In her new book, Shaky Ground: The Strange Saga of the U.S. Mortgage Giants, she writes,

Originally, Fannie and Freddie owned the mortgages they purchased. but over time, as the capital markets in this country evolved, Fannie and Freddie began to package up the mortgages they purchased, stamp them with a guarantee. . .and sell them as securities to investors.

This is true of Fannie. But for Freddie the history is the opposite. They were in the securitization business from the beginning in 1970, and only around 1990 did they start to hold a substantial share of mortgages and mortgage securities as assets. There were several reasons that Freddie shifted to holding a large portfolio, funded by debt.

1. By 1990 Freddie was a shareholder-owned company (before that, they were basically a government agency), and shareholders were interested in profits. Having a large portfolio was profitable.

2. Prior to that, Freddie was concerned about the risk of holding mortgage portfolio. If you fund with short-term debt and interest rates rise, you end up paying more in interest expense than you earn on mortgages. If you fund with long-term debt and interest rates fall, borrowers refinance at lower rates and you are stuck with the high long-term debt costs. But Fannie Mae found a solution, which consisted of issuing callable debt. For example, they might issue a 10-year bond that can be called in 5 years. The market charged a surprisingly low interest rate on such securities, so Freddie started issuing them. Combining callable debt with some interest-rate derivatives gave Freddie and Fannie something close to an arbitrage profit in portfolio lending. They were helped, of course, by their “too big to fail” status, which made investors treat their debt as risk free–until the summer of 2008.

Anyway, I am sorry McLean slipped up on this. I really liked her book with Joe Nocera, All the Devils are Here, and I still have high hopes for her new one, which I have just started. I expect to post more on it.

I found this interesting:

When they were taken over, Fannie and Freddie had a combined $5.3 trillion in outstanding debt,, which, had it been put on the government’s balance sheet, would have increased the public national debt by about 50 percent. Partly to avoid that, the government left 20.1 percent of Fannie’s common stock, as well as other securities known as preferred shares, in the hands of investors.

Fannie and Freddie were originally government agencies. Fannie was privatized not for ideological reasons, but because Lyndon Johnson wanted Fannie’s debt off the government balance sheet. He was trying to fund the Vietnam War, plus the war on poverty, and he did not want Congress bothering him with debt-ceiling issues.

So here we were in 2008, and Fannie and Freddie should have been re-nationalized, but once again, the cosmetics of the government balance sheet took precedence.