Wednesday, June 16, 2010

Why Rajan and Pinter Are Wrong About GSEs and Subprime

I’ve already discussed this a little in my review; but I thought it might be worthwhile breaking this section out a little. The question is whether Fannie and Freddie in some manner “caused” the housing bubble or the financial crisis.

I’m actually fairly sympathetic to this view. Certainly, whatever the answer to that question is—it’s clear that Fannie and Freddie are horrible ideas. They’ve eaten up something like $140 billion in taxpayer dollars, and may eventually cost up to $1 trillion.

Here’s the argument Rajan makes: economists Mian and Sufi have shown that the period from 2002-2005 saw an extraordinary burst in low-income lending. At the same time, Pinter—a former credit officer from Fannie and Freddie—has documented how the GSEs actually invested far more in subprime mortgages than other people think.

Yet there are good reasons to doubt these links. Mian and Sufi themselves point to rising securitization—rather than government involvement—for the expansion in lending to low-income households. After flooding other income groups, private lenders had nowhere left to go but down.

Meanwhile, it’s clear that Pinter’s analysis is misleading. As James Kwak has shown; the mortgages that Pinter classifies as “subprime like” (and which Rajan treats as subprime) were actually prime mortgages with poor credit qualities. Other than some investments in subprime MBS—the GSEs basically left the entire subprime field entirely.

Again, this is not mean to absolve the GSEs of any misdoing entirely. It’s clear that they loaded up on numerous credit risks they didn’t understand. Their involvement in subprime MBS boosted their market. Their role in purchasing mortgages on a secondary market had the effect of fueling an the mega-lender model in housing (think Countrywide or WaMu).

But to grant them a central role in the crisis is probably a little much. We had an extraordinary boom in all sorts of credit markets—including credit cards, commercial real estate, and auto debt. Fannie and Freddie have been around for decades. Their presence is bad enough without their being implicated in currently high unemployment.

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