congress, and some of the more zealous free marketers (like me) were suggesting that Fannie and Freddie be privatized.”, Peter J. Wallison, “Hidden in Plain Sight, Chapter 6, The Decline in Underwriting Standards”

Posted on April 10, 2015, in Postings. Bookmark the permalink. Leave a comment.

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