Former Federal Reserve Chairman Alan Greenspan on Wednesday testified that mortgage giants Fannie Mae and Freddie Mac played a critical role in fostering an explosion of growth in the subprime mortgage market that led to the global financial crisis.
Deflecting the blame from himself and the central bank, which had broad authority to regulate banks and the mortgage market, the former Fed chairman, in testimony before the congressional Financial Crisis Inquiry Commission, gave the most prominent voice to date to Republican charges that congressional meddling with Fannie Mae and Freddie Mac played a critical role in the run-up to the crisis that brought down the global economy in the fall of 2008.
Mr. Greenspan pointed to the mandates Fannie and Freddie received in 2000 from Congress and the Clinton-era Housing and Urban Development Department to make housing more affordable to minorities and disadvantaged people by using their vast resources to purchase more subprime mortgage securities.
As the mortgage giants started to scarf up the subprime securities, much of which had been engineered to earn AAA ratings from credit rating agencies, that caused rapid growth in the subprime market, he said, estimating that it burgeoned from less than 2.5 percent of the mortgage market in 2000 to encompass 40 percent of Fannie’s and Freddie’s mortgage portfolios by 2004.
The enormous appetite for subprime mortgages that Fannie and Freddie brought to the market is the reason that interest rates on mortgages fell so dramatically from 2003 onwards and many exotic instruments were created to satisfy the demand for the loans, including extremely low initial “teaser” rates, loans with no down payments and so-called liar loans where people didn’t have to document their incomes to get loans.
“A significant proportion of the increased demand for subprime mortgage-backed securities during the years 2003-2004 was effectively politically mandated,” Mr. Greenspan said. “The subprime market grew rapidly in response [to political mandates and] subprime loan standards deteriorated rapidly,” worsening an investment bubble that was already developing in the housing market, he said.