But they didn't like losing their market share, and they pushed the envelope on credit quality as far as they could inside the constraints of their charter: they got into "near prime" programs (Fannie's "Expanded Approval," Freddie's "A Minus") that, at the bottom tier, were hard to distinguish from regular old "subprime" except--again--that they were overwhelmingly fixed-rate "non-toxic" loan structures. They got into "documentation relief" in a big way through their automated underwriting systems, offering "low doc" loans that had a few key differences from the really wretched "stated" and "NINA" crap of the last several years, but occasionally the line between the two was rather thin. Again, though, whatever they bought in the low-doc world was overwhelmingly fixed rate (or at least longer-term hybrid amortizing ARMs), lower-LTV, and, of course, back in the day, of "conforming" loan balance, which kept the worst of the outright fraudulent loans out of the pile. Lots of people lied about their income (with or without collusion by their lender) in order to borrow $500,000 to buy an overpriced house in a bubble market. They weren't borrowing $500,000 from the GSEs.

Why did it go wrong?
When interest rates go up and refinancings end, the industry has to contract. It's never fun. But at the end of the last cycle in 2004-05, all of a sudden—and some of us think not accidentally—instead of normal contraction we had this amazing growth of the subprime industry. It distributed the benefit of homeownership to people who never would have qualified for mortgages otherwise.

Is that how the industry rationalized exotic loans?
That was one of the excuses. In the name of trying to enfranchise everybody, we started creating unstable loans that were designed to blow up in two years. Now the loans need the tooth fairy to keep up their values.

Why did that happen?
There's an old Wall Street adage that there's a nexus between fear and greed. If you diminish fear, you get more greed. People got braver issuing this stuff. All the participants felt they could act merely as agents and collect fees. Nobody was prepared to say "I have liability."

To a point, housing finance experts agreed with Fannie that its drop in market share was attributable to the proliferation of adjustable-rate mortgages. They noted that Fannie typically does not buy adjustable-rate loans from retail mortgage lenders because the lenders generally do not want to sell them.

But the experts added that the regulatory pressure on Fannie Mae is also helping constrict its business as it cuts back some of its investing activities to preserve capital. OFHEO has ordered Fannie to raise the amount of capital it has in reserve as a percentage of its holdings, a goal the company is pursuing by conserving cash and reducing its portfolio.

"The banks are far more willing to hold adjustable-rate mortgages than 30-year fixed. With the consumer preference for adjustable rates, it's harder for [Fannie] to get the volumes. Couple that with the spreads and the political and regulatory problems surrounding portfolio growth, and it's hard for them to be growing market share," said Josh Rosner, an analyst with Medley Global Advisors LLC in New York.