Lecture: The GSEs

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The Global Financial Crisis

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Yale University

The Global Financial Crisis

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Former U.S. Secretary of the Treasury Timothy F. Geithner and Professor Andrew Metrick survey the causes, events, policy responses, and aftermath of the recent global financial crisis.

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Lecture: The GSEs5:21

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Andrew Metrick
Michael H. Jordan Professor of Finance and Management
Yale School of Management
Timothy Geithner
Lecturer in Management, Yale SOM, Former U.S. Secretary of the Treasury
Yale School of Management

[MUSIC]

In our module on housing, we talked about the government-sponsored enterprises,

Fannie Mae and Freddie Mac,

very large government agencies that were also private corporations.

So it was a strange amalgam, which played an enormous roll in the mortgage markets

leading up to the financial crisis.

Let's talk about what happened to them before those crucial months before

the crisis.

As of 2008, Fannie and Freddie, or we'll just call them the GSEs,

guaranteed or owned nearly half of the mortgage market.

Here's the picture.

In blue is Fannie Mae's mortgage credit book of business, and

in red is Freddie Mac's total mortgage portfolio.

They use different terms in their reporting.

But in both cases this represents two important groups, for

each of the institutions.

One is the loans that they have guaranteed.

And you can recall from an earlier module when we talked about housing,

that they will only guarantee loans that meet certain standards,

that are called conforming loans.

During most of this time period, this was loans, mortgages that were $417,000 or

less, and where the borrowers met certain conditions.

They put at least 20% down.

They had a credit score and income documentation that was sufficient.

But these totals also include

portfolio loans that have been purchased by Fannie or Freddie as investments.

This is where Fannie and Freddie had their largest role in the subprime market.

They did not guarantee subprime loans, but they did buy many of them.

Although their participation in the market stayed roughly between 30 and

40% during this time period.

So they were not a majority of the market, but

they certainly had very large investments in a growing market.

By July of 2008, the GSEs were clearly in deep trouble.

And on September 7th, the two companies went into government conservatorship.

So the problems in July became clear.

And the treasury secretary at the time, Hank Paulson,

went to Congress, and asked for some additional authority to be

able to take the companies into conservativeship, if necessary.

He was granted that authority, but he did not need to use it until September 7th.

You can see that the markets really understood that Fannie and

Freddie were in trouble during this time.

And the largest decreases in their stock price came in this middle of 2008 period.

So at the beginning of the year, in blue we see Fannie Mae's stock price,

which was at about $40 at the beginning of 2008,

and in red we see Freddie Mac, which is just under $35.

They both fell early in 2008 when it was quite clear

that there were problems in the subprime market.

And they owned a fair amount of subprime.

So at this point it was not just the lower rated tranches, but

rather even the AAA tranches that we knew would have a problem.

And this affected the stock price of Freddie and Fannie.

It rebounded somewhat in early 2008, around the time of the rescue

of Bear Stearns, and it wasn't until mid-2008,

May, that really it became clear that the business models that they had were

unsustainable without much more significant government support.

The stock prices dropped both to about $5 by mid July.

The new congressional legislation that came out in July,

that gave the treasury secretary some additional tools to help them,

helped the stock prices rebound a little bit.

But then you can see, by the time we reach early September,

around the time of the conservatorship, the stock price had fallen almost to zero.

It continues to be a puzzle today, years after the crisis,

exactly how Freddie Mac and Fannie Mae should be handled by the government.

But it's, in retrospect, quite clear that having government agencies

that had an implicit promise from the government, and the ability to go and

gamble with that implicit promise in their portfolios, is not a good combination.

And, in fact, they ended up taking on far more risk than they could sustain.

The role however, that Fannie and Freddie played

directly in the cause of the crisis, continues to be a source of debate.

And we discussed with a fair amount of evidence in our module on the housing

crisis, while certainly they are a symptom, and they certainly played

a role in the buildup to the crisis, it is very, very difficult to pin full blame of

the financial crisis, or even a majority of the blame, on Freddie and Fannie.

In part because their participation in markets and the government participation

in markets, had been very outsized for a very long time.

If anything, it was a model that was flawed that eventually broke during

a global macroeconomic upheaval, caused by the global savings glut,

beginning in the early 2000s.

[MUSIC]

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