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KEITH HENNESSEY, DOUGLAS HOLTZ-EAKIN, AND BILL THOMAS 

renew the commercial paper they were funding and began to convert their holdings to
Treasuries and cash. Corporations that had relied on commercial paper markets for
short-term financing suddenly had to draw down their backstop lines of credit. No one
had expected these corporate lines of credit to be triggered simultaneously, and this
“involuntary lending” meant that banks would have to pull back on other activities.

The role of Fannie Mae and Freddie Mac in causing the crisis
The government-sponsored enterprises Fannie Mae and Freddie Mac were elements
of the crisis in several ways:

• They were part of the securitization process that lowered mortgage credit quality
standards.
• As large financial institutions whose failures risked contagion, they were massive
and multidimensional cases of the too big to fail problem. Policymakers were un-
willing to let them fail because:
– Financial institutions around the world bore significant counterparty
risk to them through holdings of GSE debt;
– Certain funding markets depended on the value of their debt; and
– Ongoing mortgage market operation depended on their continued
existence.
• They were by far the most expensive institutional failures to the taxpayer and are
an ongoing cost.

There is vigorous debate about how big a role these two firms played in securitiza-
tion relative to “private label” securitizers. There is also vigorous debate about why
these two firms got involved in this problem. We think both questions are less impor-
tant than the multiple points of contact Fannie Mae and Freddie Mac had with the fi-
nancial system.
These two firms were guarantors and securitizers, financial institutions holding
enormous portfolios of housing-related assets, and the issuers of debt that was treated
like government debt by the financial system. Fannie Mae and Freddie Mac did not by
themselves cause the crisis, but they contributed significantly in a number of ways.

THE SYSTEM FREEZING
Following the shock and panic, financial intermediation operated with escalating
frictions. Some funding markets collapsed entirely. Others experienced a rapid
blowout in spreads following the shock and stabilized slowly as the panic subsided
and the government stepped in to backstop markets and firms. We highlight three
funding markets here:

• Interbank lending. Lending dynamics changed quickly in the federal funds
market where banks loan excess reserves to one another overnight. Even large