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By Root 3423 0

Freddie indispensable in the new mortgage market was one simple fact: the mortgages they guaranteed were the only mortgages investors wanted to buy. After all, the GSE guarantee meant that the investors no longer had to worry about the risk that homeowners would default, because Fannie and Freddie were assuming that risk. For some investors, GSE-backed paper was the only type of mortgage they were even allowed to buy. In many states, it was against the law for pension funds to purchase “private” mortgage-backed securities. But it was perfectly okay for them to buy mortgage securities backed by the GSEs, because those were treated like obligations from the government. States, meanwhile, had blue sky laws designed to prevent investment fraud, meaning that Wall Street firms had to register with each of the fifty states to sell mortgage-backed deals, a process they had to repeat on every single deal. Mortgage-backed securities issued by the GSEs were exempt from blue sky laws. In 1977, in one of the earliest efforts to put together a mortgage-backed securities deal, Salomon Brothers developed a bond made up of Bank of America mortgages. It was a bust. After that, almost all the early deals were ones in which Fannie and Freddie were the actual issuers of the mortgage-backed securities, while Wall Street was essentially the marketer.

Even before the advent of mortgage-backed securities, Fannie and Freddie had the reputation of being “difficult, prickly, and willing to throw their weight around at a senior level,” according to one person who had regular dealings with them. It didn’t matter. They couldn’t be shut out of the market, because they were the market. By June 1983, the government agencies had issued almost $230 billion in mortgage-backed securities, while the purely private sector had issued only $10 billion. That same year, Larry Fink and First Boston pioneered the very first so-called collateralized mortgage obligation, or CMO, a mortgage-backed security with three radically different tranches: one with short-term five-year debt, a second with medium-term twelve-year debt, and a third with long-term thirty-year debt. (Fink still keeps on his desk a memento from the deal; it has a tricycle to memorialize the three tranches.) But as usual, the actual issuer of the mortgages wasn’t First Boston. It was Freddie Mac. “They [the GSEs] were the enabler,” Ranieri would later explain. “They wound up having to be the point of the spear.”

The fees from these deals were plentiful, to be sure. The sheer excitement of building this new market was exhilarating. But there was something about being subservient to the GSEs—with all the built-in advantages that came with their quasi-government status—that stuck in Ranieri’s craw. He wanted the role of the GSEs to be radically reduced. And if the only way he could get that done was to go to Washington and get some laws changed, then that’s what he would do. Thus began the quiet war between Lew Ranieri and David Maxwell.

Ranieri had strong ties to the Reagan administration and knew he would find a receptive audience there. Like every president, Ronald Reagan professed to stand squarely on the side of the American homeowner. But David Stockman, his budget director; Larry Kudlow, one of Stockman’s key deputies; and a handful of others, didn’t believe that homeownership was necessarily synonymous with Fannie Mae. In particular, they didn’t like the implied government guarantee. As market-oriented conservatives, they believed that the private sector was perfectly capable of issuing mortgage-backed securities without Fannie and Freddie. In 1982, President Reagan’s Commission on Housing even recommended that the GSEs eventually lose their government status entirely.

With Ranieri’s help, the administration drafted a bill to put Wall Street on a more equal footing with the GSEs. It was called the Secondary Mortgage Market Enhancement Act, although those in the know always used its slightly slippery-sounding acronym when they talked about it: SMMEA. Ranieri had another name for it: “the private