Fannie's Role in Crisis Moves Into Spotlight

A federal commission will delve into the role government-supported mortgage entities played in the financial crisis, with former executives from Fannie Mae and key regulators set to testify on Friday.
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NEW YORK (

TheStreet

) -- A federal commission will examine the role that government-supported mortgage entities played in the financial crisis, with former executives from

Fannie Mae

(FNM)

and key regulators set to testify on Friday.

Former Fannie President and CEO Daniel Mudd, and former Chief Business Officer Robert Levin, plan to give testimony about their experience at the firm, and how subprime lending and securitization affected the economy and financial markets. James Lockhart, onetime director of the Office of the Federal Housing Enterprise Oversight, and his predecessor Armando Falcon will also testify.

In a

draft report

released on Wednesday, the Financial Crisis Inquiry Commission outlines a broad factual overview of the history of Fannie and its sister firm,

Freddie Mac

(FRE)

, and the increasingly enormous role they played in the housing market over the past few decades.

In 1995, the two firms had roughly $1 trillion in exposure to outstanding mortgage-backed securities. By the end of September 2008, when they were placed into conservatorship, the figure had more than tripled to nearly $3.75 trillion. They controlled more than 75% of new originations by that point in time.

But Fannie and Freddie weren't acting in isolation.

The two firms took on their hybrid public-private characteristics in 1968 and 1970, respectively, as part of federal efforts to support home ownership and affordability. They buy home loans, securitize them, and sell them back to the market at a profit, holding onto the credit risk by guaranteeing against default.

In exchange for government's implied backing on those guarantees -- and low borrowing costs that come with it -- Fannie and Freddie were required to meet certain "affordable housing" goals. By 2005, federal regulators expected more than half of Fannie and Freddie's mortgage purchases to be comprised of loans made to low- and moderate-income borrowers.

Effectively, as the subprime bonanza took shape, Fannie and Freddie fueled it, and management was even less able to apply the brakes.

"The GSEs did have reputational risk at stake if they missed achieving a housing goal or sub-goal, as they sometimes did," the commission says in its report. "In addition, HUD maintained a dialogue with the GSEs regarding these goals and at times used its authority to modify the application of goals requirements."

The inquiry comes at a crucial time, as the fate of Fannie and Freddie are being hotly debated in Washington circles.

Treasury Secretary Timothy Geithner has said the

government will still play a key role

in the housing market, but that guarantees will be explicit rather than implied, and that risk will be more appropriately priced. However, the Obama administration has yet to outline a specific plan for Fannie and Freddie's future structure.

Some members of Congress have begun pressing the issue, since taxpayers have funneled $126 billion into the firms, representing the second-largest bailout behind

American International Group

(AIG) - Get Report

, with arguably less likelihood of repayment. The Treasury extended its bailout further at the end of last year, saying it would provide unlimited capital to cover losses in an effort to further stabilize the housing market.

The FCIC is intended to be a bipartisan collaboration -- of lawmakers, regulators and private experts -- to explore the reasons behind the crisis and find workable solutions. However, given other hearings, like the one focused on

Citigroup (C) - Get Report

this week, and a

broader bank examination

in January, the Fannie-Freddie hearing may provide a platform for populist outrage without much intellectual discussion.

--

Written by Lauren Tara LaCapra in New York