Charles Calomiris uses internal emails to tell the story of what happened between 2004 and 2008.

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.

Actually, a number of things had been going on. One important factor at Freddie was change at the top. The previous CEO, Leland Brendsel, had been ousted by the Freddie Mac board in an accounting “scandal” which consisted of lowering earnings to be more consistent with what economists thought was the reality of the company. Among other things, senior management was accused of putting too much into loss reserves. Rather ironic, in light of subsequent events.

So you have a new CEO, Richard Syron, who is a true believer in the view that mortgage lending standards discriminate against disadvantaged borrowers. The company needs to rebuild political capital because of the scandal. And in the mortgage industry, everybody who has been betting on rising home prices has been winning, which makes shareholders at Freddie and Fannie jealous of the profits at more aggressive players.

Anyway, Calomiris continues,

[Chief Risk Officer David] Andrukonis wrote to Chief Operating Officer Paul Peterson, “In 1990 we called this product ‘dangerous’ and eliminated it from the marketplace.” He also argued that housing prices were already high and unlikely to rise further: “We are less likely to get the house price appreciation we’ve had in the past 10 years to bail this program out if there’s a hole in it.”

Donna Cogswell, a colleague of Mr. Andrukonis, warned that Fannie and Freddie’s decisions to debase underwriting standards would have widespread ramifications for the mortgage market. In a Sept. 7 email to Freddie Mac CEO Dick Syron and others, she specifically described the ramifications of Freddie Mac’s continuing participation in the market as effectively “mak[ing] a market” in no-doc mortgages.

Ms. Cogswell’s Sept. 4 email to Mr. Syron and others also anticipated the potential human costs of the mortgage crisis. She tried to sway management by appealing to their decency: “[W]hat better way to highlight our sense of mission than to walk away from profitable business because it hurts the borrowers we are trying to serve?”

Calomiris cites a paper by Uday Rajan, Amit Seru, and Vikrant Vig, which argues that as securitizers stress certain criteria (I think of credit scores) the mortgage originators find loans that satisfy those criteria but which are risky in other dimensions. I certainly believe that the dynamics of the principal-agent problem work this way, so that if the principal sticks with a rigid formula, the agent will learn to game it. That is why I don’t think having the government set criteria for paying health care workers is going to work well. But in the game between Freddie (or Fannie) and mortgage lenders, both sides are capable of making moves. Freddie could have chosen to adjust its strategy in order to stop originators from foisting bad loans on it. Instead, Freddie went in the other direction.