During the boom, Fannie and Freddie did not insure or purchase most "exotic" mortgages. That is partly why banks and investors suffered great losses.

FanFred struggled to keep up with lenders (New Century, Countrywide) and underwriters (Lehman, Bear Stearns) who created the "private" mortgage market. There were willing investors and insurers (AIG) who did not need FanFred insurance or demand. 

I am in favor of winding down Fannie and Freddie. The government's policy of subsidizing home ownership as a middle-class entitlement is flawed. That is a separate, if related, problem from the financial crisis.

Unregulated securities and derivatives -- not Fan/Fred - created demand for the worst mortgages, which would not have existed otherwise. These derivatives later precipitated bailouts when the system could not withstand their instantaneous collapse.

Thank you all for commenting. And I recommend the FCIC book. 

Yes - I agree with you that we should have kept 20 percent down payments, and that this failure was a core of the crisis. The relaxation of capital standards (limits on borrowing), though, was not just in housing. It was part of a quarter-century-old philosophy within the financial sector and Washington, and, indeed, well beyond our shores: we didn't need to limit borrowing because we wouldn't make mistakes, and if we did make mistakes, we could fix 'em with "just this once" government interventions.

Yup -- I remember! :)

Some people who don't live in or near foreclosure-ville USA (AZ, CA, FL, NV) -- or have relatives who do -- tend to think that the crisis was rooted in government anti-poverty efforts, including affordable-housing goals.

But drive around empty or near-empty developments in FL, AZ, etc., and/or talk to the people left there, and it's easy enough to understand that they (and the economy) weren't the victims of some sort of left-wing social-justice experiment.

This ground floor of the bubble (forgive the mixed metaphor) was aspirational middle-class people, middle-class people, and upper-middle-class people. Gee, half of Westchester would be foreclosed if it weren't for the (continuing) bailouts and Bernanke's zero-percent rates. 

General government affordable-housing policies may be a problem, too, but they were not, in the main, this problem. 

Yup, a big plurality buyer could set the tone for the market.

But ... the plot thickens. Managers of CDOs, who earned fees based on the dollar amount of the assets in the CDOs, themselves used borrowed money to push up demand for the underlying mortgage securities.

As James Grant wrote in 2006 (and as referenced by the FCIC report, p133), "Mortgage traders speak lovingly of 'the CDO bid'" -- that is, CDO managers who were bidding up the price of mortgage securities. "Without it, fewer asset-backed structures could be built."

Demand came from leverage throughout the system. 

If everyone -- from the Florida homeowner to Fannie and Freddie to the managers of CDOs made up of more CDOs -- had had to put a significant, consistent percentage of cash down against losses, the thing would not have had the impact that it did. 

That is one solution: consistent capital requirements, rather than leaving them up to regulatory discretion.

Hi Kenneth -- Thanks.

But setting the criteria for a mortgage isn't the same as creating demand for a mortgage-backed security.

One of the biggest problems was that we had risky mortgages packed into supposedly risk-free AAA-rated securities. Then, on top, we had "collateralized debt obligations" (CDOs) -- that is, more supposedly riskless derivatives securities -- built out of those original mortgage-backed securities. 

Many of the original mortgages could have faltered, and the economy could have withstood it (albeit with ripples). But the economy couldn't withstand the collapse of securities built on securities built on securities built on the mortgage themselves, all thanks to borrowed money. Plus, without the demand coming from those securities and their leverage, many of the original mortgages wouldn't have existed in the first place. 

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