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Fishing in Subprime Waters

In addition to not being allowed to purchase “jumbo” mortgages, the GSEs are only supposed to purchase mortgages that are of “investment quality,” meaning not the sort of high-risk mortgages known as “subprime.” From 2004 through 2006, when most of the growth in mortgage originations was in the subprime segment, Fannie and Freddie were not able to maintain their market shares. However, notwithstanding their charter rules, they did participate in the subprime market, buying hundreds of billions of dollars in securities backed by subprime loans as well as funding other subprime loans under the guise of meeting the needs of “affordable housing.”

In 2007, the regulator of Fannie and Freddie authorized faster growth in their portfolios, in order to allow them to participate in the rescue of subprime loan borrowers. This further encouraged the GSEs to fish in subprime waters.

Full text here: Fragile by Design, By Arnold Kling