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The financial collapse of Fannie Mae and Freddie Mac in 2008 led to one of the most sweeping government interventions in private financial markets in history. The bailout has already cost American taxpayers close to $150 billion, and substantially more will be needed. The U.S. economy--and by extension, the global financial system--has a lot riding on Fannie and Freddie. They cannot fail, yet that is precisely what these mortgage giants are guaranteed to do. How can we limit the damage to our economy, and avoid making the same mistakes in the future?
Guaranteed to Fail explains how poorly designed government guarantees for Fannie Mae and Freddie Mac led to the debacle of mortgage finance in the United States, weighs different reform proposals, and provides sensible, practical recommendations. Despite repeated calls for tougher action, Washington has expanded the scope of its guarantees to Fannie and Freddie, fueling more and more housing and mortgages all across the economy--and putting all of us at risk. This book unravels the dizzyingly immense, highly interconnected businesses of Fannie and Freddie. It proposes a unique model of reform that emphasizes public-private partnership, one that can serve as a blueprint for better organizing and managing government-sponsored enterprises like Fannie Mae and Freddie Mac. In doing so, Guaranteed to Fail strikes a cautionary note about excessive government intervention in markets.
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'[Guaranteed to Fail] is more multi-dimensional and nuanced than most other books on the bloody crossroads where real estate and banking meet. . . . [The] authors show convincingly that the GSEs' subprime lending was not a noble idea that eventually went wrong or drifted into excesses--it was a fool's errand from the beginning.'--Financial Times
'[A] valuable book on how two quasi-public companies became 'the world's largest and most leveraged hedge fund'. . . . A balanced study, [Guaranteed to Fail] rises above a clash between partisans on the right--who call the companies 'ground zero' in the meltdown--and those on the left who blame deregulation and Wall Street excess. . . . Part primer, part policy prescription, the text explains in simple language what these entities are, how they got so big, and why we must fix them.'--James Pressley, Bloomberg News
'In Guaranteed to Fail, a quartet of New York University professors from its Stern School of Business, focus on the 'debacle of mortgage finance' that Fannie and Freddie helped create, and offer a plan for reform. In clear language, and with plenty of data to support their arguments, the authors provide a concise but comprehensive history of the GSEs--which alone makes their book worth reading.'--Barron's
Review
[Guaranteed to Fail] is more multi-dimensional and nuanced than most other books on the bloody crossroads where real estate and banking meet. . . . [The] authors show convincingly that the GSEs' subprime lending was not a noble idea that eventually went wrong or drifted into excesses--it was a fool's errand from the beginning. (Financial Times )
[A] valuable book on how two quasi-public companies became 'the world's largest and most leveraged hedge fund'. . . . A balanced study, [Guaranteed to Fail] rises above a clash between partisans on the right--who call the companies 'ground zero' in the meltdown--and those on the left who blame deregulation and Wall Street excess. . . . Part primer, part policy prescription, the text explains in simple language what these entities are, how they got so big, and why we must fix them. (James Pressley Bloomberg News )
In Guaranteed to Fail, a quartet of New York University professors from its Stern School of Business, focus on the 'debacle of mortgage finance' that Fannie and Freddie helped create, and offer a plan for reform. In clear language, and with plenty of data to support their arguments, the authors provide a concise but comprehensive history of the GSEs--which alone makes their book worth reading. (Barron's )
Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance, stands out among all the others. . . . [I]t is one of the very few books to focus squarely on the ultimate cause of the crisis: US government housing policy and the role of the two government-backed mortgage giants Freddie Mac and Fannie Mae in giving effect to that policy. (Stephen Kirchner The Conversation )
[T]hought-provoking . . . (Gillian Tett Financial Times )
[T]he authors provide a detailed template for reform. (The Economist )
No one can accuse the authors of failing to offer solutions to the problems they so thoroughly document. . . . One can only hope that some trace of the constructive approach of Guaranteed to Fail will inform the ongoing debate in Washington on the vitally important question of the future structure of the U.S. mortgage market. (Martin S. Fridson Financial Analyst Journal )
This book should, without question, play an important role in the policy discussion of how to reform the mortgage market. Its accessible explanation of the GSEs' growth and behavior, and its detail and care in suggesting the direction for housing finance to go--and how to get it there--are its strengths. In terms of audience, the book seems more oriented toward policy discussions than academic ones. . . . As a whole, it provides a useful overview of the rise and fall of the GSEs, and is a worthwhile read for those interested in understanding the recent crisis. (Daniel K. Fetter Journal of Economic Literature )
[T]he scholarly NYU tome focuses on policy mistakes and perverse incentives. . . . The Stern School economists [highlight the] 'race to the bottom' among mortgage lenders . . . [who] responded by 'moving down the credit curve of increasingly shaky mortgage loans.' . . . Bad lending begat worse lending. (Robert J. Samuelson Claremont Review of Books )
They combine in an ideal way research and political consulting, resulting in an easy-to-read book that nevertheless has the necessary in-depth analysis. The book is rich with quotes from the past suggesting that everybody should have seen the imminent disaster. (Rico von Wyss Financial Markets and Portfolio Management )
VIRAL V. ACHARYA is Professor of Finance at New York University Stern School of Business (NYU-Stern), Research Associate of the National Bureau of Economic Research (NBER) in Corporate Finance, Research Affiliate of the Center for Economic Policy Research (CEPR) in Financial Economics, Research Associate of the European Corporate Governance Institute (ECGI), and an Academic Advisor to the Federal Reserve Banks of Cleveland, New York and Philadelphia, and the Board of Governors. He was the Academic Director of the Coller Institute of Private Equity at London Business School during 2008-09 and a Senior Houblon-Normal Research Fellow at the Bank of England for Summer 2008. He completed his Ph.D. in Finance from NYU-Stern and Bachelor of Technology in Computer Science and Engineering from Indian Institute of Technology, Mumbai.
His research interests are in the regulation of banks and financial institutions, corporate finance, credit risk and valuation of corporate debt, and asset pricing with a focus on the effects of liquidity risk. He has published articles in the American Economic Review, Journal of Finance, Journal of Financial Economics, Review of Financial Studies, Journal of Business, Rand Journal of Economics, Journal of Financial Intermediation, Journal of Money, Credit and Banking, and Financial Analysts Journal. He is editor of the Journal of Financial Intermediation.
He is the recipient of Best Paper Award in Corporate Finance - Journal of Financial Economics, 2000, Best Paper Award in Equity Trading - Western Finance Association Meetings, 2003, Outstanding Referee Award for the Review of Financial Studies, 2003, the inaugural Lawrence G. Goldberg Prize for the Best Ph.D. in Financial Intermediation, Best Paper Award in Capital Markets and Asset Pricing - Journal of Financial Economics, 2005 (First Prize) and 2007 (Second Prize), the inaugural Rising Star in Finance (one of four) Award, 2008, European Corporate Governance Institute's Best Paper on Corporate Governance, 2008, Distinguished Referee Award for the Review of Financial Studies, 2009, III Jaime Fernandez de Araoz Award in Corporate Finance, 2009, Viz Risk Management Prize for the Best Paper on Energy Markets, Securities, and Prices at the European Finance Association Meetings, 2009 and Excellence in Refereeing Award for the American Economic Review, 2009, Review of Finance Best Paper Award, 2009 and Best Conference Paper Award at the European Finance Association Meetings, 2010.
He has co-edited the book Restoring Financial Stability: How to Repair a Failed System, NYU-Stern and John Wiley & Sons, March 2009, co-edited the forthcoming book Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance, Wiley, October 2010, and co-authored the forthcoming book Guaranteed to Fail: Fannie Mae, Freddie Mac and the Debacle of Mortgage Finance, Princeton University Press, March 2011.
THOMAS F. COOLEY is the Paganelli-Bull Professor of Economics at the New York University Stern School of Business, as well as a Professor of Economics in the NYU Faculty of Arts and Science. The former President of the Society for Economic Dynamics and a Fellow of the Econometric Society, Professor Cooley is a widely published scholar in the areas of macroeconomic theory, monetary theory and policy and the financial behavior of firms, and is recognized as a national leader in both macroeconomic theory and business education. Professor Cooley was Dean of NYU Stern from 2002-2010.
Responding to the financial crisis of fall 2008, Professor Cooley spearheaded a research and policy initiative that yielded 18 white papers by 33 NYU Stern professors, later published as "Restoring Financial Stability: How to Repair a Failed System," (Wiley, March 2009). He also writes a weekly opinion column for FORBES.com.
Professor Cooley is a member of the Council of Foreign Relations.
Before joining NYU Stern, Professor Cooley was a Professor of Economics at the University of Rochester, University of Pennsylvania, and UC Santa Barbara. Prior to his academic career, Professor Cooley was a systems engineer for IBM Corporation. Professor Cooley received his BS from Rensselaer Polytechnic Institute, and his MA and PhD from the University of Pennsylvania. He also holds a doctorem honoris causa from the Stockholm School of Economics.
MATTHEW RICHARDSON is a Professor of Finance at the Leonard N. Stern School of Business at New York University, and a Research Associate of the National Bureau of Economic Research. He has also held the title of Assistant Professor of Finance at The Wharton School of Business at the University of Pennsylvania. Professor Richardson received his Ph.D in Finance from Stanford University and his MA and BA in Economics concurrently from University of California at Los Angeles.
Professor Richardson teaches classes at the MBA, executive and PhD level. His MBA classes cover Debt Instruments and Markets and International Fixed Income. He is serving or has served as associate editor for the Review of Financial Studies, Journal of Finance and Journal of Financial and Quantitative Analysis. He has been a referee for over 20 academic journals, including Econometrica, Journal of Finance, Journal of Financial Economics, Review of Financial Studies and American Economic Review. In 1997 Professor Richardson was awarded the Rosenthal Award for Financial Innovation.
Professor Richardson has published papers in a variety of top academic journals, including, among others, Journal of Finance, Journal of Financial Economics, Review of Financial Studies, and the American Economic Review. His work has also appeared in practitioner journals and books such as Advanced Tools for the Fixed Income Professional, Emerging Market Capital Flows, and VAR: Understanding and Applying Value-at-Risk.
INGO WALTER is the Seymour Milstein Professor of Finance, Corporate Governance and Ethics and Vice Dean of Faculty at the Stern School of Business, New York University. He has taught at New York University since 1970. He has served as a consultant to various corporations, banks, government agencies and international institutions and has authored or co-authored numerous books and articles in the fields of international trade policy, international banking, environmental economics, and economics of multinational corporate operations.
A key point to note as you read this excellent book is that it is written by not one, but four professors - so, if you are expecting a thriller that explores the nefarious nexus between Washington and Wall Street, you will be deeply disappointed. I, personally, was disappointed there was no end of chapter questions and that the solutions to the non-existent odd numbered problems were missing in the back pages.
Kidding aside, I strongly believe in comparative advantage and we should not expect professors to become Carl Bernstein and Bob Woodward or vice versa. The book is very well-served by the academic approach as the authors navigate the reader through economics, finance, history, and public policy issues with ease and eloquence. Fannie and Freddie are presented as two neglected children of abusive self-serving parents (the government and the equity holder) and the entire family has developed some very bad habits. There is a striking metaphor in the book that compares the creation of the agencies and Frankenstein. I was very impressed with the aptness of several metaphors that are interspersed throughout the book. Likening the entry of Fannie and Freddie into the high risk mortgage market to Caesar's crossing the Rubicon is another one worth mentioning.
The authors demonstrate with a lot of patience, that capital, that is supposed to flow to its most efficient use in capital markets unfortunately went to its more levered use. Because of the implicit government support, the typical risk/reward considerations are marginalized and as long as the housing markets boomed, the government took advantage of the agencies to promote public policy without recognizing the cost, and the equity markets enjoyed the benefits of leverage. The cast of the whole show and their roles are examined, as the book looks at various actors including other mortgage originators, MIs and Large Complex Financial Institutions (LCFIs) and their part in the crises.
A well-researched essay on housing markets across the globe and how and why different countries stacked up the way they did during the crisis provides a global perspective. The dicussion of potential conflicts because of Fed's ownership of GSE securities and its important tool for monetary policy, the interest rate is interesting. The reforms proposed in the book, for example the recommendation to set up a system similar to TRIA will provide material to mull over several cups of coffee.
While there are references to corporate governance and implicit signals of government support through the presidential appointees in the boards, the incentive plans of Fannie and Freddie's management and how compensation metrics played a part could have been provided more context.
Despite ample coverage of the housing crisis in the popular press and numerous other publications, this book will still appeal to the student or the "student at heart" due to its well-thought out structure, clever use of anecdotes and analogies. The authors have not been averse to including quotes from a variety of sources to enhance the reader's experience.
To my knowledge, this is the best work done so far on the financial crises of 2007-09, which peaked in September 2008 when, days after Fannie Mae and Freddie Mac were placed in conservatorship by the Treasury Secretary, several of the nation's largest financial institutions became insolvent and either were sold at fire sale prices to healthier banks or went bankrupt.
I have read numerous books on the subject, and reviewed several of them on Amazon, including reviews of the Financial Crisis Inquiry Commission's report, A Colossal Failure of Common Sense, The Big Short, and Too Big to Fail. I have done my own research in primary materials published by the Fed, the GSE's, and dozens of papers published by regional Fed employees and academics around the world and hundreds of blog posts from bloggers of all political perspectives.
This is the best work I have seen. It is concise - in fact, probably too concise - and accurate. It focuses on the heart of the problem, namely the way in which several bipartisanly enacted Federal policies of promoting home ownership turned Fannie and Freddie into "Federal Frankensteins" -- giant, severely undercapitalized, voracious consumers of credit risk that were, by dint of their size and also of biases built into the capital regulations for banks and other financial institutions, so deeply embedded into global financial system that they accounted by themselves for one-sixth of all "systemic risk" in not just the nation but the world.
While focused on Fannie and Freddie, this is not the simple "Community Reinvestment Act" screed that a few have pounded the drum for, and it even goes beyond the intensive credit risk analysis of Ed Pinto and Peter Wallison that has been well publicized. It emphasizes the leverage / undercapitalization of Fannie and Freddie relative to the credit risk, and also explains - not as much as I would have liked - the way in which rules regarding the capital of banks and other financial institutions subsidized demand for ever more Fannie and Freddie paper and thus incentivized their ever deeper push into weaker and weaker credits, to the point where they had subprime exposure - just subprime - equal to 6 times their capital when they went under.
For those who do not find this account persuasive, I will end by quoting one fact that the authors strangely do not use but which I find to be the strongest support for the view that the 1995 policy changes are the wellspring of the crisis; it comes from the Fed's Flow of Funds reports. From 1986 to 1995, the annual growth in US residential mortgage debt averaged less than $200 billion per year; considering inflation and population growth, the rate of growth relative to demand declined significantly over that period. In 1995, when mortgage growth was only $150 billion, the then administration launched its "National Homeownership Strategy" to expand home ownership in which F & F financing played a major role. By 1998, mortgage growth more than doubled, past $300 billion; by 2001 it was over $500 billion, and in 2005, it exceeded $1 trillion. In other words, annual mortgage growth went up more than 600% in that decade. The authors show how most of that was backed by or was held by F & F and how F & F backed or held, in most years, large segments of the subprime volume. This is the best account of how that was a not exclusive, but certainly principal, cause of the financial crises of 2007-09.
Guaranteed to Fail falls in that difficult genre of book at once trying to appeal to a broader non-specialist audience and as well to a more informed reader seeking expert examination. This is a difficult middle ground and unfortunately I think the authors do not deliver. There is certainly no doubting the breadth of material. The reader is presented with a dizzying array of facts and figures - something that could have been well presented in better tables. Furthermore, there is no shortage of historical and policy analysis. Nevertheless I think the book comes up short. The real weakness I think is structure which is something an informed editor could have helped iron out. The introduction should have presented what exactly would be covered and the aim of the book. In missing this essential step the authors really failed to see that the text becomes a potpourri of information about the GSEs and anecdotes - issues on which they certainly have a wide breadth of expertise - but the book also fails to really set the issues in proper context. Chapter 5, for example, is just a mish mash covering the period leading up to the financial crisis and as far as I can tell provides no real insight. This could have easily been summarized in a table and appended to the first chapter which to be fair was a good introduction to the history of Freddie and Fannie. But the chapter also wanders into a non-essential description of the effects of housing on the economy, household spending and household balance sheets. It also delves into the literature surrounding the FHLB system. Again, this is testament to the depth of the authors' understanding of the issues but veers quite a bit off course. It would be a useful bit of analysis in the broader context of the housing market but does not seem on point in discussing why Freddie / Fannie were destined to fail and what should be done.
At times the authors also fail to substantiate their case. Chapter 6 goes into a discussion of the Fed's balance sheet and how the ballooning of it has complicated monetary policy. A more precise analysis is really needed here. Some very simple calculations, for example, might make the point that higher interest rates would lead to ongoing losses creating a quasi-fiscal loss that ultimately would need to be addressed. But the idea that capital losses on MBS positions would constrain the Fed is flatly dubious since the positions are valued on a hold-maturity-basis and short of defaults not covered by the GSE or Treasury would be irrelevant. In any event the authors fail to discuss the implications of central bank equity or why this would matter (inflationary finance). Nor do they highlight the ample literature on the subject or other international examples where central bank losses are relevant. This is an area where a broader analysis might be warranted but would extend the scope of the book even more.
Guaranteed to Fail also goes very quickly over topics that would seem to warrant further analysis. There is a passing reference to a rule change to the Securities Exchange Act of 1934, in August 2004, that allowed investment banks to apply greater leverage. This would seem to be a highly relevant topic since the greater investment banks gearing and expansion into mortgages - by their own hypothesis - was a precipitating factor in the housing bubble and subsequently led to catastrophic failures during the collapse. There is also little mention of the use of SPVs by commercial banks and the regulatory lapses of the Fed in allowing these vehicles which served to lever their balance sheets as well. Meanwhile the authors fail to address the more vexing question as to why there were concurrent housing bubbles globally (and some that are still inflating such as in Australia) even though Freddie and Fannie played no role there. They simply pass off any government influence in housing as somehow wasteful or counter-productive though Canada would seem to be an excellent counter-example. I think it would serve the readers to illustrate the difference in regulatory structure and how this might or might not have led to problems. After all Ireland and Spain have suffered through a similar mess but government subsides of their mortgage markets is not the apparent culprit.
I do think Guaranteed to Fail gets some footing in discussing possible reform solutions for the GSEs. Here the authors apply their expertise and provide some very credible solutions. I would have preferred a more focused analysis and less of the breezy superficial points used throughout the book. I was frankly surprised with the narrow set of solutions: for example they did not even discuss applying the covered bond model in the US despite its apparent success in Europe which is highlighted earlier in the text. As with other sections of the book the footnotes are helpful but I think this chapter in particular warrants a full bibliography and recommendations for further reading organized by topic.
In the end I find it hard to recommend Guaranteed to Fail. There is certainly a lot of information and the authors seem highly qualified to present the information. Unfortunately I think they do a particularly poor job of presenting what they have to offer and the reader can walk away feeling no more clear - albeit they will have a broader appreciation of the numbers involved. Lastly as regards one other issue which a previous reader critiqued and to which Professor Acharya responds and that is the reference to the GSEs being a giant hedge fund. While Fannie and Freddie took plenty of risk, employed derivatives and operated much like an investor (and at times like a speculator) the idea that these were hedge funds is nothing more than trite hyperbole and is completely unnecessary. The term hedge fund refers to a very specific type of alternative investment vehicle which restricts the type of investors involved - generally high net worth individuals and qualified investors such as large institutions. Of course these two entities at the time of their collapse were broadly held by the public and listed on the stock exchange. Their shares were held by professional investors and well as individuals - often through listed mutual funds. This in itself precludes them from being hedge funds. That they employed leverage, used derivatives, took credit and interest rates risk or had financing advantages over their commercial bank rivals due to government sponsorship is completely irrelevant. This would simply make them well- funded, poorly regulated and incentivized investors that also failed to see what many investors and analysts failed to see. Only they did it on the public dime. That sentiment should be brought to bear in the book but is not done so well enough.
