TightWind is written by Kyle Baxter. Stay Hungry. Stay Foolish.

Paul Krugman says Fannie Mae and Freddie Mac had nothing to do with inflating the housing bubble.

His argument is that because the housing bubble reached its maximum point of inflation in 2005, and the GSEs’ share of residential mortgages began decreasing in 2003 while the private market’s share began increasing in 2003 and overtook the GSEs’ in 2004, this means the GSEs were not responsible for inflating the bubble.

His evidence is not sufficient to support his conclusion. While housing prices reached their upper limit in 2005, they grew significantly from 1997 to 2003–the same time period where the GSEs’ share of residential mortgages, and of mortgages to borrowers with incomes below the median, grew significantly. Their purchase of loans to borrowers with incomes below the median doubled between 1997 and 2003, and their purchase of low down payment loans (loans with a down payment of 5 percent or less) grew even more drastically in the same period.1

Russell Roberts explains how this affected subprime securities prices (and thus how attractive they were for investors):

They played a significant part in the expansion of mortgage credit to low-income borrowers, an expansion that presumably pushed up housing prices in low-income neighborhoods, making subprime securitization more attractive.

The GSEs, though, did not only contribute to the housing bubble through non-prime mortgages. By purchasing prime mortgages from loan originators (banks, for example) and turning them into securities, the GSEs took those loans off of the originator’s balance sheet (which eliminates the risk for them), freeing the originators to make even more loans. Between 1997 and 2003, the GSEs total loans purchased rose by more than 65 percent.2 This contributed to the housing bubble by allowing loan originators to make loans almost without risk (because they could offload them from their balance sheet to the GSEs), which invariably led to an increase in mortgages. More loans means more people buying more homes, which means rising home prices. Moreover, this also made it easier for loan originators to make riskier non-prime loans, because they no longer had to carry their prime mortgages on their balance sheets. They could just make those loans and immediately receive a payment for them from the GSEs.

The GSEs played an important role in inflating the housing bubble between 1997 and 2003, in effect getting the ball rolling. (And, actually, much more than that: according to Krugman’s chart, this time period was responsible for about half of the total housing price inflation.)

Krugman discusses none of this. Rather, he tries to simplify the GSEs’ role in the housing market into a single chart that isn’t sufficient to justify his conclusion. This is either remarkably lazy on Krugman’s part, or he is being intentionally dishonest. And I doubt the former.

1. See Professor Robert’s excellent paper on the financial crisis, Gambling With Other People’s Money. [↩]
2. Ibid. [↩]