The GOP should run to the left of Democrats on financial issues in 2016 by positioning Democrats as the party of crony capitalism. Exhibit A is Fannie Mae. Exhibit B is Freddie Mac. Both were in bed with Democratic Party, and the Bush Administration—though not blameless on housing policy–repeatedly tried to strengthen regulation of F&F but could not get legislation past Democrats in Congress. The 2016 GOP standard bearer should promise to shut down Fannie and Freddie. This will put Hillary or Elizabeth or whoever on the defensive, while putting the GOP on the side of working class and middle class voters who were screwed by the Democratic crony capitalists as well as, eventually, by Wall Street.
Two excellent books analyze F&F’s role in the financial crisis from different angles: Reckless Endangerment by Gretchen Morgenson and Joshua Rosner, and Hidden in Plain Sight, by Peter Wallinson. Morgenson, a New York Times investigative reporter, is no friend of Wall Street; Wallinson was a lonely Republican on the FCIC, the Committee that supposedly analyzed the causes of the financial crisis and blamed it on loose regulation of Wall Street while arguing, absurdly, that F&F did not play a “primary” role in the crisis.
The housing bubble was based on a false premise embraced by Democratic activists and politicians: Even though they had every incentive to make as many good loans as possible, banks were systematically refusing to make mortgage loans to qualified low-income and minority individuals. A study by Alicia Mundell of The Boston Fed claimed to document this discrimination. It was later debunked by the simple fact that mortgage default rates were the same in black and white neighborhoods; if lending standards were tougher for blacks than white, default rates should have been lower in black neighborhoods; in fact they were the same.
For several decades housing finance was a safe and sane business where banks and S&L’s made loans to people who had documented income, a 20% down payment, and a good credit history. This was all blown up by a law passed in the early 1990s that enabled HUD (Department of Housing & Urban Development) to set the level of “Non-traditional mortgages” to minorities and in “under-served areas” that Fannie and Freddie had to purchase from banks. This level was ratcheted up over time, particularly by Andrew Cuomo who became head of HUD in 1997. So Democrats were constantly pressuring the central players in housing finance to lower underwriting standards by purchasing ever more sub-prime mortgages that later would be called “predatory loans.” Rep. Maxine Waters advocated for no-down-payment loans. To meet its ever-rising quotas, Fannie had a special arrangement to buy loans from Countrywide Financial, the biggest sub-prime lender, charging the firm a discounted fee for insuring its mortgages.
One of Wallison’s prime contentions is that Fannie had many more subprime mortgages on its balance sheet than it admitted. This has been disputed by pundits like Paul Krugman and Joe Nocera. There’s just one little problem with their position: if Fannie and Freddie did not have many sub-prime loans, why did they both go bankrupt in the autumn of 2008?
Barnie Frank’s “Great Mistake”
What is incredible is that the Democratic policy mandarins and “community activists” never considered the financial risks they were encouraging low-income borrowers to take. Owning a home is a big financial responsibility involving not just paying the mortgage but real estate taxes, maintenance, utilities, and occasionally major repairs. As none other than Barnie Frank, Fannie’s biggest defender in the House of Representatives, later said, “I hope by next year we’ll have abolished Fannie and Freddie. . . . It was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.”
F&F competed with Wall Street firms to acquire mortgage loans from lenders to package into mortgage-backed securities. Morgenson and Roser do a superb job of showing how Fannie used liberal ideology, financial clout and political in-fighting to maintain its franchise as a public / private firm that, because of its implicit Federal backing, had a lower cost of funds than private firms. Fannie’s CEO in the 1990s was Johnson, a Democratic operative. As Ralph Nader said, “It’s all a matter of know who, not know-how. They’ve perfected all the techniques of lobbying and pay massive salaries for Rolodex hiring to ensure against any change.” Democratic “big thinkers” like Peter Orszag and Larry Summers supported F&F, as did liberal think tanks like the Urban Institute.
Regulatory Failure at All Levels
Much has been said about the end of Glass Steagall in the late 1990s and the sweetheart relationship between a clueless Greenspan/Bernanke Fed, Clinton’s Treasury Department headed by Bob Rubin and big Wall Street firms, particularly Citigroup (which would soon hire Rubin, paying him much to do little).
Fair enough, but in different ways both books show that this really was not crux of the problem. Regulators were clueless throughout the Federal Government. Wallison notes that four major banks—IndyMac, Wachovia, Washington Mutual, and Citigroup—were subject to traditional regulation but still went belly-up or, in Citi’s case, had to be rescued more than once.. The same was true of smaller mortgage lenders like Fremont Investment; very late in the game (the spring of 2007) Fremont was hit by the FDIC with a cease and desist order because of its many shortcomings. As Morgenson and Rosner note, “The laundry list of ills was so voluminous that it suggested that Fremont’s bank examiners had, like Rip Van Winkle, been asleep for years.”
Another incredible regulatory failure was that, just a few years after Enron used off-balance-sheet items to mislead investors, regulators allowed firms like Citi to have enormous off-balance-sheet businesses, variously called SIVs (Special Investment Vehicles) or Asset-backed commercial paper conduits (ABCP’s) that basically enabled firms to borrow short by selling commercial paper to Money Market Funds and lend long by buying mortgage backed securities. Wall Street analysts knew nothing about this business because it was not on the balance sheets released each quarter. Still another regulatory failure, redolent of the SEC’s non-regulation of Bernie Madoff, is the hedge fund manager who repeatedly – for several years – warned the SEC about the risky operations of NovaStar, yet the SEC did nothing. As the hedgie explained, “Amy was a very nice person. But she didn’t know shit about subprime mortgages. We used to have conference calls with her on the gain-on-sale accounting, the crappy loan originations, how NovaStar was playing games with the branches. . . .Meanwhile, this things starts out crazy and goes to outrageous.”
The point here is not that the big Wall Street firms were blameless—far from it. The point is that A) Fannie and Freddie. and their enablers in the Democratic Party, were at the center of a 15-year process of lower lending standards and blowing a huge housing bubble that eventually popped and B) The central problem was not a lack of regulation—there was plenty of regulation, but the regulators were clueless and complicit in many parts of the Federal Government.
So, the GOP should insist on killing Fannie and Freddie to prevent a repeat of this housing disaster, a disaster that was particularly bad for the low-income people Democrats claim to help. To help low-income people amass the funds for a downpayment of 20%, everyone should be allowed to have a 401K plan.
Copyright Thomas Doerflinger 2015. All Rights Reserved.