The conventional wisdom today lays the blame for today’s financial crisis on the free market. The mortgage market collapse is thought to be due to unscrupulous lenders who relaxed lending standards and then sold risky mortgages to unsuspecting investors. Both Presidents Bush and Obama used this narrative in justifying their policy actions. Closer examination reveals that government interference played a much more fundamental role. Specifically, the ballooning of the secondary mortgage market by government sponsored entities, followed by the “cheap money” policy of the FED created the basic structural distortions which would ultimately lead to the financial crisis.
Government sponsored entities [GSE] such as Freddie Mac and Fannie Mae are key players in home mortgage markets. They were created by and have a specific mandate from congress to help assure “affordable” housing. Although these entities operate as “private corporations” today, they receive favorable treatment by the government and their boards and hence their operating policies are primarily government controlled. Continue reading