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SUMMARY

Although there were many contributing factors, the housing bubble of 1997-
2007 would not have reached its dizzying heights or lasted as long, nor would
the fi nancial crisis of 2008 have ensued, but for the role played by the housing
policies of the United States government over the course of two administrations.
As a result of these policies, by the middle of 2007, there were approximately 27
million subprime and Alt-A mortgages in the U.S. fi nancial system—half of all
4
mortgages outstanding—with an aggregate value of over $4.5 trillion. Th ese were
unprecedented numbers, far higher than at any time in the past, and the losses
associated with the delinquency and default of these mortgages fully account for
the weakness and disruption of the fi nancial system that has become known as the
fi nancial crisis.
Most subprime and Alt-A mortgages are high risk loans. A subprime
mortgage is a loan to a borrower who has blemished credit, usually signifi ed by
5
a FICO credit score lower than 660. Typically, a subprime borrower has failed in
4 Unless otherwise indicated, all estimates for the number of subprime and Alt-A mortgages outstanding,
as well as the use of specifi c terms such as loan to value ratios and delinquency rates, come from research
done by Edward Pinto, a resident fellow at the American Enterprise Institute. Pinto is also a consultant
to the housing fi nance industry and a former chief credit offi cer of Fannie Mae. Much of this work is
posted on both my and Pinto’s scholar pages at AEI as follows: http://www.aei.org/docLib/Pinto-Sizing-
Total-Exposure.pdf, which accounts for all 27 million high risk loans; http://www.aei.org/docLib/
Pinto-Sizing-Total-Federal-Contributions.pdf, which covers the portion of these loans that were held or
guaranteed by federal agencies and the four large banks that made these loans under CRA; and http://
www.aei.org/docLib/Pinto-High-LTV-Subprime-Alt-A.pdf, which covers the acquisition of these loans
by government agencies from the early 1990s. Th e information in these memoranda is fully cited to
original sources. Th ese memoranda were the data exhibits to a Pinto memorandum submitted to the
FCIC in January 2010, and revised and updated in March 2010 (collectively, the “Triggers memo”).
5 One of the confusing elements of any study of the mortgage markets is the fact that the key defi nitions
have never been fully agreed upon. For many years, Fannie Mae treated as subprime loans only those
that it purchased from subprime originators. Inside Mortgage Finance, a common source of data on
the mortgage market, treated and recorded as subprime only those loans reported as subprime by the
originators or by Fannie and Freddie. Other loans were recorded as prime, even if they had credit scores
that would have classifi ed them as subprime. However, a FICO credit score of less than 660 is generally
regarded as a subprime loan, no matter how originated. Th at is the standard, for example, used by the
Offi ce of the Comptroller of the Currency. In this statement and in Pinto’s work on this issue, loans that
are classifi ed as subprime by their originators are called “self-denominated” subprime loans, and loans
to borrowers with FICO scores of less than 660 are called subprime by characteristic. Fannie and Freddie
reported only a very small percentage of their loans as subprime, so in eff ect the subprime loans acquired
by Fannie and Freddie should be added to the self-denominated subprime loans originated by others in
order to derive something closer to the number and principal amount of the subprime loans outstanding
in the fi nancial system at any given time. One of the important elements of Edward Pinto’s work was to
show that Fannie and Freddie, for many years prior to the fi nancial crisis, were buying loans that should
have been classifi ed as subprime because of the borrowers’ credit scores and not simply because they were
originated by subprime lenders. Fannie and Freddie did not do this until aft er they were taken over by
the federal government. Th is lack of disclosure on the part of the GSEs appears to have been a factor in
the failure of many market observers to foresee the potential severity of the mortgage defaults when the
housing bubble defl ated in 2007.
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