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SEPTEMBER : THE TAKEOVER OF FANNIE MAE AND FREDDIE MAC 

these securities, contributing to the failure of  institutions and to the downgrading
of  to less than “well capitalized” by their regulators. 
Paulson told the FCIC that he was “naive” enough to believe that the action would
halt the crisis because it “would put a floor under the housing market decline, and
provide confidence to the market.” He realized he was wrong on the next day, when,

as he told the FCIC, “Lehman started to go.” Former Treasury Assistant Secretary
Neel Kashkari agreed. “We thought that after we stabilized Fannie and Freddie that
we bought ourselves some time. Maybe a month, maybe three months. But they were
such profound interventions, stabilizing such a huge part of the financial markets,
that would buy us some time. We were surprised that Lehman then happened a week
later, that Lehman had to be taken over or it would go into bankruptcy.” 
The firms’ failure was a huge event and increased the magnitude of the crisis, ac-
cording to Fed Governor Kevin Warsh and New York Fed General Counsel Tom Bax-
ter. Warsh also told the FCIC that the events surrounding the GSE takeover led to “a

massive, underreported, underappreciated jolt to the system.” Then, according to
Warsh, when the market grasped that it had misunderstood the risks associated with
the GSEs, and that the government could have conceivably let them fail, it “caused in-
vestors to panic about the value of every asset, to reassess every portfolio.” 
FHFA Director Lockhart described the decision to put the GSEs into conservator-
ship in the context of Lehman’s failure. Given that the investment bank’s balance
sheet was about one-fifth the size of Fannie Mae’s, he felt that the fallout from
Lehman’s bankruptcy would have paled in comparison to a GSE failure. He said,
“What happened after Lehman would have been very small compared to these .
trillion institutions failing.” Major holders of GSE securities included the Chinese

and Russian central banks, which, between them, owned more than half a trillion
dollars of these securities, and U.S. financial firms and investment funds had even
more extensive holdings. A  Fed study concluded that U.S. banks owned more
than  trillion in GSE debt and securities—more than  of the banks’ Tier  cap-
ital and  of their total assets at the time. 
Testifying before the FCIC, Mudd claimed that failure was all but inevitable. “In
, the companies had no refuge from the twin shocks of a housing crisis followed
by a financial crisis,” he said. “A monoline GSE structure asked to perform multiple
tasks cannot withstand a multiyear  home price decline on a national scale, even
without the accompanying global financial turmoil. The model allowed a balance of
business and mission when home prices were rising. When prices crashed far beyond
the realm of historical experience, it became ‘The Pit and the Pendulum,’ a choice be-
tween horrible alternatives.” 

“THE WORSTRUN FINANCIAL INSTITUTION”
When interviewed by the FCIC, FHFA officials were very critical of Fannie’s manage-
ment. John Kerr, the FHFA examiner (and an OCC veteran) in charge of Fannie ex-
aminations, minced no words. He labeled Fannie “the worst-run financial
institution” he had seen in his  years as a bank regulator. Scott Smith, who became