All the Devils Are Here [7]
Almost since the phrase “The American Dream” was coined in the early 1930s, it has been synonymous with homeownership. In a way that isn’t true in most other countries, homeownership is something that the vast majority of Americans aspire to. It suggests upward mobility, opportunity, a stake in something that matters. Historically, owning a home hasn’t just been about taking possession of an appreciating asset, or even having a roof over one’s head. It has also been a statement about values.
Not surprisingly, government policy has long encouraged homeownership. The home mortgage interest deduction is a classic example. So is the thirty-year fixed mortgage, which is standard in only one other country (Denmark) and is designed to allow middle-class families to afford monthly mortgage payments. For decades, federal law gave the S&L industry a small interest rate advantage over the banking industry—the housing differential, this advantage was called. All of these policies had unswerving bipartisan support. Criticizing them was political heresy.
Fannie Mae and Freddie Mac were also important agents of government homeownership policy. They, too, were insulated from criticism. Fannie Mae, the older of the two, was born during the Great Depression. Its original role was to buy up mortgages that the Veterans Administration and the Federal Housing Administration were guaranteeing, thus freeing up capital to allow for more government-insured loans to be made.
In 1968, Fannie was split into two companies. One, nicknamed Ginnie Mae, continued buying up government-insured loans and remained firmly a part of the government. Fannie, however, was allowed to do several new things: it was allowed to buy conventional mortgages (ones that had not been insured by the government), and it was allowed to issue securities backed by mortgages it had guaranteed. In the process, Fannie became a very odd creature. Half government enterprise, it had a vaguely defined social mandate from Congress to make housing more available to low- and middle-income Americans. Half private enterprise, it had shareholders, a board of directors, and the structure of a typical corporation.
At about the same time, Congress created Freddie Mac to buy up mortgages from the thrift industry. Again, the idea was that these purchases would free up capital, allowing the S&Ls to make more mortgages. Until 1989, when Freddie Mac joined Fannie Mae as a publicly traded company, Freddie was actually owned by the thrift industry and was overseen by the Federal Home Loan Bank Board, which regulated the S&Ls. People in Washington called Fannie and Freddie the GSEs, which stood for government-sponsored enterprises.
Here’s a surprising fact: it was the government, not Wall Street, that first securitized modern mortgages. Ginnie Mae came first, selling securities beginning in 1970 that consisted of FHA and VA loans, and guaranteeing the payment of principal and interest. A year later, Freddie Mac issued the first mortgage-backed securities using conventional mortgages, also with principal and interest guaranteed. In doing so, it was taking on the risk that the borrower might default, while transferring the interest rate risk from the S&Ls to a third party: investors. Soon, Freddie was using Wall Street to market its securities. Volume grew slowly. It was not a huge success.
Though a thirty-year fixed mortgage may seem simple to a borrower, mortgages come full of complex risks for investors. Thirty years, after all, is a long time. In the space of three decades, not only is it likely that interest rates will change, but—who knows?—the