• 1938

    The Great Depression Prompts The Government To Create Fannie Mae

    During the Great Depression and a time of disaster in the financial markets the government saw itself as a solution created the Federal Home Loan Banks (1932) and the Federal National Mortgage Association also known as Fannie Mae (1938). This was done as part of the New Deal which was created to "fix" the economy including increasing home ownership. [1]

    The government created Fannie Mae with the express purpose of funding "mortgage loans insured by . . . the Federal Housing Administration." [1]

    As we progress through the time-line you will see how Fannie Mae will detrimentally interfere with the housing market and become one of the driving forces behind the housing bubble.

    [1] Paul A. Cleveland, Freddie Mac: A Mercantilist Enterprise Link
    See also: Stanton, Thomas. Government Sponsored Enterprises: Mercantilist Companies in the Modern World, (Washington: The AEI press, 2002), pg. 10.

    • The New Deal

  • 1968

    Fannie Mae chartered as a GSE

    The government, under pressure to remove Fannie Mae's activity and debt off the federal budget [1] and obtain special privileges not granted to private institutions, was chartered as a GSE (Government Sponsored Enterprises). It could now also issue Mortgage-Backed Securities. [3]

    Freddie Mac was likewise chartered as a GSE in 1970.[2]

    Advocates for these GSEs argue that they can step in to fill the void left by the private market. While there might exist the notion that these are private companies they have at their disposal many advantages over that of a true private company:

    * Access to a guaranteed line of credit of $2.25 billion with the U.S. treasury.
    * Exempt from state and local income taxation and are exempt from SEC filings.
    * Securities listed as government securities and can be held by banks and thrifts as low-risk bonds.
    * Can afford higher risk loans than those given out through the private market because of the backing of the government with its elastic money supply.

    These advantages also make it easier to issue loans to low-income families to own homes and are publicized as such to score political points.

    The combined affect of these advantages give these institutions a substantial anti-competitive and unsustainable edge over private market forces.

    [1] Stanton, Thomas. Government Sponsored Enterprises: Mercantilist Companies in the Modern World, (Washington: The AEI press, 2002), pg. 17.
    [2] Paul A. Cleveland, Freddie Mac: A Mercantilist Enterprise Link
    [3] Fannie Mae Wesbsite (http://www.fanniemae.com/aboutfm)/charter.jhtml

  • 1977

    Community Reinvestment Act Passed

    Now that the stage was set for subprime borrowers to obtain loans through the politically connected GSEs Fannie Mae and Freddie Mac the next step the special interests took was to pressure the banks themselves in to issuing these high-risk loans. This was achieved through legislation created by the Democratic Carter Administration.

    The lobbyists behind the CRA were left-wing organizations that supported the Carter Administration, their kick-back would be delivered through their newly created powers to pressure banks into issuing loans they normally wouldn't make. [1]

    It was publicized as a law which intended to encourage banks and savings and loan associations to "meet the needs" of their communities by offering credit to minority groups, low income borrowers and small businesses owners. [2]

    In reality this new law gave the Fed and other financial regulators the power to pressure/extort banks into making more loans to less-than-creditworthy borrowers than they would normally be willing to risk. [3]

    Also, the administration funded with tax dollars numerous "community groups" that have helped the Fed, the Comptroller of the Currency, and other federal regulatory agencies to enforce the act. These (partially) tax-funded "community groups" (such as ACORN) can file petitions with regulators that can stop the bank's activities in their tracks if they are feel the bank is not "meeting the needs of the community" whenever the bank tries to perform an action such as:

    * Mergers
    * New branch openings
    * Getting into a new line of business

    and more, it must be able to prove that it has made "enough" loans to the government's preferred borrowers.

    This gave certain organizations such as ACORN lots of power to pressure banks. These banks routinely had to buy off ACORN and other "community groups" by giving them millions of dollars as well as promising to make even more dubious loans. [3]

    [1] Thomas J. DiLorenzo, The Government-Created Subprime Mortgage Meltdown, Link
    [2] FDIC Laws & Regulations Documentation page for the CRA HOUSING AND COMMUNITY DEVELOPMENT ACT OF 1977—TITLE VIII (COMMUNITY REINVESTMENT)
    [3] Thomas J. DiLorenzo, The CRA Scam and its Defenders Link

    • Jimmy Carter Administration (39th President)

  • 1986

    Tax Reform Act of 1986: Push For More Home Ownership

    Up until 1986, interest payments on all personal consumer loans were tax deductible, this included credit card debt payments. [1]

    The government used the Tax Reform Act of 1986 as a means of stimulating the housing market through a modified tax incentive. Namely, it would eliminate tax breaks on consumer loan payments except maintain a deduction for home mortgage interest payments. [2]

    This government intervention would inevitably lead to increased artificial demand for financing through home mortgages.

    [1] Home mortgage interest deduction (http://en.wikipedia.org/wiki/Home_mortgage_interest_deduction)
    [2] Tax Reform Act of 1986 (http://en.wikipedia.org/wiki/Tax_Reform_Act_of_1986)

    • Ronald Reagan Administration (40th President)

  • 1992

    GSEs Required To Supply Subprime Loans

    The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 required Fannie Mae and Freddie Mac to devote a percentage of their lending to support affordable housing increasing their pooling and selling of such loans as securities; Office of Federal Housing Enterprise Oversight (OFHEO) (Part of HUD) created to oversee them. [1]

    Ben Bernanke admitted this himself in his speech (At the Community Affairs Research Conference, Washington, D.C.):

    Securitization of affordable housing loans expanded, as did the secondary market for those loans, in part reflecting a 1992 law that required the government-sponsored enterprises, Fannie Mae and Freddie Mac, to devote a percentage of their activities to meeting affordable housing goals (HUD, 2006) [2]

    From this point onwards Fannie Mae will incur explosive growth and become a much more prominent driving force behind the the housing boom before the burst.

    [1] Wikipedia: Federal Housing Enterprises Financial Safety and Soundness Act of 1992 Link
    [2] Federal Reserve Website (http://www.federalreserve.gov/newsevents/speech/Bernanke20070330a.htm)

  • August 5, 1997

    Taxpayer Relief Act of 1997: Push For More Home Ownership

    In 1997, President Bill Clinton signed the Taxpayer Relief Act. This provided tax relief for captial gains and provided an exemption for home sales. A couple who had been in their home for two years or more could recieve a $500,000 capital gains tax exemption. This pushed more people to switch from renters to buyers and continued to increase demand for homes. [1]

    IRS Official Code [2]:
    • The sale or exchange took place after 2008.
    • The sale or exchange took place no more than 2 years after the date of death of your spouse.
    • You have not remarried.

    • You and your spouse met the use test at the time of your spouse's death.
    • You or your spouse met the ownership test at the time of your spouse's death.
    • Neither you nor your spouse excluded gain from the sale of another home during the last 2 years before the date of death.


    [1] Schiff, Peter. Crash Proof 2.0, (New Jerset: John Wiley & Sons Inc., 2009), pg. 162.
    [2] Publication 523, IRS Website, (http://www.irs.gov/publications/p523/ar02.html)

    • Bill Clinton Administration (42nd President)

  • August 31, 1999

    Repeal of Glass-Steagall Act - Misconceptions

    After the pop of the housing bubble, there was some belief that the repeal of the Glass-Steagall Act was an act of "deregulation" and this deregulation was an enabler of the free market to
    destroy real estate market. This line of thinking is invalid. [1][2]

    The Glass-Steagall Act was enacted after the Great Depression. It separated commercial banks and investment banks. However, there is a misconception that the collusion of commercial and investment banks poses any threat to the consumer at all. The big push for this separation was a byproduct of the corporate-political battle between the monolithic Rockefeller and Morgan family's interests in the banking sector. [3]

    This form of "deregulation" is far from real deregulation where private firms are held accountable for their actions. If a business can operate with the backing of the government, even if it fails, this poses a moral hazard which can easily be taken advantage of by the special interests. Therefore, this deregulation is simply a softening of the rules of the special interests which bares no resemblance to true free-market deregulation. [4]

    The real problems that were caused by this legislation were that of its inflationary effects. This deregulation opened the flood gates for banks to issue more loans in order to maintain new higher profit levels thus causing an explosion of new credit enabled by the Federal Reserve. This Federal Reserve credit, without the backing of gold, is created out of thin air. [5]

    [1] No, the Free Market Did Not Cause the Financial Crisis
    [2] Did Free Market Ideology Cause the HousingBubble?
    [3] The Quarterly Journal Of Austrian Economics Vol 1. No. 1 (1998). The Separation Of Commercial And Investment Banking: The Morgans Vs. THe Rockefellers
    [4] The Free Market Vol 13. No. 11 (1995) Banks on the Dole, Llewellyn H. Rockwell, Jr.
    [5] Does It Make Sense to Resurrect the Glass-Steagall Act? Mises Daily: Tuesday, February 16, 2010 by Frank Shostak

    • United States Federal Reserve

    • Bill Clinton Administration (42nd President)

  • July 16, 2002

    Rep. Ron Paul Attempts To Fix The Problem

    Congressman Ron Paul

    U.S. House of Representatives

    July 16, 2002


    “Mr. Speaker, I rise to introduce the Free Housing Market Enhancement Act. This legislation restores a free market in housing by repealing special privileges for housing-related government sponsored enterprises (GSEs). These entities are the Federal National Mortgage Association (Fannie), the Federal Home Loan Mortgage Corporation (Freddie), and the National Home Loan Bank Board (HLBB). According to the Congressional Budget Office, the housing-related GSEs received $13.6 billion worth of indirect federal subsidies in fiscal year 2000 alone.


    One of the major government privileges granted these GSEs is a line of credit to the United States Treasury. According to some estimates, the line of credit may be worth over $2 billion. This explicit promise by the Treasury to bail out these GSEs in times of economic difficulty helps them attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy. Thus, the line of credit distorts the allocation of capital. More importantly, the line of credit is a promise on behalf of the government to engage in a massive unconstitutional and immoral income transfer from working Americans to holders of GSE debt.


    The Free Housing Market Enhancement Act also repeals the explicit grant of legal authority given to the Federal Reserve to purchase the debt of housing-related GSEs. GSEs are the only institutions besides the United States Treasury granted explicit statutory authority to monetize their debt through the Federal Reserve. This provision gives the GSEs a source of liquidity unavailable to their competitors.


    Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges of Fannie, Freddie, and HLBB have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.


    However, despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government’s policies of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.


    Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary but painful market corrections will only deepen the inevitable fall. The more people invested in the market, the greater the effects across the economy when the bubble bursts.


    No less an authority than Federal Reserve Chairman Alan Greenspan has expressed concern that government subsidies provided to the GSEs make investors underestimate the risk of investing in Fannie Mae and Freddie Mac.


    Mr. Speaker, it is time for Congress to act to remove taxpayer support from the housing GSEs before the bubble bursts and taxpayers are once again forced to bail out investors misled by foolish government interference in the market. I therefore hope my colleagues will stand up for American taxpayers and investors by cosponsoring the Free Housing Market Enhancement Act.” [1]



    This legislation unfortunately, but not surprisingly, died out without much support. [2]

    [1] Ron Paul on the Housing Bubble – July 2002 Ronpaul.com
    [2] H.R. 3071: Free Housing Market Enhancement Act

  • May 31, 2003

    Federal funds target reaches 1%: The Beginning of The End

    As you might have noticed, many years have gone by since the beginning of the timeline yet the housing bubble did not rapidly grow and pop in this timeframe. So far, these events have been contributing factors, not the main culprit, of the housing bubble. While Fannie Mae, Freddie Mac and the Community Reinvestment Act have been mentioned thus far, many loans (including subprime loans) were issued outside of this sphere. The big catalyst was the near-instantenous drop of the federal funds target rate by Alan Greenspan of the Federal Reserve. [1] This drop will lead to a lower mortgage rate and an explosion of new lending. [2]

    All of the pieces are now in place to reach critical mass:
    (1) Loose monetary policy of the Federal Reserve.
    (2) Lax lending practices by banks and GSEs due to the CRA and
    (3) An explosion in the banking industry thanks to the now softer banking restrictions after the repeal of Glass Steagall (primarly billions of new inflationary credit created out of thin air, see last event).

    [1] Yes, Greenspan Did It Mises Daily: Wednesday, December 31, 2008 by Stefan Karlsson
    [2] The Housing Bubble in 4 Easy Steps Mises Daily: Saturday, September 27, 2008 by Mark Thornton

    • United States Federal Reserve

    • Alan Greenspan (Federal Reserve Chairman)

  • March 1, 2004

    30-Year Conventional Mortgage Rate Falls to All Time Low

    As expected, following the drop of the federal funds rate, interest rates on 30-year conventional mortgages reached their lowest levels ever during the post-gold standard era. When interest rates fall, asset prices and real estate prices tend to rise this further inflating the bubble already well underway. [1]

    [1] The Housing Bubble in 4 Easy Steps Mises Daily: Saturday, September 27, 2008 by Mark Thornton

    • United States Federal Reserve

    • Alan Greenspan (Federal Reserve Chairman)

  • February 1, 2007

    Real Estate Loans Reach All Time High

    Low rates caused borrowing and lending to explode. Commercial banks more than doubled the amount of real-estate loans they made. [1]

    So far, we haven't mentioned Wall Street's role in the process. It has become commonplance to pin the blame on Wall Street and link this failure to the failures of the free market. However, while Wall Street did play its part in the debacle and caused plenty of damage (which will be explained below) do not forget that the enabler of all of this was the Federal Reserve with it's dirt cheap credit it offered to banks.

    With Fannie Mae and Freddie Mac restricted to prime conforming paper (commercial paper with a very high credit rating [2]) and the demand for housing at record levels, including nonconforming sub prime mortgage applicants, Wall Street came up with clever securities to meet the demand.

    Collateralized mortgage obligations (CMOs): A mortgage backed security that split large pools of mortgages into different risk, rate and maturity classes called tranches. These tranches are marketed as separate bonds, placing different mortgages of different risk levels into different tranches. Wall Street started to make large amounts of profit through these securities so it had a high incentive to draw as many people into mortgages as possible. This led to the creation of even more high-risk mortgages to expand their reach over the non-conforming market.

    Adjustable-rate mortgages (ARMs): This was a means of transferring the risk of rising interest rates to the home buyer. It was sold below the going fixed rate and also given a low (sometimes below 1%) initial "teaser" rate. This allowed home owners to acquire a new mortgage at exremely low rates. So long as interest rates remained low there would be no threat of default, however, with interest rates at rock-bottom levels the only place it could go was up and this was a looming disaster for those who already could barely make the payments.

    Interest-only loans: You only need to pay the interest on the loan for a fixed initial period. Once this period is up you are liable to pay the loan at a new rate and also pay towards principal. While this made it easy to get into a loan and buy a house, after the grace period is up you now need to start making higher payments on a house in which you own 0% equity. This also means that you don't have any borrowing power thus if you can't meet the payments you will be forced to sell and possibly owe money to the bank if the house depreciated.

    These kinds of loans and securities led to a massive spike in speculation, why? Because much of the reasoning to get into these loans puth faith in the fact that:
    (a) Interest rates will not rise and
    (b) Home values will always appreciate thus calling for only a limited need of residing in a home since you will eventually sell your home for a large profit and move into a bigger home (don't forget the Tax Act of 1986)

    This speculation will eventually come crashing down because inevitabely interest rates will rise again as the spike in new credit will put pressure on the the dollar and force the Fed to raise rates. Once this happens, all these fragile securities sold on Wall St. alongside the mortgages held by the GSEs will come crashing down as the economy deteriorates and there's a market correction. [3][4]

    For a visualization of how Wall St. securities work, watch this short animated video:

    The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.



    [1] The Housing Bubble in 4 Easy Steps Mises Daily: Saturday, September 27, 2008 by Mark Thornton
    [2] Prime conforming paper definition
    [3] Schiff, Peter. Crash Proof 2.0, (New Jerset: John Wiley & Sons Inc., 2009), pg. 169-181.
    [4] Bursting Eugene Fama's Bubble. Mises Daily: Monday, February 15, 2010 by Robert P. Murphy

  • February 2, 2007

    Housing Bubble Bursts

    We will end our journey with a tribute, written by Walter Block, to all of the Austrain Economists who helped shed the light on how the housing bubble culiminated and ended. Also, for warning the general public long before the bubble popped. While not many listened before, hopefully more will listen now:

    "I think it is very important that we keep track of, and thank, the Austrians who predicted the housing bubble. Let this signal contribution of the praxeological school never fall down that proverbial memory hole. Why do I say this? For one thing, to give credit where credit is due. All too often, mainstream economists take credit for all and sundry; it is time, it is long past time, that some credit be publicly accorded to Austrian economics and its practitioners, and predicting the housing bubble will do quite well as one small part of these accomplishments. For another, I focus on these predictions in order to promote this school of economics, the last best hope for humanity. Were the school of thought of Menger, Böhm-Bawerk, Mises and Rothbard more widely known, and public policy more heavily based upon it, we would not be suffering from the economic quandary that now envelopes us. Previously, I blogged on this subject, mentioning that I was trying to put together a list of citations of Austrians who had predicted the housing bubble. I offered there the beginnings of this list, and asked people to help me make it more complete. I now thank the following scholars for helping me add to this bibliography: Rick Burner, Matt Dioguardi, Mike Finger, Kevinz Kevz, Julio Linares, Mickey Propadovich, John Spiers, Scott Sutton, Scott Weisman. As you will see below from the TBA’s, this bibliography is not yet in its final stage. So, gentle reader, please correct any of my remaining errors of omission or commission. I am determined to put together as complete and accurate a bibliography of this signal contribution of Austrian economics as possible."

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