In October 1992, Congress adopted Title XIII of the Housing and Community Development Act of 1992, which, among other things, required Fannie Mae and Freddie Mac to direct a substantial portion of their mortgage financing to borrowers who were at or below the median income in their communities.
Known as the “affordable housing goals,” the original legislative quota was 30 percent — that is, of all the mortgages Fannie and Freddie bought, 30 percent had to be made to borrowers at that income level. However, the statute gave the Department of Housing and Urban Development the authority to adjust these goals, and through the administrations of President Bill Clinton and President George W. Bush, HUD raised the quota to 50 percent by 2000 and to 55 percent by 2007. It also added “subgoals” for borrowers at 80 percent and 60 percent of median income.
It is certainly possible to find prime borrowers among people whose incomes are below the area median. But when more than half the mortgages Fannie and Freddie bought had to have that characteristic, the government-sponsored enterprises had to substantially reduce their underwriting standards in order to meet the affordable housing quotas. Throughout the 1990s, then, and until they became insolvent in 2008, Fannie and Freddie bought subprime and other risky loans with low or no down payments, interest only, low or no documentation and loans made to investors rather than homebuyers.
Fannie and Freddie were not the only government-backed or government-controlled organizations that were enlisted in this process. The Federal Housing Administration was competing with Fannie and Freddie for the same mortgages. And thanks to rules adopted in 1995 under the Community Reinvestment Act, regulated banks as well as savings and loan associations had to make a certain number of loans to borrowers who were at or below 80 percent of the median income in the areas they served. Failure to maintain a satisfactory CRA rating would result in regulatory denial of various bank applications.
Research by Edward Pinto, my colleague at the American Enterprise Institute and a former chief credit officer of Fannie Mae (supplemented by data in the Securities and Exchange Commission’s recent suit against some top officers of Fannie and Freddie) shows that by 2008 there were 28 million mortgages in the U.S. financial system — half of all loans — that were subprime or otherwise risky. Of these, more than 74 percent were held or guaranteed by Fannie and Freddie or some other government agency or government-regulated institution.
The huge government investment in subprime mortgages achieved its purpose. Home ownership increased to 69 percent from 64 percent (where it had been for 30 years). But it also led to the biggest housing bubble in American history.