There’s a lot of discussion now about the role of the GSEs in “the crisis.”  Unfortunately, not everyone is talking about the same crisis.  Some are talking about the housing bubble/crash, some are talking about the late 2008 financial crisis, and I believe both groups have the 2011 unemployment crisis in the backs of their minds (otherwise why is the debate seen as being so important?)  After all, there is no similarly high-charged debate over the auto crisis/bailout/sales slump.

Let’s start with the housing crisis.  A major theme of the Austrians is that too many houses were built in the mid-2000s, and the resulting slump has led to high unemployment.  Here are US housing starts per capita going back to 1960:

As you can see, housing starts over the last decade have been far below the level of previous decades.  We certainly don’t have a weak housing sector in 2011 because an extraordinarily large number of homes were built in the past decade.  Rather it seems the recession has caused many families to double up.  BTW, I will concede that we built too many homes in the mid-decade period, so I don’t completely deny the Austrian story.  I just don’t think too many houses is the huge “crisis” most people are talking about.

Instead, it seems to me that both sides of the GSE debate tacitly accept that lax lending standards due to either:

1.  deregulation and moral hazard causing banks to take excessive risks, or

2.  the GSEs and other federal housing rules, regulations, tax breaks, etc.,

caused a housing price bubble in the mid-2000s.  When this bubble collapsed, it created a severe banking crisis, which then led to a severe recession.

I believe this is mostly wrong.  I’ll concede that part of the housing bubble was due to the factors mentioned above (both banks and the GSEs played a big role.)  But the link between the housing bubble and the severe financial panic is much weaker than people realize.  And the link between the severe financial panic and high unemployment in 2011 is almost nonexistent.

The mistake both sides make is to look for monocausal explanations.  Here’s what the facts show:

1.  The economics profession almost entirely disagrees with me.  Yet in mid-2008 the consensus view of the economics profession was that we were NOT going to have a severe financial crisis and we were not going to have a severe recession.  Indeed growth was forecast for 2009, along with moderate unemployment.  And yet the scope of the subprime crisis was almost completely understood by that time.

After things blew up, Bernanke was mocked for early statements suggesting that likely subprime losses, even in the worst case, were not large enough to bring down the US banking system.  But of course he was right.  Here’s what actually happened:

1.  Between June and December 2008 both NGDP and RGDP fell sharply.

2.  The cause of the fall in RGDP was the fall in NGDP

3.  NGDP fell at the fastest rate since 1938 because the economy was already sluggish due to the housing slump, which reduced the Wicksellian equilibrium rate of interest.  Ditto for oil and auto sales.  Normally the Fed would cut rates enough to prevent a recession.  But this problem coincided with a severe commodity price shock, which drove up headline inflation and frightened the Fed.  They did not cut rates once between April and October, by which time the great NGDP and RGDP crash was nearly two thirds over.

4.  The big NGDP crash dramatically reduced almost all asset values in the second half of 2008.  About half way through this crash, the severe phase of the banking crisis started.  This doesn’t mean the earlier subprime fiasco played no role.  It did greatly weaken the system in 2007 and early 2008.  So the GDP crash was imposed on an already weakened banking system.  A cold turned into pneumonia.  GDP fell even faster.

5.  Estimated losses to the entire US banking system soared during this crash, and peaked in early 2009 at roughly $2.7 trillion, only a modest fraction of which were subprime mortgages.  Then expected growth rates recovered somewhat, asset values partially recovered, and estimated losses to US banking fell back under a trillion.  So the proximate cause of the financial crash was tight money which drove NGDP expectations much lower, although the earlier subprime fiasco certainly created an environment with a low Wicksellian equilibrium rate, making monetary errors much more likely.  And of course when rates hit the zero bound (which by the way didn’t occur until the great GDP crash had ended in December!!) the Fed had an even more difficult time steering the economy.

6.  To summarize, the severe financial crisis could not have caused the great GDP collapse, because monthly GDP estimates show it was half over before the post-Lehman crisis even began.  But even if this view is wrong, there is not a shred of theoretical or empirical evidence linking the current 9.2% unemployment with the 2008 financial crisis.  Theory suggests that if a central bank inflation targets, it drives NGDP.  The Fed says it has the economy where it wants it (in nominal terms), and doesn’t think we need more inflation.  When it did think we needed more inflation mid-2010 (when the core rate had fallen to 0.6%) it did QE2, which raised core inflation back up to roughly where the Fed wanted it.  Of course (just as in mid-2008) commodity price inflation is distorting Fed policy, but that’s a problem attributable to the Fed, not the financial crisis.

This graph shows how IMF estimates of total US banking losses are inversely correlated with expected total inflation and RGDP growth in 2009 and 2010.

I see three separate crises.  A “misallocation of resources into housing crisis,” a “federal bailout of banks crisis,” and a high unemployment crisis.  Who’s to blame for each?

1.  The private banking system and the GSEs both played a major role in causing too much housing to be built in the mid-2000s.  The errors of the private banking system were due to both misjudgment (they did lose money after all) and bad incentives (moral hazard due to various government backstops.)  Pretty much the same is true of the GSEs, although their role has always been a bit more politicized, and Congress must accept some blame for pushing them to boost the housing market.  But this was a modest problem, as the first graph shows.  It’s not the “real” issue that the left and right is debating so vigorously.

2.  The GSEs are far more to blame than the banks for the bailout problem.  And the banks most to blame are often smaller banks that made loans to developers, not the more famous subprime mortgages.  Last time I looked the estimated losses to the Treasury from the GSEs was a couple hundred billion, from the smaller banks (i.e. FDIC–which is financed by taxes, BTW) was over a hundred billion, and the big banks was near zero (depending on how much they lose on Bear Stearns.)  That’s all you need to know about where to apportion blame for the bailout crisis.

3.  As far as the high unemployment crisis, the proximate cause is low NGDP, which means the Fed is to blame.  Then we can apportion some blame to Obama for not putting more of his people on the Fed, and not doing it sooner.  But ultimately we macroeconomists are to blame, as both the Fed and Obama take their lead from us.  We were mostly silent on the need for vigorous monetary stimulus in the last half of 2008, and many have remained silent ever since.

The hero is the EMH, as markets warned the Fed that money was way too tight in September 2008.

In the history books it says the 1929 stock market crash triggered the Depression.  After an nearly identical crash in 1987 had zero effect on GDP, we learned that was false.  But it’s hard to blame historians for connecting a high profile financial collapse, with an economic collapse that was barely underway, and suddenly got much worse.   Economists should know better.

Here’s the GDP data I referred to (from Macroeconomics Advisers):

Here’s what Paul Krugman had to say about the role the Community Reinvestment Act played in encouraging reckless lending by Countrywide Financial:

As others have pointed out, Fannie and Freddie actually accounted for a sharply reduced share of the home lending market as a whole during the peak years of the bubble. To the extent that they did purchase dubious home loans, they were in pursuit of profit, not social objectives””in effect, they were trying to catch up with private lenders. Meanwhile, few of the institutions engaged in subprime lending””such as Countrywide Financial””were commercial banks subject to the Community Reinvestment Act.

I’m in no position to judge the accuracy of that statement, as mortgage banking is far from my area of expertise.  However a commenter named Patrick Sullivan sent me the following link from 1994, which casts a very different light on the relationship between Countrywide and the CRA.  It is from a ABA Banking Journal article written by Steve Cocheo:

A group of lenders not subject to CRA–and more directly under HUD’s purview–are the nation’s mortgage banks. In mid-September, the Mortgage Bankers Association of America-whose membership includes many bank-owned mortgage companies, signed a three-year master best-practices agreement with HUD. The agreement consisted of two parts: MBA’s agreement to work on fair-lending issues in consultation with HUD and a model best-practices agreement that individual mortgage banks could use to devise their own agreements with HUD. The first such agreement, signed by Countrywide Funding Corp., the nation’s largest mortgage bank, is summarized on this page. Many have seen the MBA agreement as a preemptive strike against congressional murmurings that mortgage banks should be pulled under the umbrella of the CRA.

Read the entire link, it is quite interesting.  I still think the GSEs were a far bigger problem than the CRA.  But as we saw in the previous post, Krugman also seems to have underestimated the role of the GSEs.

I seem to be the only blogger talking about this, which makes me think either I am ahead of the curve, or more likely making a bonehead error.  But as of yet no commenter has yet found the bonehead error I am making.

Last time I wrote on this subject the eventual cost to the government from bailing out the big banks was estimated at a negative $7 billion–in other words a profit to Uncle Sam of $7 billion.  There was an expected loss on the AIG bailout of $36 billion, and I acknowledged that could be viewed as a backdoor bailout of the big banks.  Indeed the entire TARP is a giant favor to the banking industry even if every dollar is repaid.  And now it appears it all will be repaid, even the AIG bailout.  (I am excluding the loans to automakers, which I regard as a separate issue.)

When the crisis first broke we were told the main problem was the big banks, and the underlying regulatory problem was “Too Big to Fail,” which encouraged the big banks to take excessive risks.  I now think my original view was wrong.  It appears that at the end of the day the biggest banking fiasco in the history of the universe will not result in any long run net taxpayer transfer to big banks.  And yet the owners and managers of those banks incurred mind-boggling losses.  So how plausible is it that TBTF was the primary cause of excessive risk taking in 2004-07?  If even a crisis this big didn’t result in  the long-run transfer of one cent of taxpayer money to big banks, does it seem likely that expectations of those transfers were a powerful motivating factor in the the MBSs they bought? Were they expecting an even bigger banking fiasco?  I suppose it’s possible, but I just don’t see it.

In contrast, massive quantities of taxpayer funds will be transferred to depositors at smaller banks, who (in collusion with the banks themselves) gambled recklessly by lending taxpayer-insured funds out to risky construction projects.  There I really do see a moral hazard problem, indeed what happened was essentially a repeat of the 1980s S&L crisis.  Once might be a fluke; twice is a systemic problem.  I’m increasingly likely to view the big bank crash as a fluke and the smaller bank crash as a chronic policy problem.  Indeed didn’t the same dichotomy occur during the Great Depression, with most failures being smaller banks?

So here are the eventual taxpayer losses we are looking at:

Fannie and Freddie  — $165 billion and rising

FDIC — Over $100 billion

FHA — Who knows, even today they’re still encouraging new sub-prime loans.

AIG — $0

The big banks — negative $7 billion

Would it be fair to say that the initial reporting of the crash of 2008 was a bit misleading?  The reporting that led most people to form indelible opinions that they will probably never re-visit or re-evaluate?

Some will argue that the Fed policy of buying MBSs indirectly helped the big banks.  Maybe so, but if we are talking about indirect effects from government programs, then what about the indirect effects of the Fed letting NGDP fall 8% below trend in 2008-09?  That hurt banks far more than any Fed MBS purchases helped them.

So tell me, why is my hypothesis wrong?

Continental Illinois was just the largest and most dramatic example of a bank failure in which creditors were spared any pain. Irvine Sprague, in his 1986 book:

“Of the fifty largest bank failures in history, forty-six””including the top twenty””were handled either through a pure bailout or an FDIC assisted transaction where no depositor or creditor, insured or uninsured, lost a penny.”

The 50 largest failures up to that time all took place in the 1970s and 1980s. As the savings and loan (S&L) crisis unfolded during the 1980s, government repeatedly sent the same message: lenders and creditors would get all of their money back. Between 1979 and 1989, 1,100 commercial banks failed. Out of all of their deposits, 99.7 percent, insured or uninsured, were reimbursed by policy decisions.

Then Russ discusses LTCM and the 1995 Mexican bailout before eventually arriving at the current crisis:　

That brings us to the current mess that began in March 2008. There is seemingly little rhyme or reason to the pattern of government intervention. The government played matchmaker and helped Bear Stearns get married to J. P. Morgan Chase. The government essentially nationalized Fannie and Freddie, placing them into conservatorship, honoring their debts, and funding their ongoing operations through the Federal Reserve. The government bought a large stake in AIG and honored all of its obligations at 100 cents on the dollar. The government funneled money to many commercial banks.

Each case seems different. But there is a pattern. Each time, the stockholders in these firms are either wiped out or see their investments reduced to a trivial fraction of what they were before. The bondholders and lenders are left untouched. In every case other than that of Lehman Brothers, bondholders and lenders received everything they were promised: 100 cents on the dollar.

A few comments:

1.  Reading Russ’s paper makes me realize just how much our system is biased toward debt.  And by the way, it isn’t just moral hazard; our tax system is also biased toward debt and against equity.  People talk about Americans borrowing too much, but given all these distortions it’s surprising that we don’t have even more debt.  Why didn’t I take out some mortgages and buy Florida condos?  I’d like to think it was civic virtue, but I suppose it was just laziness.

2.  This also made me realize the importance of Lehman’s failure.  It wasn’t just an isolated bankruptcy; it was a regime change that made enormous quantities of debt appear to be far riskier than just a few days earlier.  And the change was made just as the US was entering a severe recession.  I’m all for cracking down on moral hazard—but September 2008 was not the best time to do so.

Here Russ discusses how the system encouraged abuse:

George Akerlof and Paul Romer describe similar incentives in the context of the S&L collapse.   In Looting: The Economic Underworld of Bankruptcy for Profit, they describe how the owners of S&Ls would book accounting profits, justifying a large salary even though those profits had little or no chance of becoming real. They would generate cash flow by offering an attractive rate on the savings accounts they offered. Depositors would not worry about the viability of the banks because of FDIC insurance. But the owners’ salaries were ultimately coming out of the pockets of taxpayers. What the owners were doing was borrowing money to finance their salaries, money that the taxpayers guaranteed. When the S&Ls failed, the depositors got their money back, and the owners had their salaries: The taxpayers were the only losers.

This kind of looting and corruption of incentives is only possible when you can borrow to finance highly leveraged positions. This in turn is only possible if lenders and bondholders are fools””or if they are very smart and are willing to finance highly leveraged bets because they anticipate government rescue.

When you read Russ’s paper you begin to wonder if much of the US economy is just a giant Ponzi scheme:

1.  Bank creditors ignore risk, knowing they will be bailed out.

2.  Bank equity-holders have an incentive to borrow at low rates (due to the protection of creditors), and so they take highly leveraged gambles.

3.  Bank presidents have an incentive to take big risks, as they can earn large bonuses if the gambles pay off.

4.  Bank depositors have an incentive to look for the highest rate of return, regardless of how reckless the bank is.

5.  Home-buyers have an incentive to take out mortgages with the smallest possible down-payments, particularly in non-recourse states.

Taxpayers are left holding the bag.

And that is just the banking system.  Insurers like AIG (and their customers) had an incentive to take enormous ricks, knowing they would be bailed out.  Hospitals in McAllen Texas spent vast amounts treating poor patients, knowing Medicare will bail them out.  Then there is our pension system; corporations have an incentive to have underfunded pension plans.  And does anyone think Uncle Sam would allow states like California or Illinois to default on pension obligations?  And why stop at states?  Perhaps whole countries are playing this game.  What about lenders to Greece?  How about Iceland; didn’t their citizens recently vote down a proposal that they pick up the cost of meeting deposit insurance obligations in British and Dutch branches of Icelandic banks?  I am certainly not suggesting that the Icelandic banking fiasco was some sort of nefarious plot hatched by Icelandic taxpayers, but rather that there may be a good reason why they never contemplated the tax liability associated with the European branches of Icelandic banks.  With the possible exception of taxes, government-created moral hazard is the primary factor distorting market economies around the world

Some of my commenters suggest that if we had my monetary nirvana of 5% expected NGDP growth, then people would take greater risks.  Perhaps, but also think about this.  The biggest single factor driving bailouts is the fear that failures would worsen a recession.  If government policymakers knew there was going to be 5% expected NGDP growth regardless of whether Lehman was bailed out or not, then I think it would be easier for them to ‘do the right thing” and refrain from bailouts. I don’t recall all that many bailouts during the prosperous Clinton years.  Gambles were made (in tech stocks) but for the most part those who lost money paid the price.  My point is not that Clinton himself had anything to do with the difference, rather that we are more risk averse when a financial failure seems likely to trigger a recession.

I have been a long-time foe of Fannie and Freddie (going back 20 years) and I am pleased that Russ was able to dig up a lot of dirt.  Here is just one of many examples:

The most important change at Fannie and Freddie, however, was their approach to the down payment. In 1997, fewer than 3 percent of Fannie and Freddie’s loans had a down payment of less than 5 percent.

But starting in 1998, Fannie created explicit programs where the required down payment was only 3 percent. In 2001, it even began purchasing loans with zero down. With loans that had a down payment, it stopped requiring the borrower to come up with the down payment out of his own funds. Down payments could be gifts from friends or, better still, grants from a nonprofit or government agency.

A few weeks ago I was kind of shocked to see respected bloggers speak well of the financial reform package.  I can’t see how it addressed ANY of the major causes of the 2008 fiasco.  But easily the most inexcusable aspect of the bill was that it didn’t even address Fannie and Freddie.  People excuse that on the basis that there is a lot of political support for F&F.  But if you can’t reform them right after a $165 billion taxpayer bailout, when will they be unpopular enough that we can address their flaws? (And the best way to address the flaws would be to phase them out of existence.)

And no ban on sub-prime mortgages?  I thought that was the cause of the crisis.  You’d think a minimum 20% down-payment would have been the centerpiece of the bill.   Two years ago all my left wing friends said; “See how bad capitalism is?  All those unregulated banks made lots of sub-prime loans.”  OK left-wing friends, where is the regulation that prevents banks from reverting back to sub-prime lending?

When the crisis broke in 2007 I was completely ignorant about some of the details of what had been going one.  Of course I had heard that there were lots of sub-prime loans, and that in recent years almost anyone could get a mortgage.  But when I bought my house in 1991 I was told I needed to put 20% down or else buy mortgage insurance.  I had no idea that the practice had been phased out.  Here is Russ describing what happened:

When the down payment was less than 20 percent, Fannie and Freddie required private mortgage insurance (PMI). On a zero down payment loan, for example, the borrower would take out insurance to cover 20 percent of the value of the loan, protecting Fannie and Freddie from the risk of the borrower defaulting. But starting in the 1990s, an alternative to PMI emerged””the piggyback loan, a second loan that finances part or all of the down payment. The use of piggyback loans grew quickly beginning in the 1990s through 2003 and even more dramatically in the 2004-2006 period.  For example, in a study of the Massachusetts mortgage market, the Warren Group found that in 1995, piggyback loans were 5 percent of prime mortgages. The number grew to 15 percent by 2003. By 2006, over 30 percent of prime mortgages in Massachusetts were financed with piggyback loans. For subprime loans in Massachusetts, almost 30 percent were financed with piggybacks in 2003 and more than 60 percent by 2006.

Here is something I haven’t heard many people talk about.  Couldn’t one argue that moving away from mortgage insurance for less than 20% downpayment mortgages was a factor in the crisis?  Maybe I am missing something simple here, but it seems to me that with mortgage insurance you actually have institutions with “skin in the game.”  Perhaps the mortgage insurance companies would have been just as reckless as AIG, and allowed O% no -income verification mortgages with phony appraisals.  But even in that worst case scenario the existence of mortgage insurance have reduced the losses to the banking industry.  Even if the mortgage insurance companies had to be bailed out, at least they would have absorbed some of the losses now absorbed by banks and taxpayers.   And I think in practice they would not have been quite that reckless.

My second observation is that the big mistakes were made in the 1990s, when we allowed F&F to dramatically lower their standards and stopped requiring mortgage insurance on less than 20% down mortgages.  And this loosening of standards occurred right after one of the biggest banking fiasco’s in American history–the S&L crisis, which required an enormous taxpayer bailout of our deposit insurance system.  When this happened everyone was running around saying “See deregulation doesn’t work, we need to re-regulate the banking system.”  And I think that they did tighten up in a few areas like capital requirements.  But the most important trend in the 1990s was actually deregulation, the dramatic lowering of the standards on who could get a mortgage.  I don’t know how much of this was explicit deregulation, and how much was a failure of regulators to do something affirmative in the face of financial “innovation.”  So I am not trying to make an ideological point here, or point fingers at one party of the other.  My point is that we responded to the S&L crisis by talking about the need for tighter regulation, and then acted in a completely contrary way.  As far as I can see our current actions also have little to do with the 2008 crisis.

I think the debate over regulation gets clouded by ideology.  What does “increased regulation” mean?  Does it mean more government involvement in banking, or less?  Consider our current banking system in America, where we essentially nationalized all bank liabilities in 1934.  When you deposit $100 in the bank, you are loaning it to the Treasury, which re-loans it at the same rate to the bank.  Those are insured deposits.  Now consider a “regulation” that said banks could only lend out money from insured deposits on mortgages with more than 20% down-payments.  While this proposal would increase “regulation,” it would also reduce the role of government in our banking system.  Instead of the government being liable for deposits in any bank failure, they would only be liable for those where banks were engaged in relatively safe behavior.  It would dramatically reduce the scope of deposit insurance.

I agree with Russ’s Hayekian perspective, we can’t solve these problems by trying to micromanage the economy.  But I also think that libertarians must be careful in offering policy advice in complex environments.  When Iceland’s government deregulated banking, and allowed Icelandic banks to open extensive branches in Europe, the Icelandic government was in many was becoming more involved in the Icelandic economy, exactly the opposite of how it may have initially appeared.  Their government took on vast new liabilities associated with the British and Dutch deposits of Icelandic banks.  That’s a responsibility that the Icelandic government did not have before deregulation.   Deregulation is usually good, but not when it increases the role of government in our financial system.  I’m afraid that much of the banking “deregulation” of the 1990s did exactly that, it enormously increased our government’s explicit and implicit liabilities.

In the 1930s the right had to choose between a modest amount of inflation (returning prices to the pre-Depression levels) or more socialism.  They weren’t thrilled with big government, but their strongest opposition was reserved toward policies of inflation.  So we ended up with deflationary policies between 1929 and 1933.  Of course the voters wouldn’t accept 25% unemployment, so we got big government instead of the inflation.

As this video shows, we are essentially facing the same choice today.  We could pump up the economy through monetary policy, or we can have Fannie and Freddie continue to throw $100s of billions down the drain, socialize the auto industry, extend unemployment benefits to 99 weeks, etc.  And if that isn’t enough there are also calls to move away from free trade policies.  And then there’s the higher taxes we’ll pay in the future to cover the costs of debts run up in a futile attempt to stimulate the economy.

Just as in the 1930s, the right seems to have decided that a little bit of socialism is better than a little bit of inflation.  What do I mean by a little bit of inflation?  I mean enough so that the post-September 2008 trend rate of inflation is the same as the pre-September 2008 trend rate of inflation.  Apparently even that little bit of inflation is more distasteful than massive government intervention in the economy.

And the irony is that many of the policies I describe, such are Fannie and Freddie propping up the housing market, unemployment insurance extensions, and trade barriers, are themselves slightly inflationary.  But they don’t just raise the price level, they also cause all sorts of distortions—they move prices away from their free market equilibrium.   (I’m looking at you Morgan.)

The even greater irony is that this isn’t even one of those pick your poison cases.  The inflation I am calling for would be nothing more than a continuation of the inflation that occurred in the previous two decades.  We’d want it even if we hadn’t had a housing crisis and recession.  I don’t recall conservatives complaining loudly that 2% inflation was a disaster when Clinton was president.  So why the sudden and hysterical opposition to 2% inflation?  Is that really a fate worse than socialism?

The still greater irony is that the more the conservatives win today, the more inflation we’ll get in the long run.  The conservatives got their way in the early 1930s, but it so discredited their ideology that it opened the door to much higher inflation over the next 40 years.

Part 2.  A few more “whiffs” of racism directed against Fannie and Freddie.

As you know, some fearless bloggers have exposed the “whiff” of racism in attempts by conservative economists like Raghu Rajan to blame the government for the mortgage fiasco.  Here for example, is Edmund Andrews:

Of all the canards that have been offered about the financial crisis, few are more repellant than the claim that the “real cause” of the mortgage meltdown was blacks and Hispanics.

Oh, excuse me — did I just accuse someone of racism?   Sorry.  Proponents of the above actually blame the crisis on “government policy” to boost home-ownership among low-income families, who just happened to be disproportionately non-white and immigrant.  Specifically, the Community Reinvestment Act “forced” banks to make bad loans to irresponsible borrowers,  while Fannie Mae and Freddie Mac provided the financial torque by purchasing billions worth of subprime paper.

The argument has been discredited time and again, shriveling up almost as soon as it’s exposed to sunlight.  But it keeps coming back, mainly because the anti-government narrative gives Republicans a way to deflect allegations that de-regulation allowed Wall Street to run wild.   It’s the financial version of Sarah Palin’s new line that “extreme environmentalists”  caused the BP oil spill.

Paul Krugman caught a whiff of it in a recent commentary by Raghuram Rajan in the FT, and quickly denounced it.

Now Bloomberg.com seems to be making those sorts of racist accusations:

June 14 (Bloomberg) — The cost of fixing Fannie Mae and Freddie Mac, the mortgage companies that last year bought or guaranteed three-quarters of all U.S. home loans, will be at least $160 billion and could grow to as much as $1 trillion after the biggest bailout in American history.

.   .   .

The companies’ liabilities stem in large part from loans and mortgage-backed securities issued between 2005 and 2007. Directed by Congress to encourage lending to minorities and low- income borrowers at the same time private companies were gaining market share by pushing into subprime loans, Fannie and Freddie lowered their standards to take on high-risk mortgages.

Many of those went to borrowers with poor credit or little equity in their homes, according to company filings. By early 2008, more than $500 billion of loans guaranteed or held by Fannie and Freddie, about 10 percent of the total, were in subprime mortgages, according to Fed reports.

It seems even the Fed is peddling those vicious racist lies.

Even worse, they assert that Fannie and Freddie’s heavy involvement in sub-prime lending continued even during the height of the housing bubble:

The composition of the $5.5 trillion of loans guaranteed by Fannie and Freddie suggests that the surge in delinquencies may continue. About $1.98 trillion of the loans were made in states with the nation’s highest foreclosure rates — California, Florida, Nevada and Arizona — and $1.13 trillion were issued in 2006 and 2007, when real estate values peaked. Mortgages on which borrowers owe more than 90 percent of a property’s value total $402 billion.

That doesn’t seem to mesh with what I’ve been reading in Krugman’s blog:

He [Schwarzenegger] asserted, as a simple matter of fact, that “government created the housing bubble”, because Fannie and Freddie made all these loans to people who couldn’t afford to pay them.

This is utterly false. Fannie/Freddie did some bad things, and did, it turns out, get to some extent into subprime. But thanks to the accounting scandals, they were actually withdrawing from the market during the height of the housing bubble “” the vast majority of the loans now going bad came from the private sector.

Yet it’s now clear that the phony account of the crisis “” that it’s all due to Fannie, Freddie, and nasty liberals forcing poor Angelo Mozilo to make loans to Those People “” is setting in as Republican orthodoxy

If you are wondering what the phrase “it turns out” refers to, perhaps it is this earlier post by Krugman:

But here’s the thing: Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.

Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t: the definition of a subprime loan is precisely a loan that doesn’t meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.

So whatever bad incentives the implicit federal guarantee creates have been offset by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can take. You could say that the Fannie-Freddie experience shows that regulation works.

Just to get serious for a moment; when I get upset at “Those People,” I am thinking about the Congressmen who created Fannie, Freddie and the CRA.  And yes, I know that the CRA was only a minor factor in the crisis, but everyday it becomes clearer that Washington’s attempts to enlist Fannie and Freddie into their crusade to make every American a homeowner lies at the center of this crisis.  Indeed the misdeeds of the “too-big-to-fail” banks (and their associated bailout with TARP funds), now comes in a distance third (or fourth if you include the Fed), far less costly to taxpayers than even the misbehavior of smaller banks that exploited the incompetence of the FDIC.

The experts say we can’t eliminate F&F right now, and I suppose they are right.  But only because we don”t have a monetary policy that stabilizes NGDP growth expectations.