The following is a sneak preview from the Prospect's September issue:
Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon By Gretchen Morgenson and Joshua Rosner, Times Books, 331 pages, $30.00
As the Wall Street crisis unfolded, one prominent financial writer after another weighed in with an important book. Followers of these events have eagerly awaited a book by one of the best, The New York Times's Gretchen Morgenson. After most of the major topics had been taken, Morgenson chose to focus on mortgage behemoth Fannie Mae and its role in the crisis. Reckless Endangerment, co-written with Wall Street analyst and reform advocate Joshua Rosner (whose name appears on the cover in smaller type), provides a vivid portrait of a corrupted institution, but it gets key facts egregiously wrong.
There are really three books here. One is a richly deserved takedown of Jim Johnson, the chief executive of Fannie Mae during the 1990s, followed by the story of the eventual collapse of Fannie due to its speculative investments and corrupt accounting. Johnson converted Fannie from a staid and prudent quasi-public utility that purchased safe mortgages in a secondary market into a high-flying financial-services company bent on increasing its market share, its stock value, and the compensation of its top executives. Johnson's own pay peaked at $21 million in 1998. That's shocking for the head of a government-chartered company serving a public purpose of promoting homeownership and, not incidentally, putting taxpayers at risk. In 2008, the government had to take over Fannie at a cost that has now risen to about $85 billion and could go higher. (Oddly, this denouement is barely discussed.)
The second book is a series of choppy digressions on other aspects of the crisis unrelated to Fannie Mae. Some of this free-standing material is excellent, such as the discussion of the corruption of the credit-rating agencies, the analysis of the housing bubble, and the description of how subprime came to dominate lending in Georgia -- though Fannie is nowhere to be seen in these chapters, and it feels as if the reader has suddenly parachuted into another tale.
But most disappointing -- disgraceful -- -is a third book that blames the entire financial collapse on misguided efforts to increase homeownership among minority and moderate-income Americans and places Fannie Mae at the center of that enterprise. "Fannie Mae led the way in relaxing loan underwriting standards," Morgenson and Rosner write, "a shift that was quickly followed by private lenders." They have that backward.
The public record is unequivocal: The private lenders led the deterioration of mortgage standards; Wall Street financed them; and Fannie resisted and then belatedly followed. This part of the book, from the first pages in the opening chapter, is overheated in its prose, sloppy with its facts, and disingenuous in its story line. It is a serious disservice to a fair understanding of the crash and its origins.
According to Morgenson and Rosner, here is how Fannie Mae caused the great collapse. In 1994, President Bill Clinton launched the National Partners in Homeownership. At the time, Jim Johnson, aspiring financial mogul, wanted to build Fannie Mae into a giant, but he faced enemies and needed cover. And what better cover than a social mission of expanded homeownership? The plan "was to commit so much money to low income housing," Morgenson and Rosner write, "that no one would dare to criticize its other activities."
The enemies included other bankers who resented both the credit line at the Treasury and the implicit government guarantee that allowed Fannie to sell bonds and obtain capital at lower cost than its purely private competitors. Fannie's quasi-governmental status and growing market share as a private financial -- services company also enraged intellectuals at conservative think tanks. The Wall Street Journal editorial page and the American Enterprise Institute regularly excoriated Fannie. Johnson worried that the free-marketeers in power in Congress would revise Fannie's charter to cut it loose from the government guarantee.
The discussion of Fannie's jousting with critics is accurate and compelling -- but then Morgenson and Rosner make two leaps not supported by the evidence. In their account, the increased commitment to moderate-income housing in the 1990s was nothing but a cynical move in a Washington chess game. In their rendition, Fannie's decision, in league with Clinton's housing goals, to liberalize terms of the mortgages the company purchased led directly to the subprime epidemic and subsequent collapse.
The first contention is speculative. But even if Fannie's embrace of expanded homeownership was entirely self-serving, the second and more serious allegation is false. For starters, the timing is off. Fannie did start purchasing large numbers of sketchy mortgages, in an effort to defend its market share, but only around 2004. By then, subprime was a huge industry with plenty of buyers on Wall Street. As late as 2005, according to Reckless Endangerment, non-Fannie mortgage-backed securities packaged by Wall Street investment banks accounted for 55 percent of mortgage volume.
As Morgenson and Rosner obliquely acknowledge elsewhere in the book, other Wall Street firms created the subprime bubble precisely because Fannie would not buy those loans. Morgenson and Rosner admit this contradiction when they write of the Wall Street-financed boom in poor-quality loans that took off circa 2001: "Because higher-quality borrowers were still at this time the domain of Fannie Mae and Freddie Mac, Wall Street could not hope to compete in this area. So the big investment firms stepped up their interest in alternative mortgage products offered to sub-prime or near-prime borrowers." In other words, Wall Street went where Fannie prudently feared to tread.
Morgenson and Rosner contend that Fannie's perdition began in the mid-1990s when the company started purchasing mortgages with down payments of just 5 percent. "Traditionally," they write, "banks had required that borrowers put 20 percent of the property price down to secure a mortgage loan." That's an embarrassingly novice mistake. Veterans' loans under the GI bill accepted zero down payments. For decades, the Federal Housing Administration has insured loans with down payments of 5 percent -- and these loans were purchased by Fannie Mae. Private mortgage insurers, which began competing with the FHA in the 1960s, also offered insured loans with small down payments. How could Morgenson and Rosner have missed something so basic and central to the story? What made these loans safe and insurable and liquid in the secondary market was careful underwriting, of the property value and the borrower's capacity to pay, not the down payment. It was the lack of serious underwriting that made subprime such a disaster.
Morgenson and Rosner also repeat the red herring that efforts to combat racial discrimination and redlining led to pressure to lower lending standards, which in turn led to the crash. Extensive research shows that honorable lenders who avoided subprime were able to expand their origination of conventional, fixed-rate loans to minority and moderate -- income homebuyers without any increase in defaults. (Authoritative work on this has been done by scholars at the Center for Community Capital at the University of North Carolina.)
Only late in the game did Fannie Mae seriously water down its standards. It's true -- and appalling -- that Fannie became the largest purchaser of subprime loans from one of the worst mortgage hustlers in the game, Jim Johnson's pal Angelo Mozilo, the CEO of Countrywide Mortgage. But that was in the period from 2003 to 2005, when Wall Street had already provided the financing and created the securities market for subprime. Fannie was playing catch-up.
So in the rogues' gallery of scoundrels that caused the financial collapse, a fair reckoning would rank Fannie Mae fifth or sixth. Far higher on the list would be:
- Alan Greenspan's Federal Reserve, which lowered interest rates without increasing regulation, refused to enforce a 1994 law requiring prudent underwriting standards and turned a blind eye to abuses in the process of loan securitization.
- The Office of Thrift Supervision, which let savings banks under its supervision engage in outlandishly risky practices.
- The Wall Street firms that bankrolled subprime lenders and turned their high-risk loans into securities
- The credit-rating agencies that blessed toxic subprime securities with Triple-A ratings.
- The SEC's failure to police those agencies.
- And, of course, the subprime lenders themselves.
These other malefactors are mentioned willy-nilly by Morgenson and Rosner, but they stick to their improbable story line of Fannie as villain-in-chief. In the book's penultimate chapter, which recapitulates the role of giant firms like Goldman Sachs, Morgenson and Rosner abruptly go off on a different tangent: "Of all the partners in the homeownership push, no industry contributed more to the corruption of the lending process than Wall Street." So which is it -- Fannie or Goldman? Inconsistency like this pervades the book.
The fair indictment of Fannie Mae, which you can find scattered throughout Reckless Endangerment (though you need tweezers), goes like this: Jim Johnson wanted to expand Fannie's market share, so he increased both Fannie's debt and its loan purchases. He cultivated allies all over the real-estate and mortgage industry, including bad actors like Mozilo of Countrywide. Johnson staved off accountability by creating a foundation, buying friends in both parties and intimidating critics, including Fannie's outgunned regulatory agency. Thanks to its special status, Fannie was permitted to hold reserves far lower than those of competing banks, so it was highly leveraged with little margin of error. Under Johnson's successor, Frank Raines, Fannie cooked its books in order to exaggerate its earnings, stock price, and executive bonuses. After these abuses were exposed, Raines lost his job and paid a civil fine. When the housing bubble popped, Fannie's reserves were too thin to cover the decline in the value of its mortgage portfolio. By then, Fannie had compounded the risk by purchasing some subprime loans and their close cousin, Alt-A loans. Fannie went broke, and the government had to take it over. And because Fannie had been permitted to grow so large, the cost was immense.
That part of the story is well told by Morgenson and Rosner, and it offers grist for indignation. Fannie Mae, certainly, was guilty of plenty of wrongdoing -- -without inventing its role in the broader collapse. But this is not a book by a couple of wing nuts. The authors are Gretchen Morgenson, one of the great financial reporters of our era, and Joshua Rosner, one of the first Wall Streeters to warn about the housing bubble. It is bewildering that they would echo the right-wing narrative and stretch their story to attribute the financial collapse to Fannie Mae's work to broaden homeownership, much less to the government's effort to remedy discrimination in mortgage lending. At the very least, they owe their admirers factual corrections and an explanation.