Our business model investing in and guaranteeing home

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“Our business model – investing in and guaranteeing home mortgages – is a good one, so good that others want to ‘take us out”…Under our new strategy, we will take and manage more credit risk , moving deeper into the credit pool to serve a large and growing part of the mortgage market.” The data tell the story. As described in Chapter 2, from 1992 to 2002, Fannie Mae and Freddie Mac were clearly major participants in high risk mortgage lending. Nevertheless, the period 2003-2007 represented a significant shift. Table 3-4 presents data for “risky” mortgage loans for both Fannie Mac/Freddie Mac and private label securitization for this period. For comparison purposes, we restrict ourselves to the size of mortgages at or below the conforming limit level. For example, from 2001 to 2003, for mortgage loans with LTVs greater than 80% and/or FICO scores less than 660, Fannie Mae and Freddie Mac represented respectively 86%, 80% and 74% of this high risk activity. From 2004-2005, this changed as both the dollar volume and share of high risk lending of conforming size loans moved towards the private sector, with
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45 $168 billion (and a 26% share) in 2003 to $283 billion (and a 52% share) in 2004 and $330 billion (and 58% share) in 2005. Consistent with the race to the bottom, Fannie and Freddie responded by increasing their high risk mortgage participation by recovering a majority share of 51% in 2006 and an almost complete share of the market in 2007 at 87%. Equally important, as a percentage of its own business, Table 3-4 shows that Fannie and Freddie’s risky mortgage share increased from 25% in 2003 to 36% in 2007. Even more telling, if the above analysis is restricted to the very highest risk mortgage loans, i.e., those with LTVs>90% and FICO<620, Table 3-4 shows an almost identical “race-to-the-bottom” pattern in Fannie and Freddie’s share during the 2003- 2007 period, culminating in a doubling of these particularly risky mortgages from $10.4 billion in 2006 to $20.3 billion in 2007. 23 Table 3-4: The Increasingly Risky GSE Lending Activity (2003-2007) Sources: FHFA, OFHEO Annual Report, Inside Mortgage Finance Notes: GSE new business represents originated guaranteed MBS plus non-private label MBS portfolio purchases; the private market new business represents all MBS financed through private label securitization. On top of this high risk lending activity, Table 3-4 also provides evidence that Fannie and Freddie grew their mortgage portfolio as the race to the bottom unfolded. For example, compared to $103 billion of risky private label MBS purchased in 2003, over the next three years, Fannie and Freddie averaged $204 billion per year even though their overall MBS purchases essentially halved. In other words, their percentage share in risky MBS for their own portfolio quadrupled over this period. $ Billions GSE New business GSE Mortgage Portfolio Purchases Private Market New business (Non Agency) GSE High Risk % GSE Share in High risk activity High risk (1) LTVs>80% and/or FICO<660 Very high risk LTVs>90 % and FICO<620 Total (2) Private- Label Securities (PLS) Percentag e of PLS/Tota l High risk (4) LTVs>80% and/or FICO<660
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