This is what happened. In the final proofs that we were able to review, that sentence used to read: “We do not subscribe to the theory that the financial crisis is primarily due to Fannie and Freddie,” with the same footnote at the end. In that context, it’s clear that we are citing the Calomiris and Wallison article as an example of that theory.

In the final edits, we decided that this “we do not subscribe to the theory” language was unnecessary scaffolding and an unnecessary use of the first person, so we deleted it. The problem is that without the word “theory,” now it superficially looks like we are citing Calomiris and Wallison to support our position. Since the word “theory” vanished from the text, we should have put it in the footnote, as in, “For an example of this theory, see . . .”

The support for our assertion that “the financial crisis was not primarily due to Fannie and Freddie” is obviously not in the footnote; it’s in the next two pages of the main text.

Anyone with the faintest familiarity with our writings would realize that we could not possibly be citing Calomiris or Wallison as support, as either of them would certainly acknowledge. And even without an explicit signal in the footnote, I would expect most thinking readers, seeing the title of the Calomiris-Wallison article, to realize instantly that we are citing Calomiris and Wallison as intellectual opponents, not support. Nevertheless, Gene Epstein referred to this mistake as “outright dishonesty” in an article for Barron’s (behind a paywall). I guess everyone is entitled to his opinion.

Update: A reader kindly sent me the full text of Epstein’s article. Basically he says that we are wrong, because Fannie and Freddie held the majority of subprime loans. Here’s the claim:

“Figures provided by [Edward] Pinto, now a consultant to the mortgage-finance industry, are staggering. By mid-2008, nearly half, or 27 million, of the 55 million first mortgages in the U.S. were high-risk, classified according to his criteria as subprime or ‘Alt-A.’ Of those 27 million, 19.2 million were accounted for by government, whether by virtue of being held or guaranteed by Fannie or Freddie (12 million), held by the Federal Housing Authority (5 million), or held by private institutions (2.2 million) under the requirements of the Community Reinvestment Act and HUD.

“That leaves 7.8 million risky mortgages issued solely by Wall Street.”

Looks pretty compelling, right? Well, only until you realize that Pinto’s definition of subprime is one he made up himself. (See the words “by his criteria” in the quotation above.) In his December 2008 Congressional testimony,* he said there were 25 million high-risk loans. In that analysis, he said there were 17 million subprime loans, of which Fannie/Freddie held 5.7 million, or 34 percent. But drop down to PDF page 56 and you see that this 5.7 million is made up of:

• 0.8 million are “subprime private label mortgage backed securities”
• 4.9 million are “‘prime’ loans < 660 FICO”

In other words, Fannie and Freddie held zero subprime whole loans by the conventional definition (loans denominated as subprime by the issuer, which is the definition used by LoanPerformance). They held 4.9 million loans that Pinto, in his wisdom, decided to call subprime, and subprime-backed MBS that are equivalent to 0.8 million loans.

Now, Pinto knows more about mortgages than I do. Maybe loans with a FICO below 660 should have been counted as  subprime all along, and maybe they should have gone into the LoanPerformance subprime database. But they weren’t. The fact remains that Fannie and Freddie had standards, and there were some loans they would not buy. Maybe those standards were too low; I would probably agree with Pinto on that one. But that’s a different issue. Pinto’s “data” don’t contradict the fact — pointed out by many people more knowledgeable than I — that Fannie and Freddie simply could not legally buy or guarantee the worst of the subprime loans.

(As for the 0.8 million loans in subprime MBS that Fannie/Freddie bought — that was a real problem, and one we point out on page 146 of the book.)

* Epstein’s numbers are slightly different from those in the December 2008 testimony, so I imagine Pinto updated his numbers. But they are close enough that the underlying principles are almost certainly the same.

Culture Gabfest is a weekly podcast in which Metcalf, Julia Turner, and Dana Stevens discuss major themes and events in the world of popular culture (this week included the SNL episode hosted by Betty White, the fiftieth anniversary of the Pill, and Iron Man 2). Each week each of the hosts endorses something drawn from any genre. (One week Metcalf endorsed his socks. The next week they did the endorsements with fake French accents, which was the funniest thing I have heard in years.) Anyway, Metcalf said some very nice things about the book and the blog, and my heart went pitter-patter.

Oh, and Simon did a segment on the book on PBS NewsHour today, around forty minutes past the hour.

Update: If it wasn’t obvious, the Culture Gabfest is in my usual podcast rotation, along with This American Life, Radiolab, Planet Money, and Fresh Air.

So far, we’ve had:

• Tyler Cowen arguing that it is the government that is calling the shots, not the banks — “It’s our government deciding to assemble a cooperative ruling coalition – which includes banks — at the heart of its fiscal core.”
• Noam Scheiber arguing that the administration is not trying to break up the banks because it would be too hard to push through Congress.
• William Black criticizing the administration’s attempts so far to constrain what he calls “systemically dangerous institutions.”
• Mike Konczal on the other ways in which Wall Street’s culture is affecting the real economy.
• Mark Thoma on the importance of history and economic history.

We’ve also written three posts of our own about the book on the Huffington Post Books page, on the “banana peel” theory of the crisis, the key charts in the book, and the problems with measuring bank size.

My response to Tyler Cowen is now up.

“In 2004 and 2005, both Moody’s and Standard & Poor’s modified their rating models in ways that made it easier to give higher ratings to CDOs, helping extend the structured finance boom.”

The source for that sentence is a Bloomberg article entitled “‘Race to Bottom’ at Moody’s, S & P Secured Subprime’s Boom, Bust.” The article begins this way:

“In August 2004, Moody’s Corp. unveiled a new credit-rating model that Wall Street banks used to sow the seeds of their own demise. The formula allowed securities firms to sell more top-rated, subprime mortgage-backed bonds than ever before.”

Further down, the article focuses on a rating model introduced in August 2004 by Gary Witt, which shifted from the older “binomial expansion technique” (BET) for modeling diversity in a portfolio of assets to a “correlated binomial” technique, and quotes other sources saying that the effect of the new model was to boost the ratings of CDOs.

Gary Witt is now a professor of statistics and finance at Temple University, and he sent me the following information by email:

• The new model would have increased the projected losses for AAA CDOs relative to the BET approach, which might have implied lower ratings, but not higher ones.
• The model introduced in August 2004 was not actually adopted by Moody’s for rating CDOs based on RMBS (residential mortgage-backed securities) or ABS (asset-backed securities, a category that often included subprime mortgage-backed securities).
• Instead, in 2005 Moody’s adopted the normal copula approach (favored by the investment banks).

So, if Witt is correct (and I have no reason to think he isn’t), the underlying article we used was wrong. There is still the question of what impact the 2005 change to the normal copula approach had. (Felix Salmon has previously criticized this type of model.)

Witt’s opinion is that the new model on balance did not make it easier to give higher ratings for CDOs. The BET had assumptions about independence that were clearly inaccurate by 2005, and the new model was an improvement. Still, Witt acknowledges that it’s not an open-and-shut case, in part because the models take different approaches to measuring correlation. For one thing, introducing a new model induces investment banks to behave strategically and game the new model, so it doesn’t make sense to simply take a given CDO and rate it using the two models; in practice, the banks will create different CDOs that are influenced by the properties of the two models.

So on balance, the sentence at the beginning of this post isn’t supported by the source we cited (at least when it comes to Moody’s).

I still don’t think the CFR is calling the shots, but I was wrong on the facts. Sorry.

And, Tyler Cowen’s discussion of the book is also up at The Huffington Post. I think we’ll probably wait for a couple of more posts and then write a synthesized response.