Fannie and Freddie’s affordable housing goals (authorized by the ironically named Federal Housing Enterprises Financial Safety and Soundness Act—the GSE Act—and enforced by HUD) were responsible for many distortions of the housing finance market. One of the most significant was that Fannie and Freddie (the GSEs) were required to compete with FHA and subprime lenders for loans that qualified under one or more of the affordable housing goals. The GSEs’ competition with FHA started in 1993 and by the mid-1990s had expanded to subprime. This competition combined with the National Homeownership Strategy required the GSEs (and the market generally) to progressively reduce down-payment requirements. By the early 2000s zero down loans had become commonplace across all market segments including subprime and Alt-A.
The GSE Acts also set low capital standards for Fannie and Freddie. These allowed them to operate at extraordinary leverage levels (for example: 220:1 on their MBS guarantee business).
The resulting high levels of leverage greased the slippery slope of declining standards and fueled the housing boom. It is now five years after home prices started declining and we have yet to deal with excessive leverage.
Michael Cembalest, Chief Investment Officer of JPMorgan, wrote an article that makes use of research from my Government Housing Policies in the Lead-up to the Financial Crisis: A Forensic Study relating to diminishing down payments and Fannie’s competition with FHA.