Mae you need us more than we need you and if you dont

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Mae, “You need us more than we need you, and if you don’t take these loans, you’ll find you can lose much more.” - Charles Duhigg, New York Times , October 5, 2008 In their important 1932 book on the American corporation, The Modern Corporation and Private Property , Adolf Berle and Gardiner Means introduce the concept “race to the bottom”: the idea that competition can lead to a reduction of standards. While Berle and Means were referring to regulatory standards and competition among the (then) 48 states, it is not difficult to see how the same arguments could be applied to government-sponsored enterprises and likewise financial institutions. Figure 3-1 graphs the tremendous growth in the mortgage market (solid line, plotted against the right axis), and the fraction of residential mortgage originations each year that were securitized by the GSEs or private-label firms, as well as the amount not securitized (dashed lines plotted against the left axis). As can be seen from Figure 3-1, the mortgage market increased dramatically in size, especially in the latter period with the emergence of the riskier mortgage lending. It also shows that mortgage securitization generally increased every year from 1995 onwards, albeit for different reasons. In the period up to 2003, the GSEs dominated the market, but, then post 2003, non-GSE MBS more than tripled from 12% to 38% of the origination market. By 2006 and 2007, Figure 3-1 illustrates well the competitive struggle as the GSEs recovered some of their market share (and currently dominate the market completely). The housing boom that began in the late 1990s and the concomitant rise of “private label mortgage-backed securities” (PLS) shown in Figure 3-1 posed a challenge to the GSEs. This is because the PLS involved non-conforming mortgages (securitized, for instance, by investment banks) that were of lower quality than the mortgages that met the GSEs’ usual underwriting standards or were for amounts that exceeded the GSE conforming loan limit. Borrowers who might otherwise have qualified for a conforming loan were being encouraged by lenders to borrow greater amounts (pushing them into “jumbo” territory) and/or to structure their loans in ways that wouldn’t meet the GSEs’ underwriting standards (pushing them into the non-
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34 conforming territory). The latter was done, for example, by the borrower’s making less than the requisite 20% down payment but not arranging for private mortgage insurance, or by getting a second mortgage loan to cover some or even all of the down payment, or by getting an initial low “teaser” interest rate but with a scheduled upward adjustment after two or three years. Figure 3-1. Growth in Mortgage Market, Securitization, and % Share of Market Source: Inside Mortgage Finance Chapter 2 described the increasingly risky mortgage profile of Fannie and Freddie from the mid 1990s through 2003. After 2003, faced with more competition and a declining market share (and, after accounting scandals in 2003 and 2004, limited in their ability to expand their
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