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 FINANCIAL CRISIS INQUIRY COMMISSION REPORT

bought its mortgage portfolio by borrowing short- and medium-term. In ,
when the Fed increased short-term interest rates to quell inflation, Fannie, like the
thrifts, found that its cost of funding rose while income from mortgages did not. By
the s, the Department of Housing and Urban Development (HUD) estimated

Fannie had a negative net worth of  billion. Freddie emerged unscathed be-
cause unlike Fannie then, its primary business was guaranteeing mortgage-backed
securities, not holding mortgages in its portfolio. In guaranteeing mortgage-
backed securities, Freddie Mac avoided taking the interest rate risk that hit Fannie’s
portfolio.
In , Congress provided tax relief and HUD relaxed Fannie’s capital require-
ments to help the company avert failure. These efforts were consistent with lawmak-
ers’ repeated proclamations that a vibrant market for home mortgages served the
best interests of the country, but the moves also reinforced the impression that the
government would never abandon Fannie and Freddie. Fannie and Freddie would
soon buy and either hold or securitize mortgages worth hundreds of billions, then
trillions, of dollars. Among the investors were U.S. banks, thrifts, investment funds,
and pension funds, as well as central banks and investment funds around the world.
Fannie and Freddie had become too big to fail.
While the government continued to favor Fannie and Freddie, they toughened
regulation of the thrifts following the savings and loan crisis. Thrifts had previously
dominated the mortgage business as large holders of mortgages. In the Financial In-
stitutions Reform, Recovery, and Enforcement Act of  (FIRREA), Congress
imposed tougher, bank-style capital requirements and regulations on thrifts. By con-
trast, in the Federal Housing Enterprises Financial Safety and Soundness Act of ,
Congress created a supervisor for the GSEs, the Office of Federal Housing Enterprise
Oversight (OFHEO), without legal powers comparable to those of bank and thrift
supervisors in enforcement, capital requirements, funding, and receivership. Crack-
ing down on thrifts while not on the GSEs was no accident. The GSEs had shown

their immense political power during the drafting of the  law. “OFHEO was
structurally weak and almost designed to fail,” said Armando Falcon Jr., a former di-
rector of the agency, to the FCIC. 
All this added up to a generous federal subsidy. One  study put the value of
that subsidy at  billion or more and estimated that more than half of these bene-
fits accrued to shareholders, not to homebuyers. 
Given these circumstances, regulatory arbitrage worked as it always does: the
markets shifted to the lowest-cost, least-regulated havens. After Congress imposed
stricter capital requirements on thrifts, it became increasingly profitable for them to
securitize with or sell loans to Fannie and Freddie rather than hold on to the loans.
The stampede was on. Fannie’s and Freddie’s debt obligations and outstanding mort-
gage-backed securities grew from  billion in  to . trillion in  and
. trillion in . 
The legislation that transformed Fannie in  also authorized HUD to prescribe
affordable housing goals for Fannie: to “require that a reasonable portion of the cor-
poration’s mortgage purchases be related to the national goal of providing adequate