By filing a civil fraud suit in mid-December against former executives of Fannie Mae and Freddie Mac, the Securities and Exchange Commission (SEC) took an action that has benefits far beyond bringing justice for investors. Among other things, it ruined the holidays of some of the nation’s most prominent liberal commentators by exposing the flaws of their narrative blaming the “unfettered free market” for the housing meltdown.
The American Prospect’s Robert Kuttner and The New York Times’s Joe Nocera spent part of their winter breaks attacking the SEC and lashing out at long-time critics of the government-sponsored entities (GSEs) who were vindicated by the SEC suit. “The SEC does Wall Street’s bidding,” screams the headline of Kuttner’s December 23 column. For his part, Nocera continued his long-running jeremiad against American Enterprise Institute fellow Peter Wallison, called the SEC’s case “weak” and charged that it was brought “in part for political reasons.” He then asked, “How better to curry favor with House Republicans than to go after former Fannie and Freddie executives?”
Never mind that the SEC, which like all other “independent” agencies is run by a 3-2 majority from the president’s party, has done the left’s bidding on issues from the “proxy access” rule that empowers union pension funds in shareholder battles (recently struck down by a federal appeals court) to mandated disclosure of companies’ alleged risk to the climate. The commission is even fighting modest bipartisan attempts in Congress to pare back the crushing Sarbanes-Oxley accounting mandates for smaller public companies.
But its lawsuit against the Fannie and Freddie executives does show that this SEC has a scintilla of integrity when it comes to its core mission of protecting investors from fraud. But even this scintilla is too much for big-government ideologues. And in that regard, they are right to be fearful of the SEC’s findings. Those findings shatter the narrative the GSEs’ apologists have settled on: that Fannie and Freddie did buy some subprime mortgage securities that they shouldn’t have bought, but only after the big, bad private sector forced them to do so in order to keep market share.
“Fannie and Freddie got into subprime mortgages, with great trepidation, only in 2005 and 2006, and only because they were losing so much market share to Wall Street,” Nocera proclaimed late last month. “The reality is that Fannie and Freddie followed the private sector off the cliff instead of the other way around.”
Yet mounting evidence, now supported by the SEC lawsuit, shows that Fannie and Freddie led, rather than followed, the private sector into the subprime market, hiding their footprints from investors and regulators. Wallison and his AEI colleague Edward Pinto, Fannie’s former chief credit officer, analyzed the GSEs’ portfolios and found that, beginning in the mid-1990s, Fannie and Freddie misclassified millions of subprime loans as “prime.” Mortgages with no down payment requirements, credit scores below 660 and/or lack of income verification were all tossed into the GSEs’ “prime” mortgage basket.
Wallison and others note that much of these purchases stemmed from “affordable housing” quotas on the GSEs from the Housing and Community Development Act of 1992, which Rep. Barney Frank (D-MA) strongly supported. In The Wall Street Journal, Wallison writes that these quotas requiring purchases of loans from borrowers at or below the median incomes of their communities rose from an initial 30 percent to 40% in 1996, 50% in 2000 and 55% in 2007.