Also to blame, of course, were regulators, who gave the private mortgage market little, if any, oversight. The market’s watchdogs were lulled to sleep by a misplaced view that self-interested private financial institutions would regulate themselves. This flawed thinking was most pervasive at the nation’s most important financial regulatory agency, the Federal Reserve.
Getting history right for this dark economic period is critical if we are to design a better mortgage finance system for the future. If Fannie Mae and Freddie Mac are responsible for the debacle, then perhaps government’s role in a future mortgage finance system should be minimal. But if private lenders deserve most of the blame, the case grows for giving government an important role in backstopping and overseeing the system.
“If it grows like a weed, it probably is a weed.” This age-old banking adage aptly applies to the private mortgage lending business during the housing bubble. Between 2004 and 2007, private lenders originated three quarters of all subprime and alt-A mortgage loans. These were loans to financially fragile homeowners with credit scores under 660, well below the U.S. average, which is closer to 700. But only a fourth of such loans were originated by government agencies, including Fannie, Freddie and the Federal Housing Administration.
The dollar amount of subprime and alt-A loans made during this period by the private sector was jaw-dropping, reaching nearly $600 billion at the height of the lending frenzy in 2006. For context, this is about equal to the total amount Americans currently owe on bank credit cards. By contrast, government lenders made just over $100 billion in subprime and alt-A loans in 2006. Even in 2007, when the housing market was beginning its free fall, private lenders still handed out more than $300 billion via these very shaky mortgage loans.
All this can be seen in the share of total residential mortgage debt insured or owned by Fannie Mae and Freddie Mac. At the start of 2002, before the housing boom got going, the two agencies’ market share accounted for almost 54 percent of all mortgage debt. By summer 2006, the bubble’s apex, their share had fallen to only 40 percent. It is difficult to see how the agencies could have been responsible for inflating the housing bubble at a time when they were losing a full 14 percentage points of market share. Indeed, the opposite was true, as their position in the housing market rapidly diminished.