The Friday Podcast: The Frankenstein Mortgage : Planet Money The 30-year, fixed-rate mortgage -- the bedrock of American home ownership -- is a really weird loan.

The Friday Podcast: The Frankenstein Mortgage

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BETHANY MCLEAN: Once you get into them, they're the most interesting companies on the face of the planet because they're just so weird and you cannot believe that something like this existed for so many years in the supposedly rational world of American business.



Hello, and welcome to PLANET MONEY. I'm Alex Blumberg.


And I'm Jacob Goldstein. Today's Friday, January 14. And that was the journalist Bethany McLean you heard at the top. Those most interesting companies on the face of the planet she was talking about? They're Fannie Mae and Freddie Mac, the two...

BLUMBERG: ...Mortgage giants. And they are the subject of today's podcast we're going to be talking to Bethany McLean and to Joe Nocera, The New York Times columnist. They wrote a book together, "All The Devils Are Here: The Hidden Story Of The Financial Crisis." And a lot of the book, which is excellent, focuses on Fannie Mae and Freddie Mac. And we're going to hear why they're the most fascinating companies on the face of the planet in a minute. But first, the PLANET MONEY indicator.

GOLDSTEIN: Today's PLANET MONEY indicator is 0.8 percent. That is how much prices rose last year in the U.S., according to the core inflation numbers that the government put out today.

BLUMBERG: And that 0.8 percent, that is really, really low inflation, inflation so low that it makes the Fed nervous. And remember that we've talked about this a lot on the podcast. The Fed wants there to be certain very, very sort of basic inflation rate. It likes it to be about 2 percent. 0.8 percent is lower than they like. They worry about it dipping into deflation, which would cause all sorts of horrible things in the economy and could tip us back into a - another spiral downward.

GOLDSTEIN: And so this low inflation combined with the really high unemployment rate - unemployment's still over 9 percent - these things combined basically mean the Fed is going to - it's going to continue on the same path it's been on. These pretty radical Fed policies that are in place, those are going to stay in place for the foreseeable future.

BLUMBERG: Right. As you know, Jacob, we had a big story on "This American Life" this past weekend about the Fed and its crazy policies, which you can hear on the "This American Life" website. So should we go on to the subject of the podcast today?

GOLDSTEIN: Yeah. I'm always glad to talk about Fannie and Freddie. And I mean that.

BLUMBERG: (Laughter) I know you do. I know.

GOLDSTEIN: Any time.

BLUMBERG: (Laughter) I know. (Laughter) So - all right. So let's just play a game here. OK. I know you know a lot about housing. I think you and I are the - sort of the big housing maniacs at - here at PLANET MONEY. So you know, over the last couple of years, we have been introduced to a whole bunch of really crazy, exotic mortgages. Like, you know, they just have these crazy names, like the option ARM, the no doc, interest-only, neg am, the - you know, the famous NINA loan - no income, no asset. So if you were to survey the world of the crazy exotic mortgages, what do you think is the craziest?

GOLDSTEIN: I'm really a big fan of the NINJA loan. I mean, not - obviously, if it's called the NINJA, it starts with a big advantage.

BLUMBERG: (Laughter).

GOLDSTEIN: But it really runs from there, right? NINJA stands for no income, no job or assets. And yeah, here, you don't have those things, but here, take half a million dollars. Go buy a house.

BLUMBERG: All right. That's a good guess. But Bethany McLean and Joe Nocera argue, as you're gonna hear in a couple minutes, that the strangest and most unnatural mortgage product out there is the 30-year fixed-rate mortgage. The most plain, vanilla, straightforward mortgage product in existence, that is the craziest one out there.

GOLDSTEIN: This is basically, like, the mortgage your grandfather got and put 20 percent down and paid the mortgage off month after month and, 30 years later, owned the house outright. That's what you're talking about.

BLUMBERG: That is what I'm talking about. And according to Joe Nocera and Bethany McLean, this is an abomination (laughter) in the financial world. It shouldn't exist. And, in fact, Bethany wrote a recent op-ed in The New York Times where she said the 30-year fixed-rate mortgage is, quote, "a financial Frankenstein's monster." And a lot of the reason why has to do with Fannie Mae and Freddie Mac, the most interesting companies on the face of the planet. So I and our colleague Adam Davidson sat down with Bethany and Joe. And Bethany started to explain why the 30-year fixed-rate is so weird.

MCLEAN: Maybe the best way to put it is that it's the most straightforward product imaginable from the standpoint of a consumer and a great product, and it's a financial nightmare from the standpoint of the lender. And that's because a 30-year fixed-rate mortgage has two kinds of risks for a lender - interest rate risk and credit risk. One is the risk that the interest rates are going to change wildly, and the lender is going to get stuck with an unprofitable loan.

BLUMBERG: So what you're saying is if I'm a lender, and I loan you money at 5 percent, and then all of a sudden, inflation takes off and the inflation rate becomes 10 percent, I'm losing money.

MCLEAN: You're stuck with a really unprofitable loan on your books. You're stuck with something that's earning you 5 percent. And it's going to cost you a lot more to fund that mortgage. And so you're going to be losing money on that mortgage, and you're going to be losing money for a really long time because 30 years is a really long time.

JOE NOCERA: And then think about what happens in the course of 30 years - 30 years. You can lose your job. You know, you can get into some health problems. You can...

ADAM DAVIDSON, BYLINE: You could get divorced and remarried a bunch of times.

MCLEAN: (Laughter).

NOCERA: Well, you could. All of which affects (laughter) your house and your ability to pay for your house.

BLUMBERG: So as a lender, what you're saying is that not only do I have this interest rate risk, this risk that I can lend out something at a very low interest rate, and then all of a sudden, interest rates go through the roof and I'm stuck, but also it's 30 years. It's forever. And so anything can happen to the people I've let my money to in that 30 years. They could die. They could get divorced. They could lose their jobs. They could become depressed and just stop paying for whatever reason. They could gamble all their money away, whatever.

MCLEAN: And that kind of risk the industry calls credit risk. It's the risk that I make you a loan, and you don't pay it back.

DAVIDSON: So - OK. If the 30-year fixed-rate mortgage is so crazy, Alex, why is it that we feel like it's the most normal thing in the world? It's just the most ordinary mortgage that an American could get.

BLUMBERG: Well, there's a couple of reasons. They're historical reasons. But the most important has to do with Fannie Mae. All right. So Fannie Mae was created way back during the Great Depression. And before then, typically, if you wanted to buy a house, you had to put something, like, half your money down. And you'd only have, like, five to 10 years to pay the mortgage back. But in the Great Depression, the housing market cratered. And the government created Fannie Mae to try and help people be able to afford houses again.

DAVIDSON: Here's Bethany and Joe again.

MCLEAN: The basic thinking behind Fannie Mae was if you set up this government-owned creature that could buy these loans from these small banks around the country, then you could create a national mortgage market because the local banks could turn around and sell their mortgages to this national company. And then they'd have the capital to be able to turn around and make more mortgages. So the real transition was from what had been a purely local market became a national market thanks to the creation of Fannie Mae.

DAVIDSON: And if I can just - because this is something that Alex and I - it took us a little while, early in the housing crisis, to get our heads around - the phrase selling a mortgage that comes up a lot. But basically, a mortgage is an obligation that someone will pay certain amount every month for a certain period of time. And selling the mortgage means the bank is selling the right to receive that payment for the time of the loan. And this is...

MCLEAN: Precisely.


MCLEAN: You're selling something of value. Just like selling a car is selling something of value, selling a mortgage, you're selling something that has value to it.

DAVIDSON: And that thing of value is a piece of paper that says, somebody's going to be paying you this amount of money for 30 years.

MCLEAN: Exactly. Somebody's going to be paying you this amount of money every month for this many years.

DAVIDSON: We hope.

MCLEAN: We hope (laughter).

BLUMBERG: (Laughter) And the way - and so it - so the way it works, if I'm an S&L, it's not like a savings and loan. If I'm a savings and loan - which was where most of the mortgages were originated in the - in - before the '70s, right? - if I'm a savings and loan, it's not like I borrow $100 from Adam, and then I lend the $100 to you, Bethany, so that you can buy your mortgage. And then I just sit around for the next 30 years.

That's not what happens, right? So what happens is I borrow it from Adam. I lend it to you. And then I sell it to Fannie and Freddie. I get more money. And then I do the process again and again and again.

MCLEAN: And then I do the process again. Right. And by having Fannie and Freddie as these buyers that sat in Washington, D.C., you were making homeownership around the country a more equal proposition.

DAVIDSON: So we have this new government agency in the housing business, Fannie Mae. And it changes housing in America in a really profound way. It makes the 30-year fixed-rate mortgage, which would have been unthinkable before, this very normal, everyday thing.

BLUMBERG: Right. So if I'm a bank, I'd be unwilling to loan somebody money for 30 years because of all the (laughter) risks that we just discussed. But if there's this big government agency willing to buy the mortgage from me, then, you know, what the hell. Let the government worry (laughter) about the risks.

DAVIDSON: (Laughter) Right.

BLUMBERG: I'll be - I'll make the loan and then sell it to them.

DAVIDSON: What this new kind of mortgage does - what the 30-year mortgage does, it makes housing much more affordable for everyone. Right? If you take out a loan, and you have to pay the whole thing back in five or 10 years, that's a really big monthly payment compared to if you have 30 years to pay back the same amount of money. So more people can buy houses.

BLUMBERG: And this was the situation we had for decades after World War II, basically. Local banks made these crazy 30-year-long mortgage loans, sold them to Fannie Mae. And consumers, people who were buying houses, started to think of this as totally normal.

DAVIDSON: OK. Now - I feel like we need a transition here. You know, I want to come in and be like, the year was 1968.

BLUMBERG: (Laughter) Right. Exactly.

DAVIDSON: President Johnson facing escalating deficits over the war in Vietnam.

BLUMBERG: Bring up some Jimi Hendrix music. Play it over, like...

DAVIDSON: Right. (Laughter) Right. Shots of Woodstock, yeah.

BLUMBERG: Exactly. OK, listeners. Imagine that under you.

DAVIDSON: So the war in Vietnam is leading to higher deficits. And President Johnson is looking for ways to make the government's books look better. And there's Fannie Mae sitting there on the government's books, making the national debt look much bigger.

MCLEAN: And if you can take it, and you can sell it off and say, this is no longer a government entity, then, voila, the government debt goes down.

DAVIDSON: And it's easy to imagine President Obama, if someone came in and said, hey, I worked out this idea - we could sell off the Department of Transportation and cut the U.S. debt in half...

NOCERA: (Laughter).

MCLEAN: It'd look pretty (laughter)...

DAVIDSON: ...That'd be a very tempting thing to do.

MCLEAN: It'd look pretty damn good, wouldn't it (laughter)?

DAVIDSON: Yeah. Right. And...

MCLEAN: Exactly.

NOCERA: So Fannie Mae became this - there's - really was nothing like it in American life. It was a private corporation with shareholders, with a the board of directors, with a CEO...

BLUMBERG: Making real profits that went to actual non-government employees.

NOCERA: Right. But it also had a congressional mandate to help meet certain affordable housing goals. So it's supposed to help poor people get into homes, allegedly. And it had this subterranean - because it was never really acknowledged - implicit government guarantee that if it ever got into trouble, real trouble, the government would come in and bail it out.

BLUMBERG: Now, this implicit, subterranean government guarantee, this is a huge deal because what it does is it confers this immense advantage onto this now-private company Fannie Mae. So remember, Fannie Mae has to borrow lots of money to buy all these mortgages. And let's just imagine there's another company trying to compete with Fannie. Let's call it - I don't know - Jacob's Mortgage Purchase Company or something like that.

GOLDSTEIN: OK. So as it happens, I am the CEO of Jacob's Mortgage Purchase Company. And I go out to investors and say, lend me some money. I'm going to go buy mortgages with the money you lend me, and then I'll pay you back.

BLUMBERG: But those investors might take one look at you and - I hope you don't take this the wrong way - but they might think, maybe you're not good for that money. So they might charge you a little bit more interest.

But if those same investors were to look at Fannie Mae and Freddie Mac, which was also created around this time - that's we also talked about, Fannie and Freddie - if they were to look at Fannie and Freddie, who are doing the same thing as you, Jacob, the investors would think, though, Fannie and Freddie, if they can't pay me back, the government is going to come in and bail them out. That's this implicit guarantee. And so that means this implicit guarantee means the investors will charge Fannie and Freddie a lower interest rate than a private player like you, Jacob.

MCLEAN: And in the mortgage business, where the sums of money are immense, the difference in a half-point, a quarter-point in interest rates...

DAVIDSON: A half a percentage point, yeah.

MCLEAN: ...Can - half a percentage point - can make an enormous amount of difference in profitability. It can take what could be an unprofitable loan and make it a profitable loan. So this double game that Joe was talking about, which is really just one of the great double games in American business history when you think about it - (laughter) it's just - it's shocking that we all play this game of let's pretend - was at the very heart of Fannie and Freddie's business model. It wasn't just a small advantage off to the side. It was at the very heart of the business model.

BLUMBERG: And to...

DAVIDSON: We should emphasize here that even though the government by its implicit guarantee was enabling Fannie to be fantastically profitable, Fannie gave nothing back to the government. I mean, it wasn't like the government was getting any of those returns. It was all going directly to a fully private company with private shareholders. And people were becoming millionaires at Fannie and Freddie.

MCLEAN: It depends on how you think about giving back to the government because Fannie paid fortunes in lobbying money. So they gave back to the politicians...


MCLEAN: ...(Laughter) If you want to think about that as giving back to the government.


GOLDSTEIN: So - OK, Alex, just to recap where we are. Fannie Mae is created in the Depression. It makes the 30-year mortgage the sort of bread-and-butter American mortgage. In the late 1960s, it becomes a private company. But it continues its role alongside Freddie Mac, which was created in 1970. And then, in the years that follow that, lots of other things start to happen - banking regulations change, money starts flowing more freely all around the globe. And Fannie and Freddie really change their business model.

BLUMBERG: So before, they would simply buy them mortgages and hold on to them. Now what they start doing is bundling them together and selling them off to investors around the world. And here's the important part - those bundles that they sell off to investors around the world, Fannie and Freddie give them a guarantee, a promise that if the mortgage holder doesn't pay the money back, then Fannie and Freddie will step in and pay it back for them. They'll guarantee the loan.

GOLDSTEIN: In other words, even though Fannie and Freddie are not holding these mortgages anymore, they're still taking on that credit risk we talked about at the beginning, the reason banks don't want to make 30-year mortgages in the first place. Fannie and Freddie are still assuming that risk.

BLUMBERG: And in the years when the housing market was really cranking, Fannie and Freddie borrowed even more cheap money using their implicit government guarantee. And they got into riskier subprime mortgages too. They bought up a bunch of those risky subprime mortgage bonds. So here they are. They're guaranteeing regular 30-year mortgages. They're buying risky subprime bonds. And then, of course, the crisis hit. And for the first time, this implicit government guarantee of Fannie Mae and Freddie Mac became explicit.

GOLDSTEIN: In September of 2008 - right? - in the most crisis-y month of the crisis, the federal government basically took over Fannie Mae and Freddie Mac. It was a huge bailout. It's cost taxpayers more than $100 billion so far. It's probably going to cost more. And Fannie and Freddie are now government entities. They are not private companies anymore.

Nobody thinks things should stay the way they are now. We have this big decision to make as a country. Congress is going to be debating it. Basically, what is our mortgage industry going to look like? And what will the government's role be in it? But as this debate takes place, there is this really key fact on the ground right now, which is almost all the mortgages people are getting in America today are guaranteed by the federal government.

NOCERA: Because the banks are so used to government guarantees and government involvement, they're terrified. They won't make a loan. They will not make a loan without the involvement of the federal government. And so between Fannie, Freddie and the Federal Housing Administration, 95 percent of the loans - mortgages made in America are guaranteed by the government. One of the reasons the Democratic administration has not come up with a plan about what to do about Fannie and Freddie is that they're terrified about the possibility of the housing market, you know, basically going into freefall if they start to withdraw this heroin known as Fannie and Freddie guarantees.

MCLEAN: Right. So you have guys like Bill Gross at PIMCO, the world's largest bond fund, who - and they buy mortgages. But he said he would charge three full percentage points more for a mortgage if it didn't have the backing of Fannie and Freddie, in other words, the backing of the U.S. government, because now he's so scared. And that makes you understand the role that Fannie and Freddie, and hence the U.S. government, and hence taxpayers are paying in the - playing in the housing market today.

BLUMBERG: And so the thing that we've sort of started this conversation talking about, the 30-year fixed-rate, which people think of as, like, the basic, sanest, safest, nothing crazy about that - it's not some sort of crazy subprime loan - but the 30-year fixed-rate loan is in fact one of the craziest inventions out there. If it was just left to the private market, it's unclear whether that loan would ever be made. But it has become the bedrock of U.S. housing. And it doesn't seem like it's going anywhere.

MCLEAN: Right. And if you want to have - I think our point is that if you want to have the widespread availability of a low-cost, 30-year fixed-rate mortgage, then you need the government in the housing market. There are no ifs, ands or buts about it. And so the American people have to stop being hypocrites. And we have to stop saying, we want our 30-year fixed-rate mortgage, but get the damn government out of our housing market, because you can't - you don't get to have both.


KINGS OF LEON: (Singing) It's in the water. It's where you came from. It's in the water. It's where you came from.

BLUMBERG: We're going to be doing much more on Fannie Mae and Freddie Mac in upcoming podcasts and stories. We're going to be working with Joe and Bethany on future stories. They are, in fact, the most interesting companies in the world. And we're going to be doing a lot about just why. We would love to hear your comments, your questions about Fannie Mae, Freddie Mac, the future of American housing. Please send them to us here at

GOLDSTEIN: And on the blog, we'll have links to Joe and Bethany's book "All the Devils Are Here." I'll link to the op-ed where Bethany calls the 30-year fixed-rate Frankenstein's monster. And I'll also link to a post going over some of the possible options for what might happen with the mortgage market in this country. The blog, of course, I'm Jacob Goldstein.

BLUMBERG: And I'm Alex Blumberg. Thanks for listening.


KINGS OF LEON: (Singing) Just drink the water where you came from, where you came from. The road, it was carved from yonder. Never sold yourself away. It's in the water. It's in the story.

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