Timothy Howard was an executive at Fannie Mae through the 90s and into the 2000s, leaving just a few years before the big crash of 2008 when the government bailed out the Government Sponsored Enterprise (GSE). This book is an incredibly detailed inside-view of the secondary mortgage market and the rise and fall of the GSEs in the modern economy.
Most people know Fannie Mae from the 2008 mortgage crisis where the government stepped in and bailed them out, but it’s been around in various forms since the New Deal. Fannie Mae does not issue loans to consumers directly; rather, they are (still) a major player in the “secondary mortgage market”—that is, they purchase existing loans from the banks that originally lend the money out. This is fantastic for the banks: when they sell their loan on the secondary market, they immediately earn their profit (interest), their risk disappears (since they are no longer servicing the loan and thus aren’t on the hook in case of a default), and they have their capital back to loan out again.
The common criticism of Fannie Mae’s behavior leading up to 2008 is that they were so interested in fueling minority and low-income home ownership that they were willing to gobble up just about any loans that lenders would originate, regardless of risk or quality. This skewed the incentive for lenders to issue billions in bad loans, knowing they could off-load them on Fannie. The conservative/libertarian economic view is that, since Fannie Mae (and Freddie Mac, another GSE) had an implicit backing from the federal government, they were able to complete unfairly against non-sponsored (i.e. private) enterprises in the secondary mortgage market, and that government backing prompted artificial trust by investors that otherwise would not have existed in the free market. In other words, government’s intervention in the mortgage market skewed up the economics involved, negatively impacted the risk variables, and caused the financial crisis. He writes: “The U.S. financial crisis was the direct result of a pitched battle between supporters and opponents of the GSEs for control of the $11 trillion residential mortgage market” (16).
But according to Timothy Howard, the exact opposite is true. As an employee of Fannie Mae beginning in the 80s, and ultimately an executive, he has a unique vantage point on the crisis—how it developed, why it crashed the way it did, and who deserves the blame. Howard was forced out in 2006 due to a political scandal and a lawsuit that was litigated until 2012, during which he could not publicly defend himself or Fannie Mae. He was eventually exonerated, and The Mortgage Wars is his personal and professional defense. And it is vigorous.
Howard argues that, contrary to the public perception developed in the media, Fannie Mae took an extremely conservative and stringent approach to risk management all the way through the 90s and up to the point where he was forced out due to political and legal issues. He claims that, because of their implicit government backing, free market economists such as Milton Freidman and Alan Greenspan ideologically targeted Fannie for (full) privatization, regardless of how superbly they managed the risk in their portfolio. Indeed, Howard argues that Fannie actually resisted getting into the speculative and risky sub-prime loans and mortgage-backed securities (MBS) which the rest of the market began indulging in, and as a result they lost market share to the big private players. According to Howard, it was actually their irresponsible actions that toppled the entire system.
Howard goes into great technical detail (for the layman reader, at least) about how Fannie Mae developed and refined their risk management strategies during his tenure; he describes the frequent political battles Fannie’s executive team faced with the Treasury Department, Congress, and the various agencies tasked with regulating their business. By his account, Fannie’s financial management was impeccable and full of integrity despite constantly being on defense against political and ideological enemies who wouldn’t play fairly.
Howard blasts the credit rating agencies as being complicit in the rapid growth of junk mortgage-backed securities and other financial vehicles that were so complex as to obscure their real risks. He argues that the de-regulation of the late 90s fueled the irresponsible and risky growth of Fannie’s private competitors in the secondary mortgage market. In Howard’s version, Fannie was the lone responsible participant standing strong against the tide of speculative (but immensely profitable) private lending in the early 2000s. For example, he writes:
Fueled by the relaxation of underwriting standards and the new types of high-risk loan products being introduced, growth in outstanding residential mortgages—which had been in double digits since 2001—accelerated to 14 percent in 2004. That same year, Fannie Mae’s combined portfolio and mortgage-backed securities grew by less than 5 percent. The credit guaranty business we were losing to the private-label market had a related effect on our portfolio. Diminished issuance of Fannie Mae mortgage-backed securities led investors with a preference for these securities to bid up their prices, and this caused spreads between the yields on Fannie Mae debt and MBSs to fall to a level where many fewer mortgages met our risk and return criteria for purchase. The portfolio, having grown at an average rate of 14 percent between 2000 and 2003, barely grew at all in 2004. With faster market growth and much slower growth in each of our two businesses, Fannie Mae’s 28 percent share of outstanding mortgages financed in December 2003 plunged to 26 percent just 12 months later […]
Having lost to the private-label market the ability to influence the types of loans being made to borrowers, our job now had become to maintain our credit discipline and protect ourselves as best we could, so that when the private-label market finally succumbed to its excesses (as it inevitably would), we would be in a position to step back in and help the recovery process. How long that might take— and how much damage would be done to borrowers, the mortgage market, and the housing market in the interim—was anybody’s guess.
Another claim that contradicts the mainstream narrative:
The government-sponsored enterprises had a public mission, and because their business was limited to the residential mortgage market, they had strong incentives to protect it. (Fannie Mae had contemplated going public with concerns about interest-only ArMs [adjustable rate mortgages] in 2004, only to decide against it for fear of a backlash from our lenders.) Investment banks and hedge funds, in contrast, were free-market institutions with free-market incentives. And rather than pour water on the private-label securities fire, their response was to add gasoline to it in the hopes of making money from the conflagration
I am no expert of the ins and outs of the mortgage market, especially when it gets into the complexities of securitization and risk management models involving hundreds of billions of dollars. Howard’s book was an eye-opening alternate story to the one I was familiar with, and while I’m not necessarily convinced that of his intellectual and economic premises concerning the government’s role in the mortgage market (or any market, rather), his narrative definitely added to the complexity of my understanding and provided much food for thought. I would recommend this book to anyone looking to better understand all sides of the 2008 mortgage crisis. We are still feeling its effects, and no doubt the final version of its history is yet unwritten.
(A digital copy of this book was provided by the publisher through Netgalley for purposes of review.)