The Demise of Fannie Mae

I came across an interesting article from the New York Times Online regarding the failure of Fannie Mae and the subsequent takeover by the government. The link for this website is http://www.nytimes.com/2008/10/05/business/05fannie.html?pagewanted=1&_r=1. For those of you who don't know, Fannie Mae is a government sponsored enterprise created to increase the availability and reduce the cost of credit in the mortgage market. Fannie Mae makes their money by purchasing mortgages from lenders, holding some and reselling most to Wall Street investors. Loans are classified according to their level of risk. Fannie Mae will guarantee to pay a loan it sells in case of default for a fee according to its risk. If the risks are accurately classified the fees should cancel out the cost of the loan.
Where Fannie Mae went wrong was in taking on too many risks. There was pressure from shareholders, Congress, and even the mortgage companies they were buying the loans from. Countrywide Financial, a longstanding and important trading partner, demanded that Fannie take on riskier loans or else they would sell to competitors. Fannie Mae felt that too much business would be lost and bought loans they weren't necessarily comfortable with. I think the main problem was that the risks weren't being properly identified. A former employee speaking on the condition of anonymity said that they were buying loans that would have previously been rejected and that they weren't charging nearly enough for payment in case of default. They felt they had to keep up with competitors and this was justification for taking on so much risk. For a two year period, they didn't have a Chief Risk Officer. When they did hire one he urged the CEO to charge more for the risky loans, but that urging went unheeded.