CHARLES W. CALOMIRIS: no doubt that reductions in mortgage-underwriting standards were at the heart of the subprime crisis

See The Mortgage Crisis: Some Inside Views: Emails show that risk managers at Freddie Mac warned about lower underwriting standards—in vain, and with lessons for today. From the WSJ, 10-27. Excerpt:

"Occupy Wall Street is denouncing banks and Wall Street for "selling toxic mortgages" while "screwing investors and homeowners." And the federal government recently announced it will be suing mortgage originators whose low-quality underwriting standards produced ballooning losses for Fannie Mae and Freddie Mac.

Have they fingered the right culprits?

There is no doubt that reductions in mortgage-underwriting standards were at the heart of the subprime crisis, and Fannie and Freddie's losses reflect those declining standards. Yet the decline in underwriting standards was largely a response to mandates, beginning in the Clinton administration, that required Fannie Mae and Freddie Mac to steadily increase their mortgages or mortgage-backed securities that targeted low-income or minority borrowers and "underserved" locations.

The turning point was the spring and summer of 2004. Fannie and Freddie had kept their exposures low to loans made with little or no documentation (no-doc and low-doc loans), owing to their internal risk-management guidelines that limited such lending. In early 2004, however, senior management realized that the only way to meet the political mandates was to massively cut underwriting standards.

The risk managers complained, especially at Freddie Mac, as their emails to senior management show. They refused to endorse the move to no-docs and battled unsuccessfully against the reduced underwriting standards from April to September 2004."

"The decision by Fannie and Freddie to embrace no-doc lending in 2004 opened the floodgates of bad credit. In 2003, for example, total subprime and Alt-A mortgage originations were $395 billion. In 2004, they rose to $715 billion. By 2006, they were more than $1 trillion.

In a painstaking forensic analysis of the sources of increased mortgage risk during the 2000s, "The Failure of Models that Predict Failure," Uday Rajan of the University of Michigan, Amit Seru of the University of Chicago and Vikrant Vig of London Business School show that more than half of the mortgage losses that occurred in excess of the rosy forecasts of expected loss at the time of mortgage origination reflected the predictable consequences of low-doc and no-doc lending. In other words, if the mortgage-underwriting standards at Fannie and Freddie circa 2003 had remained in place, nothing like the magnitude of the subprime crisis would have occurred."

Mr. Calomiris is a professor of finance at the Columbia Business School and a research associate of the National Bureau of Economic Research.