Unaffordable Housing and Political Kickbacks Rocked the American Economy

By Issa, Darrell | Harvard Journal of Law & Public Policy, Spring 2010 | Go to article overview

Unaffordable Housing and Political Kickbacks Rocked the American Economy


Issa, Darrell, Harvard Journal of Law & Public Policy


The economic earthquake that shook the world financial markets and bankrupted seemingly invulnerable multinational corporations exposed perilous fault lines of the federal government's own creation. Under mounting pressure, at a critical moment, the fault lines cracked and took down everything from auto manufacturers to insurance providers.

Now that the Obama Administration's comprehensive regulatory reform proposals are making their way through Congress, the time has come to identify the root causes of the most recent economic downturn. Many leading economists agree: The economic crisis we are experiencing is directly tied to an over-inflated housing bubble wherein mortgage lenders made reckless, high-risk loans. These loans were given in record number to over-extended, under-qualified borrowers to satisfy an increasingly aggressive government drive for home ownership. Why the lenders adopted such counterintuitive and irresponsible business practices is the critical question. The answer reveals the disastrous folly of government intervention in the housing market spanning more than three quarters of a century.

To secure affordable housing, Congress created a new Government Sponsored Enterprise (GSE) known as the Federal National Mortgage Association (Fannie Mae) during the Great Depression to purchase and securitize home mortgages and promote greater liquidity in the mortgage market (1) At a time of unprecedented economic strain, the nation welcomed this fundamental component of President Franklin Delano Roosevelt's New Deal.

For thirty years, Fannie Mae had a near-monopoly on the secondary mortgage market and, with the backing of the federal budget, an ostensibly endless supply of capital. In 1965, President Lyndon Johnson established the Department of Housing and Urban Development (HUD) as a part of his Great Society plan to eradicate poverty and promote homeownership through a government-run housing program and government subsidized mortgage lending. Facing mounting debt, however, Johnson later contrived a scheme to privatize Fannie Mae, removing the corporation's liabilities from the federal balance sheets without limiting the potential for a taxpayer bailout. (2)

By 1970, Congress was pushing Fannie Mae to purchase conventional mortgages, though the effort was complicated by federal restrictions on numerous primary lenders that were unable to work with Fannie Mae. The solution? Congress created the Federal Home Loan Mortgage Corporation (Freddie Mac) as a wholly-owned government-run mortgage lender, (3) and then re-chartered it in 1989 as a publicly traded enterprise. (4)

As the market for secondary mortgages grew, Fannie Mae and Freddie Mac nearly achieved monopoly results thanks to numerous competitive advantages guaranteed through their unique relationship with the federal government. (5) Among these advantages were government-backed lines of credit equal to a whopping $2.25 billion and a corollary market reputation that led investors to believe the GSEs were too big to fail. (6) This inflated investor confidence and exclusive government protection resulted in an unnatural expansion of Fannie Mae and Freddie Mac's market dominance, and by the time the 1990s rolled around, the corporations together held more than three quarters of the secondary market for prime mortgages. (7)

The GSEs were aided immensely by the federal government because Congress charged Fannie Mae and Freddie Mac with keeping the secondary mortgage market liquid and increasing the availability of affordable housing. No other private companies could borrow money at such an affordable rate. Private debt markets were willing to lend the GSEs money at an interest rate not much higher than the relatively risk-free rate they charged the U.S. government itself. (8)

As a matter of regular business, Fannie Mae and Freddie Mac sold their bonds in the debt markets at relatively low price points and used the borrowed money to purchase mortgages from primary lenders like Countrywide Financial that dealt directly with customers seeking home loans. …

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