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The strong growth in private label subprime mortgage

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borrower and to monitor the loan after it was issued were reduced substantially. The strong growth in private-label subprime mortgage originations and securitizations had important consequences for the GSEs. First, as shown in Figure 3-1, their market share of originations fell dramatically between 2003 and 2006. Second, the loss in market share made it harder for them to meet their ever-increasing Congress-mandated quotas. To preserve the profit growth rates of the pre-2003 period and to simultaneously meet their quotas, the GSEs embarked on an all-in policy, which saw them dramatically ramp up the risks of their portfolio. This policy started as far back as 2000-2001 with the motivation that a stronger GSE presence in the subprime market would create lower priced mortgages for some subprime borrowers. While there is little doubt that the housing goals played an important role in shifting Fannie Mae and Freddie Mac’s profile to riskier mortgage loans, it remains an interesting question whether Fannie Mae and Freddie Mac deliberately chose to increase the riskiness of the loans that they bought 2004 onward or whether they were forced to do so by the U.S. Congress, which wanted to promote home ownership. While the public/private nature of the GSEs leads to a moral hazard problem even in normal times, the question is whether moral hazard was exacerbated by the astronomical growth of the subprime market segment. As pointed out earlier in Chapter 2, the GSEs saw consecutive increases in their low- and moderate-income, special affordability, and underserved areas goals in each of 1996, 1997, 2001, 2005, 2006, 2007, and 2008. However, the largest increases took place in 1996 and in 2001,
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44 outside of the rapid growth of the 2003 period and onward. Moreover, the target increases in 2005, 2006, and 2007 were more modest, yet that is when most of the increase in riskiness took place. Finally, Fannie and Freddie missed one or more of their mission targets on several occasions, without severe sanctions by the regulator, suggesting that adherence was largely voluntary. Former FHFA director James Lockhart testified that both Fannie and Freddie “had serious deficiencies in systems, risk management, and internal controls.” Furthermore, “there was no mission related reason why the Enterprises needed portfolios that totaled $1.5 trillion.” He chalked it up to “the Enterprises’ drive for market share and short-term profitability.” In fact, in testimony to the Financial Crisis Inquiry Commission on April 9, 2010, former Fannie Mae CEO Daniel Mudd admitted as much: “In 2003, Fannie Mae’s estimated market share of new single-family mortgage-related securities was 45%. By 2006, it had fallen to 23.7%. It became clear that the movement towards nontraditional products was not a fad, but a growing and permanent change in the mortgage marketplace, which the GSEs (as companies specialized in and limited to, the mortgage market) could not ignore.” Similar language can be found in Fannie Mae’s own strategic plan document, “Fannie Mae Strategic Plan, 2007-2011, Deepen Segments – Develop Breadth,” in which the company outlined its 2007 onwards strategy:
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