The Last Trillion-Dollar Commitment: The Destruction of Fannie Mae and Freddie Mac

Abstract

The government takeover of Fannie Mae and Freddie Mac was necessary because of their massive losses on more than $1.6 trillion of subprime and Alt-A investments, almost all of which were added to their single-family book of business between 2005 and 2007. The most plausible explanation for the sudden adoption of this disastrous course-disastrous for them and for the U.S. financial markets—is their desire to retain the support of Congress after their accounting scandals in 2003 and 2004 and the challenges to their business model that ensued. Although the strategy worked-Congress did not adopt strong government-sponsored enterprise (GSE) reform legislation until the Republicans demanded it as the price for Senate passage of a housing bill in July 2008—it led inevitably to the government takeover and the enormous junk loan losses still to come. Now that the federal government has been required to take effective control of Fannie and Freddie and to decide their fate, it is important to understand the reasons for their financial collapse—what went wrong and why. That is the purpose of this article. <b>TOPICS:</b>Financial crises and financial market history, legal and regulatory issues for structured finance