Fannie Mae's Impact
on the United States Economy

Edward J. Dodson

[A letter submitted to the New York Times, 18 June, 2011.
This letter to the editor was not acknowledged or published]

Reading the June 16 commentary on Fannie Mae by David Brooks, I struggle to recognize the company and the character of the individuals described. I say this as someone who worked at Fannie Mae for twenty years, from 1984 until early in 2005.

Fannie Mae's story is, from my perspective, far more complex than what appears in the newspapers or even in the new book by Gretchen Morgenson and Joshua Rosner. As a lower level member of Fannie Mae's management group, I was not always in agreement with the decisions made by our senior management, but the work we did played an important role in bringing needed credit to many people who for many decades were ill-served by the banking sector.

When David Brooks tells readers that "Fannie Mae ... cost taxpayers about $153 billion" as fallout from the current crash of the nation's property markets, he does so without the necessary context. What has cost taxpayers hundreds of billions of dollars is a long process of ideologically-driven dismantling of regulatory oversight of the financial services industry. This process began in the 1970s with creation of the first money market funds which, within a few short years, brought on the collapse of the savings and loan industry. Stagflation added to the problems by lowering the value of mortgage loan portfolios held by the banks - and by Fannie Mae and Freddie Mac. When I joined Fannie Mae at the end of 1984 the company was in jeopardy of insolvency. Two 'innovations' - the introduction of adjustable rate mortgage loans and mortgage-backed securities - saved the residential mortgage market from what might have been a total collapse.

Whether Lyndon Johnson's decision to privatize Fannie Mae was right or merely expedient is a question for economic historians to resolve. However, privatization meant that the company had to compete in the credit markets for funding and had to establish and meet earnings targets to satisfy Wall Street stock analysts. As the U.S. economy stabilized, as interest rates fell and the housing markets began to recover in the mid-1980s, the size of conventional mortgage market exploded with tens of millions of homeowners refinancing out of higher rate mortgage terms - not just once, but two or even three times as rates continued to fall. The surviving savings banks and almost all of the commercial banks no longer originated mortgage loans for portfolio. They were more than happy to book origination fees, then pass on the interest rate risk to MBS investors. Fannie Mae and Freddie Mac established uniform standards, introduced initiatives to expand homeownership to minorities, and closely monitored lender performance. Risk management was, in my experience, always a very high priority at the company, even as the nature of the growth in the sub-prime mortgage market - and Wall Street's creation of higher-yielding private placement MBS -- imposed heavy market share and volume pressures on the GSEs.

A good deal has been written about the motivations of Fannie Mae's top executives to, as David Brooks writes, "expand their clout, their salaries and their bonuses." For this to occur, the company had to become profitable. David Maxwell guided the company into profitability during the years of stagflation and then recession. Johnson faced enormous challenges during his tenure as volumes skyrocketed and the entire industry was moving from a paper-intensive business to one increasingly in need of state-of-the-art technologies to keep pace. Fannie Mae needed to recruit and retain people not only highly motivated by the company's public mission but who also commanded levels of compensation available working on Wall Street or at the trading desks of major banks. In our era of unbridled greed, the amounts received by James Johnson and others who followed him are well down the list. Were they paid too much for a corporation with a stated public purpose and benefiting by its AAA bond-rating attributable to its "special status?" Perhaps. Those decisions were made by members of the board of directors. With each passing year, the value of Fannie Mae's stock increased, which broad modest levels of new wealth to the majority of employees and significant wealth to top executives.

Clearly, to those who held Fannie Mae stock or invested in conventional mortgage-backed securities, the company was not "a cancer that helped spread risky behavior and low standards across the housing industry." That honor, from my perspective, goes to the originators of sub-prime mortgages (often predatory in structure and plagued by widespread fraud), the bond rating agencies, the Wall Street firms that packaged these loans for sale to investors, and investors who failed to do due diligence on the nature of the underlying collateral. At least up until the time I retired from Fannie Mae, very little of the sub-prime mortgage volume being originated made it past our risk management group.

The great failure of leadership at Fannie Mae (and Freddie Mac) was the failure to recognize the depth of damage the sub-prime business model was exacting on an inherently dysfunctional but integrated national property market. That failure is shared by most economists and most elected officials responsible for enacting law. Our property markets go through boom-to-bust cycles every 18-20 years, driving by speculative forces and fueled by the ability to leverage savings with debt. As property prices were driven up each year, Fannie and Freddie accommodated speculation by annually increasing their maximum loan limits, moving into what had historically been treated as the "jumbo" market. To keep transaction volumes high, there was no choice but to raise permitted loan-to-value ratios and even eliminate down payment requirements. The private mortgage insurance carriers went along and assumed much of the increased risk of loan losses. Property appraisals revealed, of course, that the mortgage financing provided by the GSEs was devoted more and more to the purchase of land and less and less to the purchase of actual housing. Land-to-total value ratios in many metropolitan markets averaged 50 percent or greater.

The collapse of the sub-prime mortgage market accelerated the timetable of the collapse of the speculative bubble in the property markets, but the bubble was set to burst anyway. Fannie Mae might have weathered the storm if there had been a normal recessionary downturn. But, when the private placement MBS market crashed, the crash extended into the conventional MBS market as well, even though the performance of the underlying loans had not yet been adversely affected. Fannie's stock values plummeted, making it impossible to raise capital and meet regulatory stress tests. The nail in the coffin came with recession and rising unemployment, causing rising delinquencies on conventional loans and (even after mortgage insurance claim payments) increasing losses.

There are measures that could be adopted to prevent the return of yet another boom-to-bust property market cycle and all the harm that results. Whether Fannie Mae should be dissolved totally or become an agency of the government again is but a small part of the debate. The trouble is, almost none of the debate is focused on the measures required to tame our property markets.