Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance [Englisch] [Gebundene Ausgabe]

A key point to note as you read this excellent book is that it is written by not one, but four professors - so, if you are expecting a thriller that explores the nefarious nexus between Washington and Wall Street, you will be deeply disappointed. I, personally, was disappointed there was no end of chapter questions and that the solutions to the non-existent odd numbered problems were missing in the back pages.

Kidding aside, I strongly believe in comparative advantage and we should not expect professors to become Carl Bernstein and Bob Woodward or vice versa. The book is very well-served by the academic approach as the authors navigate the reader through economics, finance, history, and public policy issues with ease and eloquence. Fannie and Freddie are presented as two neglected children of abusive self-serving parents (the government and the equity holder) and the entire family has developed some very bad habits. There is a striking metaphor in the book that compares the creation of the agencies and Frankenstein. I was very impressed with the aptness of several metaphors that are interspersed throughout the book. Likening the entry of Fannie and Freddie into the high risk mortgage market to Caesar's crossing the Rubicon is another one worth mentioning.

The authors demonstrate with a lot of patience, that capital, that is supposed to flow to its most efficient use in capital markets unfortunately went to its more levered use. Because of the implicit government support, the typical risk/reward considerations are marginalized and as long as the housing markets boomed, the government took advantage of the agencies to promote public policy without recognizing the cost, and the equity markets enjoyed the benefits of leverage. The cast of the whole show and their roles are examined, as the book looks at various actors including other mortgage originators, MIs and Large Complex Financial Institutions (LCFIs) and their part in the crises.

A well-researched essay on housing markets across the globe and how and why different countries stacked up the way they did during the crisis provides a global perspective. The dicussion of potential conflicts because of Fed's ownership of GSE securities and its important tool for monetary policy, the interest rate is interesting. The reforms proposed in the book, for example the recommendation to set up a system similar to TRIA will provide material to mull over several cups of coffee.

While there are references to corporate governance and implicit signals of government support through the presidential appointees in the boards, the incentive plans of Fannie and Freddie's management and how compensation metrics played a part could have been provided more context.

Despite ample coverage of the housing crisis in the popular press and numerous other publications, this book will still appeal to the student or the "student at heart" due to its well-thought out structure, clever use of anecdotes and analogies. The authors have not been averse to including quotes from a variety of sources to enhance the reader's experience.

To my knowledge, this is the best work done so far on the financial crises of 2007-09, which peaked in September 2008 when, days after Fannie Mae and Freddie Mac were placed in conservatorship by the Treasury Secretary, several of the nation's largest financial institutions became insolvent and either were sold at fire sale prices to healthier banks or went bankrupt.

I have read numerous books on the subject, and reviewed several of them on Amazon, including reviews of the Financial Crisis Inquiry Commission's report, A Colossal Failure of Common Sense, The Big Short, and Too Big to Fail. I have done my own research in primary materials published by the Fed, the GSE's, and dozens of papers published by regional Fed employees and academics around the world and hundreds of blog posts from bloggers of all political perspectives.

This is the best work I have seen. It is concise - in fact, probably too concise - and accurate. It focuses on the heart of the problem, namely the way in which several bipartisanly enacted Federal policies of promoting home ownership turned Fannie and Freddie into "Federal Frankensteins" -- giant, severely undercapitalized, voracious consumers of credit risk that were, by dint of their size and also of biases built into the capital regulations for banks and other financial institutions, so deeply embedded into global financial system that they accounted by themselves for one-sixth of all "systemic risk" in not just the nation but the world.

While focused on Fannie and Freddie, this is not the simple "Community Reinvestment Act" screed that a few have pounded the drum for, and it even goes beyond the intensive credit risk analysis of Ed Pinto and Peter Wallison that has been well publicized. It emphasizes the leverage / undercapitalization of Fannie and Freddie relative to the credit risk, and also explains - not as much as I would have liked - the way in which rules regarding the capital of banks and other financial institutions subsidized demand for ever more Fannie and Freddie paper and thus incentivized their ever deeper push into weaker and weaker credits, to the point where they had subprime exposure - just subprime - equal to 6 times their capital when they went under.

For those who do not find this account persuasive, I will end by quoting one fact that the authors strangely do not use but which I find to be the strongest support for the view that the 1995 policy changes are the wellspring of the crisis; it comes from the Fed's Flow of Funds reports. From 1986 to 1995, the annual growth in US residential mortgage debt averaged less than $200 billion per year; considering inflation and population growth, the rate of growth relative to demand declined significantly over that period. In 1995, when mortgage growth was only $150 billion, the then administration launched its "National Homeownership Strategy" to expand home ownership in which F & F financing played a major role. By 1998, mortgage growth more than doubled, past $300 billion; by 2001 it was over $500 billion, and in 2005, it exceeded $1 trillion. In other words, annual mortgage growth went up more than 600% in that decade. The authors show how most of that was backed by or was held by F & F and how F & F backed or held, in most years, large segments of the subprime volume. This is the best account of how that was a not exclusive, but certainly principal, cause of the financial crises of 2007-09.

On a forum such as Amazon, book readers are free to write whatever reviews they like; but when they completely miss the point, throw in quotes out of context, and mistakenly ignore important sources of data used in a book, authors feel compelled to respond. In response to the review and exchange by "nycreader1", we suggest that readers should consider our clarifications below and also look at what we believe are more balanced and accurate book reviews provided in the Financial Times and Bloomberg:

[...]

The title "Guaranteed to Fail" refers to the fact that the GSEs took on the credit risk of almost 50% of the mortgage market with very little capital. It is also an intended pun as they were for all practical purposes guaranteed by the government.

With respect to the reviewer ("nycreader1")'s points concerning gaps and omissions, we beg to differ:

(1) The fact that the GSE mortgages were higher quality than others is discussed in the book, but unfortunately those mortgages were not sufficiently high given that the GSEs held less capital (much higher leverage), as confirmed by their eventually facing losses in the range of (at least) $200 billion.

(2) The government-sponsored hedge fund reference is only meant to describe their risk taking, with the focus on "government-sponsored" not just on hedge fund, nor to say that they were actually organized as a hedge fund. Their extensive use of derivatives to hedge some of their interest rate risk is consistent with that terminology.

(3) The reviewer's comment on interest rate risk is taken out of context. The book explains how analysts and academics missed the boat by not focusing on the credit risk of the GSEs' holdings and guarantees -- i.e., by not realizing that the mortgages were not sufficiently safe relative to the GSEs' (far too thin) capital levels.

(4) Our reference to the accounting scandals is made in passing and is used just to explain why their mortgage portfolios didn't grow. We are unsure why these scandals should be necessarily have been called "frauds". More importantly, we do make a compelling case that there were portfolio and leverage issues at the GSEs even post-accounting scandals.

(5) We do describe the GSE loan performance. The data used are primarily those of Fannie and Freddie themselves, and their regulator (the FHFA). We in fact went to great lengths to ensure our conclusions were consistent with their own data. We don't "rely" on Pinto's data (which the reviewer claims in a response to a comment) but offer it only as corroborative evidence (see pp. 37-38).

Of course, we had to rate the book to post this review and we have rated it as 5-star, but the point was to convey that we have researched hard on the GSEs before putting this book out,
unlike what the review by nycreader1 (mistakenly) asserts.

- Viral Acharya, Matthew Richardson, Stijn van Nieuwerburgh and Lawrence J. White, authors of Guaranteed to Fail