Look back to the first chart from the St. Louis Fed, and you can figure out what happened. The GSEs were like most private lenders. When faced with reduced revenues and profits from their core business, they became willing to make up the shortfall by going downmarket. How did they get comfortable with the increased risk? With private mortgage insurance. The private market, in its wisdom, chose to insure almost all of the Fannie's and Freddie's loans with an original LTV in excess of 90%. Private insurers covered more than 30% of the GSEs' exposure to all loans with FICO scores below 660. They covered 35% of Fannie's interest-only exposure and almost 40% of its Alt-A exposure. Of course, GSEs made the mistake of believing that those insurers' double-A and single-A ratings meant something.
Even worse, they made the mistake of believing in the triple-A ratings assigned to the private label Alt-A and Option-ARM bonds they acquired. Those bonds incurred $25 billion in writedowns.
Bottom Line: At the end of the day, the GSEs' biggest problems came from loans that had nothing to do with Affordable Housing Goals, because they had the predatory attributes that some politicians had sought to outlaw. The GSEs' chief enabler for acquiring toxic loans was the private insurance market, and, perhaps, regulators who were indifferent to the dangers of predatory lending.
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