Banks and other mortgage originators have taken the bulk of criticism for selling so-called toxic mortgages and causing financial harm to investors and homeowners. But are these completely at fault?
The federal government blames low-quality underwriting standards for producing Fannie and Freddie’s overgrown losses. While it’s clear that underwriting standards were at the center of the subprime crisis – losses taken by Fannie and Freddie reflect these low standards – declining underwriting standards were a response to mandates of a decade ago that called for the two agencies to increase their mortgages targeting low-income or minority borrowers in locations labeled as underserved.
It was in 2004, however, that issues with mandates began to surface. Because the agencies’ internal risk-management guidelines had them keeping their exposure to little- or non-documented loans low, they realized that in order to meet mandates underwriting standards would have to be greatly reduced.
Risk managers at the agencies argued against reduced underwriting standards and the move to non-documented loans, but to no avail.
According to some within the agencies, lower lending standards did not make sense since reduced standards had already been done and were dangerous – leading to large losses and even producing cases of fraud.
To risk managers, the consequences of the proposed reductions were foreseen, and the human costs were anticipated. To their credit, their advice was not to move forward. In the end, however, politics is what pushed Freddie Mac to do away with its previous limits.
It was the decision, then, by Fannie and Freddie to embrace non-documented lending eight years ago that unleashed the flood of bad-credit. It’s been examined and determined that if Fannie and Freddie’s mortgage underwriting standards had remained unaltered, the subprime crisis as we know it would have not occurred.