The Congressional committee at which I appeared the other day got a lot of documents from Freddie Mac and Fannie Mae, many of which they leaked. The Wall Street Journal writes,
One Fannie Mae document from March 2005 notes dryly, "Although we invest almost exclusively in AAA-rated securities, there is a concern that the rating agencies may not be properly assessing the risk in these securities." But they bought them anyway...
In the alternative history, the CEO of Freddie or Fannie speaks out in early 2005 to an investor conference and calls baloney sandwich on the rating agencies. The CEO exposes the flaws in the ratings and calls them to the attention of the Fed and the FDIC. These warnings cause the private-label subprime securities market to contract. The housing bubble pops in 2005, and Freddie Mac and Fannie Mae have stayed out of the subprime market. There is a mild downturn in housing, and the worst of the private subprime mortgage lenders go out of business, but overall the financial consequences are mild.
I think that the CEO's at Freddie and Fannie were in a better position than anyone else to stop the madness. But if your idea of a housing system is to build up two firms with enormous power and count on them to exercise that power judiciously, then you might want to rethink your model.
Incidentally, I think that the WSJ may have been overly pessimistic in suggesting that the Democrats were there to whitewash Freddie and Fannie. Perhaps I was misled by what I saw, but it seemed to me that the Democrats were genuinely angry at the CEO's of Freddie and Fannie, and that this anger translated into serious doubts about the private-public status of those organizations.