The intent

was that Fannie Mae's enforcement of the underwriting standards they maintained for standard
conforming mortgages would also provide safe and stable means of lending to buyers who did
not have prime credit. As Daniel Mudd, then President and CEO of Fannie Mae, testified in
2007, instead the agency's underwriting requirements drove business into the arms of the
private mortgage industry who marketed aggressive products without regard to future
consequences:

We also set conservative underwriting standards for loans we finance to ensure the
homebuyers can afford their loans over the long term. We sought to bring the standards we
apply to the prime space to the subprime market with our industry partners primarily to expand
our services to underserved families.

Unfortunately, Fannie Mae-quality, safe loans in the subprime market did not become the
standard, and the lending market moved away from us. Borrowers were offered a range of
loans that layered teaser rates, interest-only, negative amortization and payment options and
low-documentation requirements on top of floating-rate loans. In early 2005 we began
sounding our concerns about this "layered-risk" lending. For example, Tom Lund, the head of
our single-family mortgage business, publicly stated, "One of the things we don't feel good
about right now as we look into this marketplace is more homebuyers being put into programs
that have more risk. Those products are for more sophisticated buyers. Does it make sense for
borrowers to take on risk they may not be aware of? Are we setting them up for failure? As a
result, we gave up significant market share to our competitors."[24]

Alex Berenson of The New York Times reported in 2003 that Fannie Mae's risk is much larger
than is commonly held.[25] Nassim Taleb wrote in The Black Swan: "The government-sponsored
institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite,
vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deem these
events 'unlikely'".[26]

On January 26, 2005, the Federal Housing Enterprise Regulatory Reform Act of 2005 (S.190)
was first introduced in the Senate by Sen. Chuck Hagel.[27] The Senate legislation was an effort
to reform the existing GSE regulatory structure in light of the recent accounting problems and
questionable management actions leading to considerable income restatements by the GSEs.
After being reported favorably by the Senate's Committee on Banking, Housing, and Urban
Affairs in July 2005, the bill was never considered by the full Senate for a vote.[28] Sen. John
McCain's decision to become a cosponsor of S.190 almost a year later in 2006 was the last
action taken regarding Sen. Hagel's bill in spite of developments since clearing the Senate
Committee. Sen. McCain pointed out that Fannie Mae's regulator reported that profits were
"illusions deliberately and systematically created by the company's senior management" in his
floor statement giving support to S.190.[29][30]

At the same time, the House also introduced similar legislation, the Federal Housing Finance
Reform Act of 2005 (H.R. 1461), in the Spring of 2005. The House Financial Services
Committee had crafted changes and produced a Committee Report by July 2005 to the
legislation. It was passed by the House in October in spite of President Bush's statement of
policy opposed to the House version, which stated: "The regulatory regime envisioned by H.R.
1461 is considerably weaker than that which governs other large, complex financial
institutions."[31] The legislation met with opposition from both Democrats and Republicans at
that point and the Senate never took up the House passed version for consideration after
that.[32]

The mortgage crisis from late 2007[edit]

Following their mission to meet federal Housing and Urban Development (HUD) housing goals,
GSEs such as Fannie Mae, Freddie Mac and the Federal Home Loan Banks (FHLBanks) had
striven to improve home ownership of low and middle income families, underserved areas, and
generally through special affordable methods such as "the ability to obtain a 30-year fixed-rate
mortgage with a low down payment... and the continuous availability of mortgage credit under
a wide range of economic conditions".[33] Then in 2003–2004, the subprime mortgage
crisis began.[34] The market shifted away from regulated GSEs and radically toward Mortgage
Backed Securities (MBS) issued by unregulated private-label securitization conduits, typically
operated by investment banks.

As mortgage originators began to distribute more and more of their loans through private label
MBSs, GSEs lost the ability to monitor and control mortgage originators. Competition between
the GSEs and private securitizers for loans further undermined GSEs' power and strengthened
mortgage originators. This contributed to a decline in underwriting standards and was a major
cause of the financial crisis.[35]

Investment bank securitizers were more willing to securitize risky loans because they generally
retained minimal risk. Whereas the GSEs guaranteed the performance of their MBSs, private
securitizers generally did not, and might only retain a thin slice of risk.[35] Often, banks would
offload this risk to insurance companies or other counterparties through credit default swaps,
making their actual risk exposures extremely difficult for investors and creditors to discern.[36]

The shift toward riskier mortgages and private label MBS distribution occurred as financial
institutions sought to maintain earnings levels that had been elevated during 2001–2003 by an
unprecedented refinancing boom due to historically low interest rates. Earnings depended on
volume, so maintaining elevated earnings levels necessitated expanding the borrower pool
using lower underwriting standards and new products that the GSEs would not (initially)
securitize. Thus, the shift away from GSE securitization to private-label securitization (PLS)
also corresponded with a shift in mortgage product type, from traditional, amortizing, fixed-rate
mortgages (FRMs) to nontraditional, structurally riskier, nonamortizing, adjustable-rate
mortgages (ARM's), and in the start of a sharp deterioration in mortgage
underwriting standards.[34] The growth of PLS, however, forced the GSEs to lower their
underwriting standards in an attempt to reclaim lost market share to please their private
shareholders. Shareholder pressure pushed the GSEs into competition with PLS for market
share, and the GSEs loosened their guarantee business underwriting standards in order to
compete. In contrast, the wholly public FHA/Ginnie Mae maintained their underwriting
standards and instead ceded market share.[34]

The growth of private-label securitization and lack of regulation in this part of the market
resulted in the oversupply of underpriced housing finance[34] that led, in 2006, to an increasing
number of borrowers, often with poor credit, who were unable to pay their mortgages –
particularly with adjustable rate mortgages (ARM), caused a precipitous increase in home
foreclosures. As a result, home prices declined as increasing foreclosures added to the already
large inventory of homes and stricter lending standards made it more and more difficult for
borrowers to get mortgages. This depreciation in home prices led to growing losses for the
GSEs, which back the majority of US mortgages. In July 2008, the government attempted to
ease market fears by reiterating their view that "Fannie Mae and Freddie Mac play a central
role in the US housing finance system". The US Treasury Department and the Federal
Reserve took steps to bolster confidence in the corporations, including granting both
corporations access to Federal Reserve low-interest loans (at similar rates as commercial
banks) and removing the prohibition on the Treasury Department to purchase the GSEs' stock.
Despite these efforts, by August 2008, shares of both Fannie Mae and Freddie Mac had
tumbled more than 90% from their one-year prior levels.

On Oct 21, 2010 FHFA estimates revealed that the bailout of Freddie Mac and Fannie Mae will
likely cost taxpayers $224–360 billion in total, with over $150 billion already provided.[37]

2008 – crisis and conservatorship[edit]

Main article: Federal takeover of Fannie Mae and Freddie Mac

On July 11, 2008, The New York Times reported that U.S. government officials were
considering a plan for the U.S. government to take over Fannie Mae and/or Freddie Mac
should their financial situations worsen due to the U.S. housing crisis.[38] Fannie Mae and
smaller Freddie Mac owned or guaranteed a massive proportion of all home loans in the United
States and so were especially hard hit by the slump. The government officials also stated that
the government had also considered calling for explicit government guarantee through
legislation of $5 trillion on debt owned or guaranteed by the two companies.
Fannie stock plunged.[39] Some worried that Fannie lacked capital and might go bankrupt.
Others worried about a government seizure. U.S. Treasury Secretary Henry M. Paulsonas well
as the White House went on the air to defend the financial soundness of Fannie Mae, in a last-
ditch effort to prevent a total financial panic.[40][41] Fannie and Freddie underpinned the whole
U.S. mortgage market. As recently as 2008, Fannie Mae and the Federal Home Loan
Mortgage Corporation (Freddie Mac) had owned or guaranteed about half of the U.S.'s $12
trillion mortgage market.[38] If they were to collapse, mortgages would be harder to obtain and
much more expensive. Fannie and Freddie bonds were owned by everyone from the Chinese
Government, to money market funds, to the retirement funds of hundreds of millions of people.
If they went bankrupt there would be mass upheaval on a global scale.[42]

The Administration PR effort was not enough, by itself, to save the GSEs. Their government
directive to purchase bad loans from private banks, in order to prevent these banks from
failing, as well as the 20 top banks falsely classifying loans as AAA, caused instability.
Paulson's plan was to go in swiftly and seize the two GSEs, rather than provide loans as he did
for AIG and the major banks; he told president Bush that "the first sound they hear will be their
heads hitting the floor", in a reference to the French revolution.[42] The major banks have since
been sued by the Feds for a sum of $200,000,000, and some of the major banks have already
settled.[43] In addition, a lawsuit has been filed against the federal government by the
shareholders of Fannie Mae and Freddie Mac, for a) creating an environment by which Fannie
and Freddie would be unable to meet their financial obligations b) forcing the executive
management to sign over the companies to the conservator by (a), and c) the gross violation of
the (fifth amendment) taking clause.

On September 7, 2008, James Lockhart, director of the Federal Housing Finance

Agency (FHFA), announced that Fannie Mae and Freddie Mac were being placed
intoconservatorship of the FHFA. The action was "one of the most sweeping government
interventions in private financial markets in decades".[44][45][46] Lockhart also dismissed the firms'
chief executive officers and boards of directors, and caused the issuance to the Treasury new
senior preferred stock and common stock warrants amounting to 79.9% of each GSE. The
value of the common stock and preferred stock to pre-conservatorship holders was greatly
diminished by the suspension of future dividends on previously outstanding stock, in the effort
to maintain the value of company debt and of mortgage-backed securities. FHFA stated that
there are no plans to liquidate the company.[44][45][46][47][48][49][50]