Most people know that Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) had billions in bad loans on their books when the financial crisis hit, but the reason for all those bad loans seems not to have been as well publicized. Barely a year into profitability, and we’re already getting calls to repeat past mistakes.

Fannie Mae Freddie Mac FHFA Federal National Mortgage Assctn Fnni Me (FNMA)

“Fannie and Freddie — by far the largest sources of mortgage money in the country — continue to charge punitive, recession-era fees that can add thousands of dollars to consumers’ financing costs,” writes Ken Harney for The Courant. “This is despite the fact that the companies are enjoying record profits.”

LLPA adjusts for low credit scores, down payments

Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) use a system called loan-level price adjustments (LLPA) and adverse market delivery charges (AMDC) to increase the rates on loans made to risky buyers, measured primarily based on the borrower’s credit rating and down payment. A borrower with a 620 credit score and a 3% down payment will face much higher interest rates because the chance of default is higher, not because anyone is being penalized.

The call to help more people buy their own homes is compelling, but it’s also a slippery slope. In case you missed it the first time through, we’ve heard these arguments before almost verbatim.

“Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements,” former Fannie Mae chairman Franklin D. Raines said in 1999, reported by Steven Holmes for The New York Times. “Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”

Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) was under pressure from President Clinton (who wanted to expand homeownership), shareholders (who wanted more growth), and banks (who wanted to unload sub-prime mortgages) and it caved, facilitating the crash were still recovering from.

Crapo-Johnson may go too far to the opposite extreme

Critics of Crapo-Johnson argue that it goes to the opposite extreme, insulating taxpayers from a future crash by making mortgages too expensive. By requiring a 10% capital ratio (and adding a few basis points to interest rates to pay for reinsurance) it will raise home financing costs for even low risk borrowers. It would also establish a 3.5% minimum down payment for first time homebuyers, and a 5% minimum after that. There’s a balance to be struck between expanding home ownership and lending responsibly, but unfairly vilifying the GSEs won’t help us find it.