Russ Roberts

Kling on Freddie and Fannie and the Recent History of the U.S. Housing Market

EconTalk Episode with Arnold Kling
Hosted by Russ Roberts
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Arnold Kling of EconLog talks with host Russ Roberts about the economics of the housing market with a focus on the role of Fannie Mae and Freddie Mac. The conversation closes with a postscript on the current financial crisis.

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0:36Intro. See also recent Postscript at end of this podcast. Taping Sep. 12, 2008, financial markets in turmoil. Freddie Mac and Fannie Mae: What do those agencies do? Arnold was formerly employed at Freddie Mac. Lehman Brothers, Bear Stearns discussed previously. Freddie and Fannie: government sponsored enterprises. What is a mortgage? Piece of paper on file with the government agencies that tracks properties, encumbers your property. Mortgage is typically attached to a mortgage loan; if you pay off the loan, the mortgage is lifted; own the house "free and clear." Mortgage contract ties the loan to the mortgage. If you don't make your payments on the mortgage, the bank forecloses on the house: bank owns the house and can sell it. Typically only happens if the house is worth less than the value of the loan. Suppose $300,000 house with a $250,000 loan; suppose several months go by without making a payment. If bank says it will foreclose, and if you have enough equity in the house, you can just sell the house and pay off the mortgage. Bank loan has the house as collateral: bank mortgage loan. Securitized mortgage loan: functions divided up. One person evaluates you, gives approval, formally lends you the money, but they don't hold onto the contract; they sell the loan. Could be a mortgage broker who sells it to a bank--simple example, mortgage underwriting. Richer form of securitization: buyer of the loan pools the loan with other similar loans and creates a mortgage backed security--300 loans, 1000 loans, etc. Similar characteristics, similar interest rates, maybe from different areas of the country. Pool of mortgages, and payments that come from that pool: called a mortgage security because with Freddie Mac or Fannie Mae behind them they are more secure: Freddie Mac buys an individual loan out of the pool if one individual defaults, and then it goes back and figures out how much it can get out of the loan that was defaulted on. Freddie Mac buys mortgages and sells securities; the mortgages can default, the securities cannot. Freddie Mac is in the middle; it takes the default risk.
10:07Imagine a world with no mortgage backed securities. Banks would have their own portfolios of loans. Banks would charge a premium when making the loans to insulate them against some of the default risk. Within a community, bank would be buffeted by local forces. Not historically why it developed. Whatever the reason, financially viable to pool these mortgages and securitize them. Freddie Mac has 500 in a bundle and it is going to sell access to this pool. Suppose a bank with mortgages on its books; wants cash now instead of waiting for borrowers to pay them off. Face a problem: other investors say they didn't investigate those loans. How does another bank know it's not junk? Bank can offer to pull out and pay off any that defaults. Now a buyer might be interested. That's a securitized mortgage pool. Freddie Mac guarantees that it will pull from the pool any individual loan that defaults. Why not just a private enterprise? Historically, Fannie Mae chartered during the Great Depression. Standard balloon mortgage, go for 5 years and then all would be due; instead, amortizing mortgage over 30 years. Government encouraged amortizing mortgages, 1938, by buying those 30-year mortgages, collecting the payments and dealing with the defaults. Like a gigantic Savings & Loan. Indirectly, they were a lender. Fannie Mae's assets were mortgage loans and its liabilities were long term debt and some short term debt. They issued bonds to fund the mortgages. What was the incentive on the part of banks to make careful loans? Fannie Mae had the job of overseeing mortgage bankers; set guidelines. If mortgage banker didn't adhere to the guidelines, Fannie Mae could order the banker to repurchase the loan, suspend the banker's privileges, etc.
19:06In 1968, under Lyndon Johnson, Fannie Mae privatized. Between 1938-1968, U.S. housing market dominated by Savings and Loans: like banks, but they specialized in deposits from depositors and lending it out to mortgage borrowers. Regulations on interest rates they could pay. Limits on the interest rates they could pay to depositors; couldn't operate across state lines. In the 1970s, as inflation took off and interest rates rose and money markets developed, funds to S&Ls dried up. They had no assets to sell to meet the depositors. Across state lines problem: Freddie Mac chartered to deal with it. California was chronically short of money but no way to get it from the east. Freddie Mac securities could be bought by someone in NY even if they were mortgages on California properties. Fannie Mae's role was just another big Savings and Loan. Mortgage banker is someone who doesn't collect deposits. Lyndon Johnson privatized Fannie Mae: shareholder owned, had as its assets the mortgage loans; had its own debt. Implicit guarantee--not a guarantee--Fannie Mae had the word "Federal" in its name: Federal National Mortgage Association: if push comes to shove the government will take care of them. In the 1970s, inflation takes off. 3:6:3 industry: Pay depositors 3%, lend to mortgage borrowers at 6%, and be on the golf course by 3 p.m. In the 1970s, interest rates went way up, but because of Regulation Q they couldn't offer depositors more than 3% so no one wanted to deposit. Worse, they were deeply under water. Suppose 5% loan, but market rate is 10%, you can get about 50 cents on the dollar. Bankrupt. Suppose you lift Regulation Q: can now get deposits, but you are only getting 6% on your mortgages, so you are losing money. Fannie Mae was losing a million dollars a day as interest rates shot up. Cost of funds above the interest rate they were earning on mortgages. FDIC: deposit insurance kept people from panicking and pulling their money out of the S&Ls. When interest rates came down in the 1980s, Fannie Mae became profitable. Collapse of S&L industry also reduced competition. As they went under, they securitized their mortgage loans. Government backed Freddie Mac and Fannie Mae, but when the S&Ls made bad bets, they had to bail out the S&Ls.
30:10Latter part of the 1980s. Freddie Mac gets spun out and becomes a shareholder-owned company. Savings and Loans made a slight profit. Conforming loans. Still a limit on the amount they could lend to any individual borrower, indexed to housing market, aimed at middle class. Freddie Mac and Fannie Mae don't lend directly to borrowers. Regulatory ceiling on how big a loan can be made by banks or mortgage lenders. If they were shut down, what would happen? Do they encourage home ownership? Supposed to reassure the investor that it will turn out okay--could be foreign institutional investor, pension fund. If no mortgage securities market, the only person who can own your loan is a bank. Increases the supply of money ultimately available to mortgage loans and reduces the cost of mortgages. Typical answer is ¼ of one percent. If I'm a bank, instead of just relying on my own assets, I'm tapping in to the ultimate investors. But a risk involved, moral hazard issue. Moral hazard: banker or whoever is selling the loan has every incentive to sell junk, everything from a slightly flawed loan to total junk. Could be an empty lot. Part of job of Freddie Mac is quality control, monitoring, risk management. Kling's role, mid- to late 1980s: economists from the Federal Housing Administration, FHA, which is supposed to be doing high risk lending, government agency. Still exist; periodically go bust; might be bust again. In theory they could be making a profit. Theory: if borrower's equity goes negative then they are much more likely to default than not; if it's an investor-owned property it's more likely to go default than not--if you live in the house vs. not living in the house: Chester Foster, Robert Van Order model, simulate paths for house prices and predict number of defaults. Stress scenario, stress test. Moodie's scenario: extreme stress test. In the mid-1980s housing prices did fall: Texas, Massachusetts. Dozens of people who were familiar with the basic thrust of that model. Amount of the downpayment matters a lot. 20% down-payment mortgage is much safer than a 5% downpayment mortgage. Borrower has more of a stake; reduces odds that the value of the equity falls below the price of the house.
41:35Weird part of today's situation is people act like it's never happened before. Shiller, bubble. What has changed in the last 20 years that has made things different? Standard conforming loan had a 20% down-payment. That's gone the way of the dodo bird. Standard is only a 5% down-payment. Innovative mortgage ideas; main characteristic is that the borrower's equity tends to consist mainly of increase in the value of the house. When house prices start to fall, nobody can borrow. No such thing as a safe 3%-down-payment loan if house prices are falling. Puzzle: why did it turn out okay for 40 years? Low- to 0-down-payment loans. Also subprime part: loans to people who normally wouldn't have qualified. Didn't come from Fannie Mae or Freddie Mac. Wall Street discovered securitization: able to sell securities to investors without a Federal agency guaranteeing them. Not sure what made investors willing to buy them. All investments are risky. At Freddie Mac: Instead of having to have a human underwriter look over a file to decide whether a borrower was qualified, discovered credit scoring, statistical approach to evaluating a borrower. Private sector also discovered it, but only looked at environments where housing prices had gone up. Got away with it for a while. Freddie Mac and Fannie Mae instead of standing their ground, started to follow the Wall Street firms; somewhat in competition; and were being leaned on by people in Congress. Also, new management teams in place; institutional attitude prior to 2003 had been to treat requirements as a constraint; new management saw that as a mission, profits as a constraint, goal is to maximize support for low income housing.
49:40Government leaning on. Real component of guarantee, credit line with Treasury. Board members with Fannie and Freddie that are government appointed? How were they leaned on? Private calls from Congressman. Regulator: Office of Federal Housing Enterprise Oversight, now called something else. Charged with making sure that Freddie and Fannie are adequately capitalized; and also that they meet affordable housing goals. Certain portion of their purchases each year must support low income borrowers or renters. In the present: their stock is worth zero. They started suffering lots of default losses; they ended up owning properties and having to sell them at a loss. Had happened before but this was unprecedented amount. Lots of nonconforming loans. Their bond holders started to ask what does this implicit guarantee mean? Demanded higher risk premium to lend to Freddie and Fannie. Short term debt mixed with long term debt used to finance. Constantly in the debt market. Wake up in July and instead of being able to raise money at the rate the Treasure does or at a small premium, but have to pay more. Same situation as S&Ls: higher interest rate cuts into the profits. Snowballed; from March to July. Self-fulfilling prophecy that they were not viable. A week or so ago, Secretary of the Treasury Paulson put them into conservatorship. Borrowing from them is like borrowing from the Treasury; hope is to return them to profitability. CEOs are being forced out: who is minding the store? Who is watching that they are making good loans? Only two companies, not like the S&Ls. Will make their decisions using ordinary staff; but with a regulator standing over them. Day-to-day monitoring. Will not be allowed to take wild gambles. Otherwise normal mortgage business.
58:44Claim: Government has acted like Adam Smith's man of system who surveys the world like a giant chess board. Second: Who is to blame? Hard to figure out. Is it Lyndon Johnson who privatized it? Congressional failure of oversight? Greedy CEOs who took risks because they had the backing of the government? Us, warned that it was unstable? Government has an emergent aspect to it. No such thing as "the government"--it's really individual actors. Where do we go from here? Gains were privatized and losses were socialized. Certainly broken now. Emerged and still emerging. No czar who is going to take over and organize this. Will have to be resolved by the next administration. Housing market: state of the housing market is that we have an excess of housing. 18 million unoccupied housing. 150 million households. 2% unoccupied okay; sounds like 10%. We have plenty of housing. Need a housing market that's balanced, supply and demand in balance. Stop trying to levitate housing prices; but politically hard. When prices were going up in some cities, people were happy they had higher wealth on paper. When prices fall, it shouldn't be a crisis. Mortgage market: does the United States have too much or too little? Probably too much. People would probably be better off with more equity in their homes. In politics we act like there is too little mortgage debt. Tax deductibility of mortgage interest payments. We act is if mortgage debt is a positive externality, subsidize it like it is a public good. Dream: every American should own a home. If you believe that, why not subsidize the down-payment? Gigantic negative externality and we subsidize it. Let housing prices be. For mortgages, go back to the old-fashioned mortgages issued by old-fashioned banks to old-fashioned qualified borrowers, 20% down. Every financial institution directly or indirectly has assets backed by Freddie or Fannie. Thirty year fixed rate mortgages well understood, no accusations of predatory lending. Not a viable product though if there is inflation. Have to keep inflation low and with low variability. Self-organizing systems and feedback loops: the "right" mortgage should emerge from market forces as a backlash against the current situation. We have acted profligately. Political consequences are not going to be attractive. Politically: recycle profits from middle class loans to low income. Messy situation probably has been made messier.
1:15:19Addendum/Postscript. Two weeks later. Credit scoring took place as an innovation at the same time housing prices were rising: confusion, underestimated importance of house prices going up. Before that, humans looking over credit reports. Derivative: trying to pass risk around like the card game Old Maid. You wouldn't invest in a risky mortgage, but what if it's packaged with other mortgages and we give you a senior portion where you won't suffer any losses until 10% of the loans default. Might try that. How about if we go to AIG and they give you an insurance contract so you won't suffer any default losses? Might do that. Trading strategy had to sell short the stocks of the insurers to hedge against the possibility that they may not be around. Contingency plan if things start to go bad is to start selling short. Works for you as an individual; but if everybody has the same plan and tries to execute it at once, it's a run on the bank. Collectively the plans were not compatible. Taleb's argument about risk management: people thought they understood the risk, but didn't understand that they couldn't execute them collectively all at once. Public sector: encouraging mortgage loans with low down-payments, inherently destabilizing. Private sector players have taken a big fall; out of jobs. People who are encouraging low down-payments still have their jobs. Andrew Cuomo, Clinton administration, wanted Freddie and Fannie to count subprime mortgages, tangible goal for them to achieve. Rose to 52% in Bush administration and they met that goal. Both administrations wanted this. Commitment to home borrowership. Shiller, case for a bubble. Case-Shiller housing index, flat, then takes off like a rocket. Real or a bubble, speculative mania? Federal government subsidized the price of housing at an increasing rate. A lot of the subprime lending took off in the private sector, though. Bubble gets created because when you have low down-payment any appreciation in price makes the borrower and lender feel good, encourages more and more people to get in. Government's role ought to have been to step in and put a check on derivatives and unwise use of credit scoring. Error of omission and commission.
1:26:32EconLog suggestion: 20% down-payment would emerge in an unsubsidized market. If restricted to players understanding default risk, Foster/Van Order model. Systemic risk issue: enormously enlarged role for government on the horizon. If we had let Bear Stearns die, instead of Fed's getting J.P. Morgan to buy them, by guaranteeing them. $29 billion seemed large at the time. How might we reduce the systemic risk going forward? Sunk cost, problems were already there at time of Bear Stearns. How do you enable the healthy financial institutions to stay in business? Reduce capital requirements for new reasonable lending. Having a hard time raising capital. Risk involved. Compare to risks of other proposals. Mark to market (valuations of assets at market value): Go back to S&L crisis, exacerbated by failure to do mark to market accounting. Didn't have to acknowledge their losses; kept making more and more bad debts. Current environment: Marking to market, if one guy's marking down his portfolio and you have shares then you have to mark down your value. With everyone doing mark to market, tends to cascade into systemic risk. If you get rid of it, creates a different sort of risk: companies hiding losses, and we will eventually have to bail them out. Vulture funds, waiting to bid; but paralyzed because companies think they can get a better price through the bailout.

COMMENTS (48 to date)
Sue Lange writes:

A huge thank you to Arnold Kling for such a comprehensive, well articulated - and most importantly – an understandable explanation of some of the historic events, circumstances and influences of the U.S housing market, which have contributed to the current global financial crisis.

Living in Australia it was particularly interesting and gratifying to finally be presented with an extensive background explanation of two of the main players at the center of this crisis. To date, none of the Australian media coverage has adequately explained exactly who Fannie Mae and Freddie Mac are, and how these two enormous organizations operate. For many Australians who are unfamiliar with these two firms, it has been mystifying to try and piece together and understand what precipitated these events.

Arnold’s personal in depth knowledge and experience shed much needed light on the inner workings of these two mortgage giants, and his insight is invaluable.

I found it to be a most informative, educational and compelling podcast, which has clarified a lot of confusion and misunderstanding I previously had in relation to this topic.

Given that our own superannuation funds and investments have been adversely affected by the U.S. meltdown, your discussion on the intricacies of this important issue is most appreciated.

Congratulations on a terrific podcast, as usual Arnold was a fantastic guest and thanks to Russ for asking such a fantastic range of questions (as always). Thanks also for the addition of a post script – my husband and I had only just thought about emailing to suggest a weekly update, given the current financial situation – so we were thrilled to find you had already thought of it.

T L Holaday writes:

Please ask Arnold Kling

  • whether the 5%, 3%, and 0% downpayment mortgages were just for low income buyers
  • what the average size of a mortgage loan was for low income buyers
  • whether private lenders avoided the low income lending business because of too much default or because the loans made were so small compared to the loans made to non-low income borrowers that it wasn't worth the effort
  • to compare the expected dollar loss from a foreclosed low income loan to the expected dollar loss from a foreclosed non-low income loan
  • what proportion of the value of the US housing stock is attributable to low and non-low income homeowners
  • to explain an interest-only tranche in a mortgage-backed security and who would purchase such a thing
  • explain the difference between a seasoned and a non-seasoned mortgage pool, and whether the term "brain dead" was used inside the GSEs to describe the homeowners in a seasoned pool
  • what the most number of tranches he remembers seeing in the prospectus of any single mortgage-backed security (I believe the record is 250)
  • what similarities he sees to the current fiasco and the Drexel fiasco>

Thanks!

Norm writes:

Fantastic interview!

More! More!

I would like to see T L Holaday's questions answered, but there seems to be certain tone that conservatives are blaming the poor and it is not the poor's fault. I have no idea whether this is important.

What I do know is the the WSJ editorial page has warned year after year about the dangers inherent in the government backing of Freddie and Fannie and for every warning there was a letter or column from a prominent Democrat saying everything was AOK.

I do not care if some fool want to make an interest-only, 0% down loan to some homeowner, poor or not. I do care if I am expected to bail that fool out.

Geech writes:

I also think this was an excellent podcast. Very enlightening.

chris writes:

Great Podcast. It was not too long, it was too short!
I would appreciate it if you returned to this discussion as new events unfold.

Matt C. writes:

This was wonderfully enlightening. I have learned a lot from this podcast. I have read just about every blog post that Professor Kling has written in regards to this "crisis" yet it was very educational to have Professor Roberts probe some the more technical topics.

My only complaint has been the lack of cricism against the Fed's responsibility in all of this. Both Mssrs. Roberts and Kling co-worker Professor Boettke and other co-bloggers at The Austrian Economics blog have stated time and again that the Fed is at least responsible for the asset bubbles in the late 90s and the current Real Estate bubble. I believe Professor Larry White would agree with this assesment as well.

I would say that the loose money policy of the Fed is what allowed for the development of the MBS by private institutions. Low interest rates and appreciating asset prices allowed for these private institutions to continue to profit until that bubble ultimately collapsed. The continual priming of the pump by the Fed only allowed the bubble to continue to hold until the supply outstripped demand once the Fed raised interest rates most recently.

I would like to hear an interview with maybe, Steve Horowitz or Larry White on the Fed's response to all this. I think maybe Peter Klein on the roles of institutions or lack there of would be highly enlightening.

Arnold Kling writes:

Thanks for the kind words. If 90 minutes of me is not enough, you can get another hour here:
blogging heads tv

Ted writes:

Russ thanks for another great podcast, definitely not too long. I would love to hear more on this topic. Maybe something about the Community Improvement Acted of 1977. There has been a lot of talk of this being a root cause.

Kit writes:

The UK suffered they housing bubble as the US. As we didn't have Freddie or Fannie(rude!) then the problem lies elsewhere. My bet is low interest rate caused by deflation thanks to productivity gains and cheap Asian imports.

p.s. great podcast.

Ed writes:

Good podcast. I've always wondered why we have two of these government sponsored enterprises.

Tony Lekas writes:

Thank you for a very good podcast. I would not want you to only deal with current macro economic issues but at this time I found this helpful. It was not too long and making it somewhat longer would have been OK.

Although it was touched on I would like to have heard more discussion of the public choice issues that got us into this situation and that will probably interfere with us getting out. I suppose that at the end I was looking for something of a conclusion. In most of your Podcasts you present information with some conclusions and make us think about it to come up with our own. On a longer podcast with a complicated topic such as this something at the end that clearly reviewed the main conclusions or ideas that were reached during the discussion would be helpful.

Please provide similar podcasts in the near future that deal with related issues and expand on some dealt with here. In particular the issues around the large "bail out" that is being proposed.

Along with an earlier commenter I am also interested in the larger issues concerning the contributions that government involvement in the economy, the financial system, and in particular the monetary system have made to the creation of this overall situation.

My last request, which is probably an impossible one, is for you and your guests to present a course of action that could get us in a better situation both in the short and long term. My fear is that there is no way out of the larger economic situation that we are in without going through a major disaster. Even in that case I have no confidence the the "right thing" will be done.

(By the larger economic situation I include the government interference I mentioned above and long term problems such as Social Security, Medicare, etc.)

Thank you for the effort you put into these Podcasts. It is appreciated!

Andy Kneeter writes:

Your Arnold Kling podcast explained the changing dynamic of the mortgage market. Thanks!

What's the fix?

First, housing prices have to naturally gravitate to market clearing levels. The government trying to artificially elevate them is pointless & destructive (the Japanese financial institutions tried this in vain in the 1990s).

Secondly, housing financial institutions should design management compensation around loan-performance vs. loan-origination. Rating agencies should evaluate the institutions & their issued securities on this basis (no outsider could possibly understand underwriting as well as the underwriter, but they could easily evaluate how much "skin in the game" these lenders have).

Dial Finance (now Wells Fargo Financial) was consistently one of the best performing lenders. Even when computer credit scoring was becoming popular, Dial still put both the underwriting decision-making & collections in the hands of its branch managers. It also paid them bonuses based on the loan performance, not the origination. This focused them to write good loans.

Bob Kozman writes:

This was a most informative podcast. It took me all day at work to listen to the whole thing. But it was well worth the effort.

I, too, would appreciate periodic pertinent updates as this drama unfolds.

On Saturday, Sept. 27, Arnold advertised on EconLog, a Harvard roundtable discussion which, combined with this podcast will give the listener an even richer insight into the current economic and housing situation.

mark seery writes:

Russ,

I think the experiment of doing something topical worked. Perhaps because it was something meaty.

Michael Ulm writes:

Thank you for this highly informative podcast. I for one really enjoy these more technical discussions.
And another vote from me for periodic updates.

Alan writes:

Yeah, great show! thanks!

muirgeo writes:

Excellent discussion.

Going in this is the question I waned answered; Would this (could this) have happened if Glass Steagall was enforced as it had been through the 70's slowly being chipped away at thereafter.

What I heard was that Fannie and Freddie set up perverse incentives and seem to have invented the idea of securitizing loans. Then you say Wall Street discovered securitization. And you say you are not sure what made investors willing to buy them. It seems to me the answer is they securitized loans because it was allowed where it hadn't been so before. And my guess for the reason investors bought them is because rating agencies gave their approvals to these opaque products.

These securitization products that were allowed were completely unregulated and opaque. And I believe this was a result of recent changes in law as well that allowed their development.


Everyone wants to get an angle on this issue so they can use it to support their position on the coming debate over regulation of our financial markets.


From theFinancial Times ; “It's a strange business,” admits one senior banker. “First you make money by creating products no one understands, then you make money by cleaning the mess up.”

It seems clear to me that we can allow the markets to be unregulated and do to the complex nature of a computerized financial system there will regularly be geniuses who are able to scam the system and create the newest financial products that are simply the latest way to siphon billions of dollars out of the productive economy.

Greg Ransom writes:

Rush and Arnold -- thanks for this discussion. It was EXCELLENT.

Greg Ransom writes:

That was a typo -- thanks RUSS.

Charlie S. writes:

Very interesting. Not too long. The details are always where the answers are going to be. Scary that Dodd and Barney obstructed reform the way they did.

Floccina writes:

Good podcast. I like the insight about mortgage interest deduction encouraging debt.

Jason writes:

Why do we expect house prices to rise, at least faster than inflation?

It can be shown that increased productivity and competition have lowered the price of everything for everyone, increasing standards of living and overall wealth. Would this not include a house?

I think a house is just like another valuable item, a car. There a real improvements in automobiles in the 5 years it takes to pay off your note, there are likely real improvements in houses in the 30 years it takes to pay off your mortgage. After 5 years, you're happy if your car's price is 1/2 what you paid for it, even though that buyer will find the same value. For some reason, after 30 years, your house's price should be 3.2 times higher than you paid (assuming 4%/year, 3 for inflation, 1 for my added value)? I'm not sure I get it yet.

Arnold's webcast at bloggingheads.tv is very good, too. He explains how AIG was brought into this.

Joseph G Louderback writes:

I liked the podcast, thought Arnold Kling did a great job, as did Russ Roberts. But, then, I like most all of them.

Matty writes:

Fantastic podcast. I shall be sharing with friends to learn about this all. The whole idea of offering mortgages to lower income groups to meet some kind of diversity goals is quite concerning and something I would like to read more about.

steve writes:

If your fear was that the podcast was too long, don't worry. Difficult and complex topics that deserve more time, should get more time. I don't think you need to feel limited to one hour on any topic. I think long time listeners trust you to know when to throw the schedule out the window and just go until you're done with the topic. And if it winds up being 2 hours, that's OK with me.

I also was happily surprised by the addendum that you added. Perhaps, it might be a feature (not wanting to add even more studio time to your schedule) if there are sufficient questions or comments made after the podcast is published. Maybe a short 10 - 15 minute reponse by the guest to the comments/questions posted. Although I would limit the time frame for the comments/questions to be posed (say one week from the posting of the original podcast).

In any case, a great podcast.

Gary Rogers writes:

One of the best podcasts yet!

Johnathan writes:

Don't you have to pay private mortgage insurance (PMI) if you put down less than 20% on a house? According to what they tell you at the closing, this is supposed to protect your lender should you default on the loan. PMI was not mentioned in this otherwise excellent podcast, and so I was left wondering. This must be one of the reasons AIG went bust.

Ben writes:

This was the best EconTalk to date. Keep up the good work!

Vanessa writes:

Thanks for doing this podcast. Even though I had to listen to it 3 times to begin to understand...I think it's really important at this difficult time.

Thanks for trying to make a difficult topic more digestable!

Ken writes:

I did enjoy the discussion. Would have liked some discussion on how and why other industrialized nations differ in this area.

Snaporaz writes:

Excellent episode! This topic is so addicting, I listened to it twice.

Shawn writes:

I agree this was a great podcast with lots of insightful information and love how Russ continues to break it down for us listeners. But I also have a couple questions that I would like to see in depth, which have been posted above.

The effect the Community Reinvestment Act passed by Carter and loosened under other Presidents has played in this.

Also the effect the loosening of the Glass-Steagall Act has played in all of this. I was trying to research this and found that Frontline did some kind of a special on this a little bit. Here is the link:
http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/weill/demise.html

Loved the podcast and keep up the good work.

Thanks

David N writes:

Interesting podcast. Thanks!

A possibly dumb question from a foreigner though: Isn't the 30 year mortgage loan a bad idea and something that should be abolished (or at least be subject to competition by other time spans)? In countries where we have shorter mortgage loans (for example Sweden where I'm from) one doesn't acutually pay the full loan when it matures, one just refinance when the first loan is due. Most often this is done by default, for example a new five year loan is issued when the old one matures.

This way the banks insures themselves against having issued loans with interest rates that are lower than they themselves can borrow at in times of high interest rates, be it due to inflation or something else. - At least that is the case in the medium long to long run.

And depending on the risk aversion of the borrower the loans could be even shorter than five years, allowing the interest rate to be nearer the market rate as the banks have less risk of miscalculating a short term interest rate.

Of course there are other ways to minimize such risks for the lenders, a model where the rate is inflation + X % could be used, for example. But 30 year loans at fixed rates? It sounds way to risky for my taste, no wonder your private savings & loans-companies went bust long ago!

Alan writes:

Russ, have you been watching TV much lately? In this podcast you came across as someone who got a very important email and couldn't wait to share it with us.

I see the current crisis in terms of failure of risk management which created an asset bubble.

It seems that you think markets cannot ever be wrong, thus risk was and is always managed appropriately and assets can never become overvalued.

I submit yours is a case of "ignorant dogmatism" as referenced by Bryan Caplan in a recent post to Econblog.

Arnold was in the trenches when risk management decisions were being made at the Agencies. You graciously allowed him to define what he was going to be talking about (cheers Arnold!), but when it came down to how risk management decisions were being made you seemed to short circuit. Are you the same guy who spent an hour talking with a car dealer about the nitty gritty of business not long ago? This was disappointing.

Given your WSJ opinion piece and your performance with Arnold, Russ I challenge you to not only respond in detail to the questions (addressed to Arnold, I know, and I would like his responses as well) posed by T L Holladay above, but to take on Barry Ritholz (FusionIQ) and Luci Ellis (BIS) on the role of government policy vs. investor demand for the great volume of sub-prime mortgage loans created 2002-2007. I insist also that the role played by speculators -- people who flipped Miami condos before ground was ever broken, for example, but really everyone who bought second or more homes and/or who moved primary residence more than twice during this period, be addressed.

BTW I work in land surveying and consider myself a pragmatist with libertarian leanings (Taleb is a hero), and most of what I think I know about economics is what I've picked up from reading The Economist cover to cover for 15 years. I've been listening to your podcasts from time to time for maybe a year or so, mostly enjoying them even with what seems an excessively dogmatic/ivory tower attitude on your part.

This business of blaming the global meltdown of institutions to big/interlinked to fail on some Black Americans smacks of what I heard when I arrived in Tokyo as the Japanese bubble was gathering steam in 1987: "It's the foreigners, of course. The government let some of their banks in last year and now real estate prices are going crazy!"

If I may be so bold as to make one more suggestion, I'd like you to get together with someone who was pissing away their money on rent in '04-'06, with friends who owned homes seeing their equity skyrocket, watching themselves being priced out of the market day by day, and ask them about why they decided to buy a home and what exactly their experience was with the mortgage originator. An interview with someone who sat on the other side of the desk -- someone who was at ground zero originating lots of subprime in Phoenix, Las Vegas or Southern California -- might also be interesting.

Less Antman writes:

This podcast was terrific, and gave me several insights into the mortgage industry that I have not seen articulated anywhere else. As for the length, the slow conversational pace with a few tangents and quips to give us time to process are essential to make such a complex subject easy to follow in a podcast, and I would have hated to have you rush through it to fit a time limit that I agree should be the norm. By all means, stick to the hour limit in normal circumstances, but don't apologize for the warranted exception in this case.

Ken Milton writes:

I enjoyed your podcast with Kling on Freddie & Fannie. I did listen to the entire podcast. Thanks

Daniel writes:

Russ,
At the end of the podcast you asked for comments this show. I thought it was great. I appreciate the great explanation of how we got here. This is one of my favorite Econtalks yet. I listened to all of it.

dean albert corde writes:

Great podcast with Kling. The podcast was to short not to long. I will listen to it again probably while jogging.I do not agree with alan "It seems that you think markets cannot ever be wrong, thus risk was and is always managed appropriately and assets can never become overvalued." I think that the case is that the laws of economics are like the laws of gravity. They are understood imperfectly by individuals and misunderstood completely by governments. But the laws of gravity and economics are no different for the individual than they are for government.

Johnathan writes:

Alan, you must have listened to a different podcast than I did. I challenge you to find where Roberts or Kling blamed the meltdown on "Black Americans" as you put it.

If you're equating sub-prime lending with people of color, then perhaps you're the one with the race problem. I haven't seen any data on the demographics of the people who received these loans, but I have no reason to believe they skew any differently than the rest of the low-income population in the US, which is 69% white.

In any case, what I took away from the podcast was that subprime lending was just one contributor to the current crisis.

Dantzler writes:

This was my first econtalk podcast. I found it as I searched for meaning in this mess. I'm a Libertarian, disenfranchised and disgusted with my current .gov options. Your podcast really helped me to understand how we got here. I have a lot more research to do, but will revisit this site now in hopes that there will be follow-up on this topic. Again, thank you and Cheers! JLD

R.A. writes:

Excellent podcast, one of the best I ever heard from Econtalk.

But I have not quite understood why those problems developed in such a big crisis.

We have the public part of the mortgage market, where Fannie and Freddie were under political pressure to make insane credit deals.
And we have the private part of the mortgage market, where flawed criteria led to similar problems.

While in both parts there were over-optimistic assumptions about the house-values, the public part had the additional problem of risky customers.

Now:
Why are the Fannie/Freddie-credits causing problems - as they were issued with a (state-backed) guarantee for defaults?

Why have the rating agencies put an AAA on the dubious constructions in the private sector?

See:
http://www.bloomberg.com/apps/news?pid=20601109&sid=ah839IWTLP9s&#
http://www.bloomberg.com/apps/news?pid=20601109&sid=ax3vfya_Vtdo&refer=home

Wacky Hermit writes:

Thank you, I really enjoyed this podcast. It took me a while to get all the way through it (the kids keep interrupting!) but it was really informative and aimed right at my knowledge and interest level.

Karen Roth writes:

Russ - Yours have long been some of my favorite podcasts but I've never commented until I listened to your latest with Arnold Kling on the subprime mortgage extravaganza. 10 years ago I was an auditor with a small bank that sold almost 100% of its loans to Freddie, and I was a hard-ass. I had to be, because Freddie had high standards and we simply could not afford to have to buy back any loans. Apparently that's changed drastically. Thank goodness I'm no longer in mortgage banking or as an auditor I think I might have nipped off and shot myself out of despair. Excellent podcast - and thank you for breaking things down to a very elemental level that anyone could understand.

Joseph Tucker writes:

This podcast addressed many of the questions I had about the current events it discussed. This podcast gave me better information on those events, the history leading up to them, and the forces (both market and political) that caused them than I have received from any news source or expert I have spoken with.

The format and approach you used in this podcast to present the information is very effective and I can think of no suggestions for improvement. Recanting the history, peppering in clarifying questions, and slowly approaching the current situation is definitely an effective approach to exploring a complex economic situation.

EconTalk is an excellent podcast. In the future, if you choose to do current event episodes periodically it can only improve the overall experience.

Stephen writes:

Thankyou. Great podcast. I agree with everything Joseph Tucker just said.

Michael writes:

Russ,

I found the podcast on the economics of the housing market with a focus on the role of Fannie Mae and Freddie Mac of great interest. I would not say that there was not too much detail in this podcast and I actually prefer more detail rather than less. What the podcast did seem to support is that Fannie Mae and Freddie Mac provided "artificial" liquidity in the secondary mortgage market. If Freddie and Fannie did not exist and the mortgage brokers who made these loans had to assume (own) more of the risk they would be less likely to provide loans. Since these mortgage brokers did not seek to "own" these loans and instead were trying to speed up the process of selling into the secondary market which improved the bottom line we had a vicious circle. The GSEs were created and provided an artificial secondary market where liquidity was supplied. If the secondary market was free and there was a conversion of these mortgages into Mortgage Backed Securities it seems as though the interest rates for these higher risk mortgages would be much higher. The economics of these GSEs are unsound and in the end they ultimately fail. I learned a lesson from a mortgage broker Roger Arnold who had a national radio show in the 90s into early this decade where he talked about the rules of thumb when making loans (3Cs). The first rule is to consider the character of the borrower. Does he or she have a history of paying off debts ? The second rule is capacity and if the borrower has an income to support the loan. And finally the third rule is collateral. Does the borrower have a downpayment of significance to keep him or her tied to the loan? You can see the character of some of these borrowers who took out interest only loans in California and then just walked out of their homes and left the keys. While I can understand to a certain extent that if you bought a condo for 500 K and it drops to 350 K that this is demoralizing. I would be more likely not to buy such an expensive home and await a price correction. You also see stories of no document loans verifying the income of these borrowers and the history of their income. And of course when you have no collateral in your home and no stake in it there are bound to be borrowers who move off and leave the problems with the lender.

I have been a frequent listener to program since I found it on ITUNEs. Keep up the good work!

Kevin W writes:

I appreciate the topic as we are in the midst of an historical correction in credit and housing. Truly a perfect storm meeting on the eve of a national political power change adding tension to all sorts of markets.

Because of the gravity of this situation, making periodic updates of the situation is not only enlightening now for contemporaries, it will be a key for future generations of economists (academics, practitioners, and sideline observers like me) to gain a perspective throughout the events. This will help answer the question - why did they do that?

Keep up the good work. Interesting podcasts that make my commute a weekly lesson.

Jacob Miller writes:

Great interview. Thank you. So informative and entertaining. Keep it up.

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