Hassett: How the Democrats created the financial crisis

[Angus]

How the Democrats Created the Financial Crisis
Commentary by Kevin Hassett

Sept. 22 (Bloomberg) -- The financial crisis of the past year has provided a number of surprising twists and turns, and from Bear Stearns Cos. to American International Group Inc., ambiguity has been a big part of the story.

Why did Bear Stearns fail, and how does that relate to AIG? It all seems so complex.

But really, it isn't. Enough cards on this table have been turned over that the story is now clear. The economic history books will describe this episode in simple and understandable terms: Fannie Mae and Freddie Mac exploded, and many bystanders were injured in the blast, some fatally.

Fannie and Freddie did this by becoming a key enabler of the mortgage crisis. They fueled Wall Street's efforts to securitize subprime loans by becoming the primary customer of all AAA-rated subprime-mortgage pools. In addition, they held an enormous portfolio of mortgages themselves.

In the times that Fannie and Freddie couldn't make the market, they became the market. Over the years, it added up to an enormous obligation. As of last June, Fannie alone owned or guaranteed more than $388 billion in high-risk mortgage investments. Their large presence created an environment within which even mortgage-backed securities assembled by others could find a ready home.

The problem was that the trillions of dollars in play were only low-risk investments if real estate prices continued to rise. Once they began to fall, the entire house of cards came down with them.

Turning Point

Take away Fannie and Freddie, or regulate them more wisely, and it's hard to imagine how these highly liquid markets would ever have emerged. This whole mess would never have happened.

It is easy to identify the historical turning point that marked the beginning of the end.

Back in 2005, Fannie and Freddie were, after years of dominating Washington, on the ropes. They were enmeshed in accounting scandals that led to turnover at the top. At one telling moment in late 2004, captured in an article by my American Enterprise Institute colleague Peter Wallison, the Securities and Exchange Comiission's chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's position on the relevant accounting issue was not even ``on the page'' of allowable interpretations.

Then legislative momentum emerged for an attempt to create a ``world-class regulator'' that would oversee the pair more like banks, imposing strict requirements on their ability to take excessive risks. Politicians who previously had associated themselves proudly with the two accounting miscreants were less eager to be associated with them. The time was ripe.

Greenspan's Warning

The clear gravity of the situation pushed the legislation forward. Some might say the current mess couldn't be foreseen, yet in 2005 Alan Greenspan told Congress how urgent it was for it to act in the clearest possible terms: If Fannie and Freddie ``continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road,'' he said. ``We are placing the total financial system of the future at a substantial risk.''

What happened next was extraordinary. For the first time in history, a serious Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.

Different World

If that bill had become law, then the world today would be different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest and most venerable institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed.

But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.

That such a reckless political stand could have been taken by the Democrats was obscene even then. Wallison wrote at the time: ``It is a classic case of socializing the risk while privatizing the profit. The Democrats and the few Republicans who oppose portfolio limitations could not possibly do so if their constituents understood what they were doing.''

Mounds of Materials

Now that the collapse has occurred, the ro built by Senate Democrats in 2005 is unforgivable. Many who opposed the bill doubtlessly did so for honorable reasons. Fannie and Freddie provided mounds of materials defending their practices. Perhaps some found their propaganda convincing.

But we now know that many of the senators who protected Fannie and Freddie, including Barack Obama, Hillary Clinton and Christopher Dodd, have received mind-boggling levels of financial support from them over the years.

Throughout his political career, Obama has gotten more than $125,000 in campaign contributions from employees and political action committees of Fannie Mae and Freddie Mac, second only to Dodd, the Senate Banking Committee chairman, who received more than $165,000.

Clinton, the 12th-ranked recipient of Fannie and Freddie PAC and employee contributions, has received more than $75,000 from the two enterprises and their employees. The private profit found its way back to the senators who killed the fix.

There has been a lot of talk about who is to blame for this crisis. A look back at the story of 2005 makes the answer pretty clear.

Oh, and there is one little footnote to the story that's worth keeping in mind while Democrats point fingers between now and Nov. 4: Senator John McCain was one of the three cosponsors of S.190, the bill that would have averted this mess.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aSKSoiNbnQY0

[ThaBigP]

Been preaching that since this mess started. But it appears few are listening. They'd rather blame "free" markets. Nevermind the inconvenient fact that this market was anything but "free". Those who broke it now want total control of it. And...to add insult to injury...they DEMAND the right to sit in judgement of those who tried to stop it.

[ThaBigP]

There were some liberal Republicans who went along too; apparently they wanted in on some of the action going on between Freddie/Fannie and the committees that were supposed to oversee them. They should be hung out to dry as well.

[arglebargle]

That's like pointing out a particular bullet wound and claiming it was so terrible, when the poor guy's been shot thirty times.

It would've been a bandaid on a blown artery.

Here's some links on some of the reasons why things went wrong, and they have a very Texas background. Phil Gramm.

http://www.chron.com/disp/story.mpl/editorial/outlook/6007788.html

http://www.reuters.com/article/reutersComService4/idUSLM71801220080922?pageNumber=2&virtualBrandChannel=10112

[Aikbach]

There is bi-partisan blame for this, especially since Bush is promoting this 700 billion bailout.

[BrAinPaiNt]

There is bi-partisan blame for this, especially since Bush is promoting this 700 billion bailout.

Yep...both parties are doing a lot of finger pointing...especially the candidates.

But you know they all had a hand in it. Bout the only thing they do well together is make messes. :laugh2:

[ThaBigP]

That's like pointing out a particular bullet wound and claiming it was so terrible, when the poor guy's been shot thirty times.

It would've been a bandaid on a blown artery.

Here's some links on some of the reasons why things went wrong, and they have a very Texas background. Phil Gramm.

http://www.chron.com/disp/story.mpl/editorial/outlook/6007788.html

http://www.reuters.com/article/reutersComService4/idUSLM71801220080922?pageNumber=2&virtualBrandChannel=10112

Sorry, but as far as the reuter's link is concerned, it's as wrong as it is long. Lack of regulation did not cause this. Total regulation of critical aspects of business activity in the financial sector caused this. Look up "Community Reinvestment Act". Everybody knows that the subprime morgage collapse caused this. Everybody also knows that subprime mortgages were forced onto lending institutions by the government.

The first link wasn't so bad, it did point out attempts to remove the forced sub-prime mortgages from any oversight. So in effect, the wrong kind of regulation was enforced, the right kind was cast aside.

[Maikeru-sama]

Sorry, but as far as the reuter's link is concerned, it's as wrong as it is long. Lack of regulation did not cause this. Total regulation of critical aspects of business activity in the financial sector caused this.


Actually, greed, fraud, the re-packaging of sub prime loans with good loans in derivatives and the lack of accountability led to this.

[ThaBigP]

Actually, greed, fraud, the re-packaging of sub prime loans with good loans in derivatives and the lack of accountability led to this.

Greed = greed for votes, hence the pandering by demanding loans to those who could not repay. Greed in the marketplace, on the other hand, is met with market failure *if* the free market is allowed to work and prudence is not exercised. Futhermore, the revolving back-door between Fannie/Freddie and Congress led to a "circle jerk" situation...sit on Congressional oversight committees who are supposed to look over Fannie/Freddie, and recieve campaign contributions for beating back any attempts to regulate with sensible regulation/accountability. Then, after your Congressional tenure is up, you get fast-tracked into the boardrooms of those two entities. Then YOU get to grease the palms of the new oversight chairmen/chairwomen and sock away millions yourself in salaries and bonuses by cooking the books. And since your friends sit on the oversight committees, nobody will call you on it unless the whole thing explodes.

Fraud = well, in light of the first, I can't disagree. Furthermore, yes, sensible regulation regarding Fannie/Freddie was repeatedly beaten back. Also, the accounting scandals at said Fannie/Freddie.

re-packagine of loans....standard practice. And nothing would have been wrong with that if not for the radioactive subprimes that the lenders had no choice but to issue. I will say that the industry did not do anything approaching a good job of bundling them separately as higher-risk securities. But do bear in mind that any attempt by lenders to "set aside" subprimes was met with cries of "racism". Janet Reno threatened to sic the Justice Department on any who dared, and if I'm not mistaken the practice continues to this day.

You also have the continual drop in interest rates, which while that did not *cause* the mess, certainly helped to make it as large as it was.

[ThaBigP]

The Community Reinvestment Act (or CRA, Pub.L. (http://en.wikipedia.org/wiki/Public_law_(United_States)) 95-128, title VIII, 91 Stat. (http://en.wikipedia.org/wiki/United_States_Statutes_at_Large) 1147, 12 U.S.C. (http://en.wikipedia.org/wiki/Title_12_of_the_United_States_Code) § 2901 (http://www.law.cornell.edu/uscode/12/2901.html) et seq.) is a United States federal law (http://en.wikipedia.org/wiki/United_States_federal_law) that requires banks (http://en.wikipedia.org/wiki/Bank) and thrifts (http://en.wikipedia.org/wiki/Savings_and_loan_association) to offer credit (http://en.wikipedia.org/wiki/Credit_(finance)) throughout their entire market area and prohibits them from targeting only wealthier neighborhoods with their services, a practice known as "redlining (http://en.wikipedia.org/wiki/Redlining)." The purpose of the CRA is to provide credit, including home ownership opportunities to underserved populations and commercial loans to small businesses. It has been subjected to important regulatory revisions.
Contents

[hide (javascript:toggleToc())]
<LI class=toclevel-1>1 Original Act (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#Original_Act) <LI class=toclevel-1>2 Clinton Administration Changes of 1995 (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#Clinton_Administration_ Changes_of_1995) <LI class=toclevel-1>3 George W. Bush Administration Proposed Changes of 2003 (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#George_W._Bush_Administ ration_Proposed_Changes_of_2003) <LI class=toclevel-1>4 Changes of September 2005 (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#Changes_of_September_20 05) <LI class=toclevel-1>5 Criticism (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#Criticism) <LI class=toclevel-1>6 References (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#References)
7 External links (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#External_links)//

[edit (http://en.wikipedia.org/w/index.php?title=Community_Reinvestment_Act&action=edit&section=1)] Original Act

The CRA was passed into law by the U.S. Congress in 1977 as a result of national grassroots (http://en.wikipedia.org/wiki/Grassroots) pressure for affordable housing, and despite considerable opposition from the mainstream banking community. Only one banker, Ron Grzywinski (http://en.wikipedia.org/wiki/Ron_Grzywinski) from ShoreBank (http://en.wikipedia.org/wiki/ShoreBank) in Chicago (http://en.wikipedia.org/wiki/Chicago), testified in favor of the act. [1] (http://www.fdic.gov/regulations/laws/rules/6500-2515.html)
The CRA mandates that each banking institution be evaluated to determine if it has met the credit needs of its entire community. That record is taken into account when the federal government (http://en.wikipedia.org/wiki/United_States_Federal_government) considers an institution's application for deposit facilities, including mergers and acquisitions. The CRA is enforced by the financial regulators (FDIC (http://en.wikipedia.org/wiki/FDIC), OCC (http://en.wikipedia.org/wiki/Office_of_the_Comptroller_of_the_Currency), OTS (http://en.wikipedia.org/wiki/Office_of_Thrift_Supervision), and FRB (http://en.wikipedia.org/wiki/Federal_Reserve_System)).

[edit (http://en.wikipedia.org/w/index.php?title=Community_Reinvestment_Act&action=edit&section=2)] Clinton Administration Changes of 1995

In 1995, as a result of interest from President (http://en.wikipedia.org/wiki/President_of_the_United_States) Bill Clinton (http://en.wikipedia.org/wiki/Bill_Clinton)'s administration, the implementing regulations for the CRA were strengthened by focusing the financial regulators' attention on institutions' performance in helping to meet community credit needs. These revisions[1] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-0) with an effective starting date of January 31 (http://en.wikipedia.org/wiki/January_31), 1995 (http://en.wikipedia.org/wiki/1995) were credited with substantially increasing the number and aggregate amount of loans to small businesses and to low- and moderate-income borrowers for home loans. These changes were very controversial and as a result, the regulators agreed to revisit the rule after it had been fully implemented for seven years. Thus in 2002, the regulators opened up the regulation for review and potential revision.[citation needed (http://en.wikipedia.org/wiki/Wikipedia:Citation_needed)]
Part of the increase in home loans was due to increased efficiency and the genesis of lenders, like Countrywide (http://en.wikipedia.org/wiki/Countrywide), that do not mitigate loan risk with savings deposits as do traditional banks using the new subprime authorization. This is known as the secondary market for mortgage loans. The revisions allowed the securitization (http://en.wikipedia.org/wiki/Securitization) of CRA loans containing subprime mortgages (http://en.wikipedia.org/wiki/Subprime_lending). The first public securitization (http://en.wikipedia.org/wiki/Securitization) of CRA loans started in 1997 by Bear Stearns (http://en.wikipedia.org/wiki/Bear_Stearns). [2] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-1) The number of CRA mortgage loans increased by 39 percent between 1993 and 1998, while other loans increased by only 17 percent. [3] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-2) [4] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-3)

[edit (http://en.wikipedia.org/w/index.php?title=Community_Reinvestment_Act&action=edit&section=3)] George W. Bush Administration Proposed Changes of 2003

In 2003 (http://en.wikipedia.org/wiki/2003), the Bush (http://en.wikipedia.org/wiki/George_W._Bush) Administration recommended what the NY Times (http://en.wikipedia.org/wiki/The_New_York_Times) called "the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis (http://en.wikipedia.org/wiki/Savings_and_loan_crisis) a decade ago." [5] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-4) This change was to move governmental supervision of two of the primary agents guaranteeing subprime loans, Fannie Mae (http://en.wikipedia.org/wiki/Fannie_Mae) and Freddie Mac (http://en.wikipedia.org/wiki/Freddie_Mac) under a new agency created within the Department of the Treasury (http://en.wikipedia.org/wiki/United_States_Department_of_the_Treasury). However, it did not alter the implicit guarantee that Washington will bail the companies out if they run into financial difficulty; that perception enabled them to issue debt at significantly lower rates than their competitors. The changes were generally opposed along Party lines and eventually failed to happen. Representative Barney Frank (http://en.wikipedia.org/wiki/Barney_Frank) (D-MA) claimed of the thrifts "These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis, the more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing." Representative Mel Watt (http://en.wikipedia.org/wiki/Mel_Watt) (D-NC) added "I don't see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing."[6] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-5)

[edit (http://en.wikipedia.org/w/index.php?title=Community_Reinvestment_Act&action=edit&section=4)] Changes of September 2005

http://upload.wikimedia.org/wikipedia/commons/thumb/1/1b/Ambox_question.svg/40px-Ambox_question.svg.png (http://en.wikipedia.org/wiki/Image:Ambox_question.svg)
This section may contain original research (http://en.wikipedia.org/wiki/Wikipedia:No_original_research) or unverified (http://en.wikipedia.org/wiki/Wikipedia:Verifiability) claims.
Please help Wikipedia by adding references. See the talk page (http://en.wikipedia.org/wiki/Talk:Community_Reinvestment_Act) for details.(September 2008)
Among banks and the regulatory agencies, there was a consensus that data collection, recordkeeping, and reporting requirements imposed a heavy burden on small community institutions. As a result of a 2002 (http://en.wikipedia.org/wiki/2002) review of the CRA regulations, and revision of an initial Federal Deposit Insurance Corporation (http://en.wikipedia.org/wiki/Federal_Deposit_Insurance_Corporation) (FDIC) proposal following a public commenting period that was largely negative, the FDIC, Office of the Comptroller of the Currency (http://en.wikipedia.org/wiki/Office_of_the_Comptroller_of_the_Currency) (OCC) and the Federal Reserve Board (http://en.wikipedia.org/wiki/Federal_Reserve_Board) (FRB), made substantive changes to the implementation of regulations for the CRA for banks (not thrifts).
Previously, all institutions over $250 million in assets were subject to a three-part CRA test that covered lending (including community development loans), qualified investments, and services (including community development services) to their assessment areas. Institutions less than $250 million were subject only to a lending test.
However, as of September 1, 2005 (http://en.wikipedia.org/wiki/2005), only those institutions with more than $1 billion in assets were subject to the three-part test. Institutions below $250 million remain subject to only a lending test, and a new CRA test was created for institutions with assets between $250 million and $1 billion. This latter category, referred to as Intermediate Small Banks, is subject to the same lending test to which institutions under $250 million were subject, along with a new combined community development test that covers community development loans, qualified investments, and community development services. The $250 million and $1 billion asset thresholds also were indexed to the consumer price index (http://en.wikipedia.org/wiki/Consumer_price_index) and could change annually. Thus, all institutions remain subject to the CRA test. These substantive changes were intended to be a compromise between changes advocated by banks and community groups.
However, the changes were not received positively by all community groups. Changes to tests conducted on the Intermediate Small category were viewed by some as decreasing the institutions' obligations to meet lending requirements of low- and moderate-income households. Racial inequities in mortgage (http://en.wikipedia.org/wiki/Mortgage) acceptance rates (as reported by Inner City Press (http://en.wikipedia.org/wiki/Inner_City_Press), the National Community Reinvestment Coalition (http://en.wikipedia.org/w/index.php?title=The_National_Community_Reinvestmen t_Coalition&action=edit&redlink=1), ACORN (http://en.wikipedia.org/wiki/ACORN) and other groups) are cited as a primary reason to maintain or even increase the scope of the CRA.

[edit (http://en.wikipedia.org/w/index.php?title=Community_Reinvestment_Act&action=edit&section=5)] Criticism

Critics claim that government policy encouraged risky lending[7] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-6) and the development of the subprime debacle (http://en.wikipedia.org/wiki/Subprime_mortgage_crisis) through legislation like the CRA. Economics professor Stan Liebowitz writes that banks were forced to loan to un-credit worthy consumers with "no verification of income or assets; little consideration of the applicant's ability to make payments; no down payment." The chief executive of Countrywide Financial (http://en.wikipedia.org/wiki/Countrywide_Financial), the nation's largest mortgage lender, is said to have "bragged" that to approve minority applications "lenders have had to stretch the rules a bit."[8] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-7) Robert Gordon of the Center for American Progress (http://en.wikipedia.org/wiki/Center_for_American_Progress) disagrees, and quotes statistics that he claims show "independent mortgage companies, which are not covered by CRA, made high-priced loans at more than twice the rate of the banks and thrifts." He faults then-Federal Reserve (http://en.wikipedia.org/wiki/Federal_Reserve) chair Alan Greenspan (http://en.wikipedia.org/wiki/Alan_Greenspan) for "cheering the subprime boom" in the banking industry.[9] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-8) Economics professor Thomas DiLorenzo (http://en.wikipedia.org/wiki/Thomas_DiLorenzo) counters Gordon, stating that independent mortgage companies are "middlemen" between banks, including those regulated by the CRA, and consumers and that in any case the CRA had caused tens of billions in defaults on mortgages by unqualified borrowers.[10] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-9) Economist Yaron Brook concluded succinctly, "The Government Did It:" through the stick of the CRA [and] the carrot of Fannie Mae and Freddie Mac, the fed created the mortgage market debacle. [11] (http://en.wikipedia.org/wiki/Community_Reinvestment_Act#cite_note-10)

[Maikeru-sama]

Greed = greed for votes, hence the pandering by demanding loans to those who could not repay. Greed in the marketplace, on the other hand, is met with market failure *if* the free market is allowed to work and prudence is not exercised.


I am talking about fraud at the front line. Borrowers lying about how much money they make, lying about how many homes they own and which one is their primary place of residence. Of course Loan Officers went along with it and/or flat out failed to do a proper background check. The above was a major reason for the current housing mess.



re-packagine of loans....standard practice.


Funds and banks around the world have taken hits because they purchased bonds, or risk related to bonds, backed by bad home loans, often bundled into financial instruments called collateralized debt obligations, or C.D.O.’s.

The losses have often surprised the investors, and in some cases the funds and the executives of the banks, who were unaware of the extent of their risks.

The confusion about these products lies in part in their complexity. Structured products are pooled assets that have been sliced and diced into ever more smaller, more specialized pieces.

As low interest rates fueled a lending boom to borrowers with weak credit, banks looked for new ways to package those loans, so they could sell more. A central building block to offset the risk was asset-backed securities, which are bonds backed by pools of mortgages or other income-producing assets, like student loans, auto loans, and credit card receivables.

Banks and other financial institutions pooled those asset-backed securities into new units, dividing them up again and issuing securities against them, creating collateralized debt obligations.

The idea took off, with new combinations that were further removed from the original asset. New creations included C.D.O.’s of C.D.O.’s, called C.D.O.-squared. There is even a C.D.O.-cubed.

Weaknesses in the system were laid bare, including ratings that did not accurately reflect risk and faulty assumptions on how diversified pools with multiple layers of leverage would react.


link (http://www.nytimes.com/2007/08/31/business/worldbusiness/31derivatives.html?pagewanted=print)