Government Sponsored Enterprises

¶Between 1990 and 2004, homeownership rates in the United States increased rapidly from 64% to 69%, the highest level in 50 years.⁹³⁹³ f. While many highly regarded economists and officials argued at the time that this housing boom was the result of healthy economic activity, in retrospect, some federal housing policies encouraged people to purchase homes they were ultimately unable to afford, which helped to inflate the housing bubble.

¶Fannie Mae and Freddie Mac. Two government sponsored entities (GSE), the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), were chartered by Congress to encourage homeownership primarily by providing a secondary market for home mortgages. They created that secondary market by purchasing loans from lenders, securitizing them, providing a guarantee that they would make up the cost of other requirements, the rules prohibited lenders "from making loans based on collateral without regard to [the borrower's] repayment ability," required lenders to "verify income and obligations," and imposed "more stringent restrictions on prepayment penalties." The rules also required lenders to "establish escrow accounts for taxes and mortgage related insurance for first-lien loans." In addition, the rules "prohibit[ed] coercion of appraisers, define[d] inappropriate practices for loan servicers, and require[d] early truth in lending disclosures for most mortgages."). 91

¶12 CFR § 7.4000. 92

¶Cuomo v. Clearing House Association, Case No. 08-453,¹²⁹¹²⁹ Subcommittee interview of Steve Rotella (2/24/2010). See also 3/1/2007 Washington Mutual Inc. 10-K filing with the SEC, at 1 (Washington Mutual reduced its workforce from 60,789 to 49,824 from December 31, 2005 to December 31, 2006.); "Washington Mutual to cut 2,500 jobs," MarketWatch (2/15/2006), available at http://www.marketwatch.com/story/washington-mutual-cutting-2500-mortgage-jobs. S.Ct.²⁷¹⁰²⁷¹⁰ 3/9/2007 email exchange between Mr. Sparks and sales managers, "help," GS MBS-E-010643213. (2009).⁹³⁹³ f.

¶U.S. Census Bureau, "Table 14. Homeownership Rates by Area:¹⁹⁶⁰¹⁹⁶⁰ 9/17/2009 email to Daniel Sparks, "Mortgage commentary on Q3 earnings call," GS MBS-E-009853301, Hearing Exhibit 4/27-44. to 2009," http://www.census.gov/hhes/www/housing/hvs/annual09/ann09t14.xls.

¶any securitized mortgage that defaulted, and selling the resulting mortgage backed securities to investors. Many believed that the securities had the implicit backing of the federal government and viewed them as very safe investments, leading investors around the world to purchase them. The existence of this secondary market encouraged lenders to originate more loans, since they could easily sell them to the GSEs and use the profits to increase their lending.

¶Over time, however, Fannie Mae and Freddie Mac began to purchase larger quantities of higher risk loans, providing a secondary market for those loans and encouraging their proliferation. Between 2005 and 2007, Fannie Mae alone purchased billions of dollars in high risk home loans, including Option ARM, Alt A, and loans with subprime characteristics. For example, data from Fannie Mae shows that, in mid 2008, 62% of the Option ARM loans on its books had been purchased between 2005 and 2007.⁹⁴⁹⁴ Fannie Mae, 2008 Q2 10-Q Investor Summary, August 8, 2008, http://www.fanniemae.com/media/pdf/newsreleases/2008_Q2_10Q_Investor_Summary.pdf. Likewise, 84% of its interest-only loans were purchased in that time frame, as were 57% of those with FICO scores less than 620; 62% of its loans with loan-to-value ratios greater than 90; and 73% of its Alt A loans.⁹⁵⁹⁵ Id. While these loans constituted only a small percentage of Fannie Mae's purchases at the time, they came to account for some its most significant losses. By the middle of 2009, Fannie Mae reported an unpaid principal balance of $878 billion for its loans with subprime characteristics, nearly a third of its total portfolio of $2.7 trillion.⁹⁶⁹⁶ Fannie Mae, 2009 Second Quarter Credit Supplement, August 6, 2009, http://www.fanniemae.com/ir/pdf/sec/2009/q2credit_summary.pdf.

¶According to economist Arnold Kling, Fannie Mae and Freddie Mac purchased these loans after "lowering their own credit standards in order to maintain a presence in the market and to meet their affordable housing goals."⁹⁷⁹⁷ "Not What They Had In Mind: A History of Policies that Produced the Financial Crisis of 2008," September 2009, Mercatus Center, http://mercatus.org/sites/default/files/publication/NotWhatTheyHadInMind(1).pdf. (5/19/2004).

¶Throughout their history, Fannie Mae and Freddie Mac were able to bundle the mortgages they purchased into securities that were popular with investors, because many believed the securities carried the implicit support of the federal government. The Congressional Budget Office found the following:

"Because of their [Fannie Mae and Freddie Mac] size and interconnectedness with other financial institutions, they posed substantial systemic risk—the risk that their failure could impose very high costs on the financial system and the economy. The GSEs' market power also allowed them to use their profits partly to benefit their other stake- holders rather than exclusively to benefit mortgage borrowers. The implicit guarantee created an incentive for the GSEs to take excessive risks: Stakeholders would benefit when gambles paid off, but taxpayers would absorb the losses when they did not. …

One way that Fannie Mae and Freddie Mac increased risk was by expanding the volume of mortgages and MBSs held in their portfolios, which exposed them to the risk of losses

from changes in interest or prepayment rates. Over the past decade, the two GSEs also increased their exposure to default losses by investing in lower-quality mortgages, such as subprime and Alt-A loans."⁹⁸⁹⁸ Congressional Budget Office, "Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market," December 2010, at x, http://www.cbo.gov/ftpdocs/120xx/doc12032/12-23-FannieFreddie.pdf.

¶The risks embedded in their mortgage portfolios finally overwhelmed the GSEs in September 2008, and both Fannie Mae and Freddie Mac were taken into conservatorship by the federal government. Since that time, the Treasury Department has spent nearly $150 billion to support the two GSEs, a total which projections show could rise to as high as $363 billion.⁹⁹⁹⁹ Federal Housing Finance Agency, News Release, "FHFA Releases Projections Showing Range of Potential Draws for Fannie Mae and Freddie Mac," October 21, 2010, http://fhfa.gov/webfiles/19409/Projections_102110.pdf.

¶Ginnie Mae. Additional housing policies that allowed borrowers with less than adequate credit to obtain traditional mortgages included programs at the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA). Both agencies provided loan guarantees to lenders that originated loans for borrowers that qualified under the agencies' rules. Many of the loans guaranteed by the FHA and VA, some of which required down payments as low as 3%, were bundled and sold as mortgage backed securities guaranteed by the Government National Mortgage Association (Ginnie Mae), a government corporation. Ginnie Mae guaranteed investors the timely payment of principal and interest on mortgage backed securities backed by federally insured or guaranteed loans.

¶In the years leading up to the financial crisis, FHA guaranteed millions of home loans worth hundreds of billions of dollars.¹⁰⁰¹⁰⁰ The statistics cited in this paragraph are taken from the U.S. Department of Housing and Urban Development, "FHA Single-Family Mutual Mortgage Insurance Fund Programs, Quarterly Report to Congress, FY 2011 Q1," March 17, 2011, at 4 and 19, http://www.hud.gov/offices/hsg/rmra/oe/rpts/rtc/fhartc_q1_2011.pdf. According to FHA data, as of 2011, nearly 20% of all FHA loans originated in 2008 were seriously delinquent, meaning borrowers had missed three or more payments, while loans originated in 2007 had a serious delinquency rate of over 22%. The 2007 and 2008 loans, which currently make up about 15% of FHA's active loan portfolio, remain the worst performing in that portfolio. In 2009 and 2010, FHA tightened its underwriting guidelines, and the loans it guaranteed performed substantially better. By early 2011, the serious delinquency rate for all FHA borrowers was about 8.8%, down from over 9.4% the prior year.