Did the Federal Government Help Drive the Subprime Mortgage Bubble?

The Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) play a key role in the housing market by purchasing mortgages from the banks that issued them, which frees up the bank’s capital, which in turn lets the banks make loans to more prospective homeowners.  Fannie Mae often securitizes the mortgages it buys from banks, and for a small fee, guarantees the investors who purchased these mortgage-backed securities that they will receive their principal and interest even if the homeowners default.  Fannie Mae and Freddie Mac enjoy the implicit backing of the federal government (which became explicit during the financial crisis of 2008-2009).  They are a type of entity called a government-sponsored enterprise (GSE).

According to a study released by the American Enterprise Institute, in 1996 the federal Department of Housing and Urban Development (HUD), which helps regulate certain GSEs, began issuing guidelines stating that a certain percentage of mortgages acquired by Fannie Mae and Freddie Mac had to have originated with respect to low-income borrowers.  As home prices continued to soar in the late 1990’s and early 2000’s, the only way the agencies could fulfill that mandate was if loans to low-income borrowers had small down payment requirements or none at all.  When the subprime housing bubble finally collapsed starting in 2007, commentators pointed to various causes of the bubble- predatory lending, deregulation, and a government-mandated effort to increase home ownership rates.  Unfortunately, the study of the last factor is often mired in politics, as some critics of the banking industry view any attempt to blame the government or borrowers as misguided.

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