The unprecedented growth, eventual take-over of half the mortgage market and ultimate failure of Fannie Mae and Freddie Mac stems from the decision-making strategies of the companies’ managers. Using a three-period backwards-induction analysis, this article first explores the history and unilateral benefits the government conferred upon the two government-sponsored enterprises (GSEs), and then explains, through the lens of opportunistic managers, why and how Fannie and Freddie engaged in systemically risky activity that ensured their bailouts. I show that although both the decisions and methods of the GSEs' expansions were fraught with moral hazard problems and created a giant burden on taxpayers, the managers acted in a logical manner to maximize shareholder wealth while simultaneously mitigating risk. Therefore, the blame for the GSEs rests on the United States' economic policies covering homeownership, which lacked the appropriate mechanisms to monitor and measure the potential harm of Fannie and Freddie.
Abrams, Charles J., Fannie and Freddie Flipped: A Backward Induction Analysis of the GSEs’ Meltdown (May 1, 2011). William & Mary Policy Review, Vol. 3, No. 1, p. 157, 2011. Available at SSRN: http://ssrn.com/abstract=1970381
via papers.ssrn.com
