Planting One of the Many Seeds of the Housing Bubble


On this day in economic and financial history ...

Fannie Mae , one of the two most important organizations to the American mortgage industry, got its start on Feb. 10, 1938. That day, acting on orders of President Franklin D. Roosevelt, the Reconstruction Finance Corporation founded the "National Mortgage Association of Washington," later the Federal National Mortgage Association, seeding it with paid-in-capital stock worth $10 million and $1 million in surplus, and granting it the authority to borrow up to $211 million, or 20 times its capital.

The result of amendments to the National Housing Act of 1934, Fannie Mae was part of Roosevelt's push to rehabilitate the devastated Depression-era American economy with stable housing policies. Its original focus, according to TheWashington Post, was to "be a demonstration project of the part which such financial institutions can play in reviving a healthy recovery in housing construction, especially on a large-scale basis." RFC Chairman Jesse H. Jones told the Post what he hoped:

"Builders, material and supply people, and workmen in the building trades will cooperate generally in a building program that will produce homes at the lowest possible cost to prospective homeowners and to those who may desire to build private or multiple dwellings for rent or sale ... [A] real building program will increase employment and stimulate business more, perhaps, than any other one thing that can be done."

Then, as now, Fannie Mae was to focus on acquiring government-insured mortgages from their underwriters to repackage as investable securities, thus freeing lenders to lend more than they otherwise would. In 1970, the government allowed Fannie Mae to purchase mortgages outside its traditional government-backed sphere and created Freddie Mac to provide competition in that market. In 1981, Fannie Mae devised the modern mortgage-backed security, which had existed in various forms since 1968, when the government had split Fannie Mae into its modern form and into Ginnie Mae, which is barred from investing in private mortgages.

Fannie Mae became a focal point of the 2008 financial crisis as a result of these securities. Since the 1990s, Fannie Mae had taken on greater levels of risk, accumulating (with its two government-sponsored enterprise siblings) some $2 trillion in debts. However, the more stringent requirements of the GSEs actually encouraged homebuyers to seek out subprime shysters for their loan needs, as private lenders had less oversight and could stuff their own MBS instruments with piles of junk, sending bad debts sloshing through the financial system before anyone knew what was happening.

The implosion of the housing bubble and its attendant subprime boom nevertheless destroyed housing prices for everyone, and this in turn caused widening losses for the GSEs. The federal government stepped in with a guaranteed backstop of hundreds of billions as it placed Fannie Mae and Freddie Mac into conservatorship during the darkest days of the financial crisis. Four years later, Fannie Mae still owed $117 billion to the government, requiring billions of dollars in repayments per quarter . In spite of its precarious financial situation, Fannie Mae nevertheless provided $3 trillion in liquidity to the mortgage market in those four years, allowing nearly 9 million refinancings and 2.5 million home purchases.

Who says capitalism can't be art?
Arthur Miller's classic play Death of a Salesman premiered on Broadway on Feb. 10, 1949. The play has since become one of America's finest critiques of chasing the materialistic American dream and, more specifically, of the frustration many Americans feel when their professional lives don't live up to that dream. This play, along with the many subsequent film adaptations, offers a familiar message to millions now living in an era of heightened unemployment -- and, when employed, a diminished potential for advancement and earnings growth.

Rise of the chess-playing machines
IBM's Deep Blue became the first computer to ever defeat a reigning world chess champion under tournament conditions on Feb. 10, 1996. The supercomputer had been specifically developed to defeat Garry Kasparov (or whomever the world champion would be when it was complete), building on the Deep Thought chess computer developed at Carnegie Mellon University before IBM brought its team on board. That machine had lost badly to Kasparov in 1989 and was rated 2,551 in the Elo system -- Kasparov was rated 2,851 at his peak, the highest ever recorded until 2013. A successor to Deep Thought was rated 2,600, but it never faced Kasparov.

IBM's team was determined to triumph. A chess grandmaster was brought on board to develop proper strategies. Deep Blue was first put through its paces in the 1995 World Computer Chess Championships, where it tied for second place with a program running on a standard PC. This wasn't the ideal result, but IBM went ahead with its match nonetheless. The first match was a surprise victory for Deep Blue, which did not fall for Kasparov's style of play and instead pinned the world champion's king to the right side of the board.

Kasparov rebounded to take the match 4-2, but after heavy upgrades, IBM was soon ready to try again. A year and a half later, an improved Deep Blue finally beat the world champion in a match, with two wins and three draws to Kasparov's lone victory.

The downfall of the Dow
On Feb. 10, 1920, the Dow Jones Industrial Average suffered its worst drop yet of the short year, falling 3.8% to bring the index to a rare 15% for the first month and a half of trading. This was seen as an extension of 1919's winter decline, which had produced a 10% decline from the start of November through the end of the year. The New York Times postulated that "while the November break went far in liquidating the speculative position, it left considerable more to be completed." Foreign markets were similarly weak, which created a negative feedback loop that drove recessionary fear into the hearts of investors.

The Dow stabilized for a time, but this was a warning sign investors should have noted. From the end of Feb. 10 to the end of 1920, the Dow lost another 22% of its value and wound up with a 33% loss for the full year. There were few violent drops that year, but a creeping sense of dread created many small drops that compounded on each other to create the fifth-worst year in the Dow's history. The Dow bottomed out in 1921 and began a rapid ascent soon after.

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