Back to the Roots of the Problem (cross-posted at The Confluence)Posted: September 27, 2008 Filed under: U.S. Economy | Tags: bail out, Fannie Mae, FNMA, Freddie Mac, Subprime mortgages 8 Comments
I feel a strong need to remind people at this time of the roots of this financial crisis. They are not found beneath Wall Street, but in Washington, D.C. with Freddie Mac and Fannie Mae and the senators and congressman that empowered them.
The beginning of this crisis was the subprime mortgage market and the loose underwriting standards encouraged by FNMA and FHMLC on mortgage loans. Fannie (FNMA) and Freddie (FHLMC) are involved with about half of the mortgage loan originations in that market. Loose standards were set up to expand home ownership to folks who couldn’t pay home loans back and to improve the odds of high compensation for its CEOs. Before any bail-out, rescue, or whatever you want to call it, regulation has to be put in place to STOP this from happening again. It’s really a nice social goal to increase the level of minority ownership in the country and to move the poor into homes of their own, but you can’t force it by giving folks loans they are not prepared to handle. The House and Senate Democrats, and specifically the Black Caucus, are squarely behind this problem. It is folks like Chris Dodd and Barack Obama–folks expected to clean up this mess–that were the beneficiaries of Fannie and Freddie largess that created very poor public policy and lack of regulation that led to this problem.
Wall Street did buy up these loans up after they were “packaged” into securities by Freddie and Fannie. Freddie and Fannie bonds have been assumed to be nearly as safe as Treasury bonds so no one figured there were these toxic loans stuck into the mix. Banks are also allowed to invest in Fannie and Freddie bonds. They can’t invest in really risky assets like equities. Who would have thought that Fannie and Freddie would be so poorly run that what they were investing in, what they were originating and selling to Fannie and Freddie, and what was being put together by Fannie and Freddie, would be so risky as to send their capital into regulator panicking levels? Ask Jim Johnson. Ask Franklin Reines. Ask Barack Obama and the Black Caucus. They felt prudent underwriting was basically discriminatory and worked hard to change banks into speculators.
Here’s some examples:
Credit History: Lack of credit history should not be seen as a negative factor…. In reviewing past credit problems, lenders should be willing to consider extenuating circumstances. For lower–income applicants in particular, unforeseen expenses can have a disproportionate effect on an otherwise positive credit record. In these instances, paying off past bad debts or establishing a regular repayment schedule with creditors may demonstrate a willingness and ability to resolve debts….
If you’d like to know more about the loosening of standards, here’s a really good study to check out: http://johnrlott.tripod.com/Liebowitz_Housing.pdf
Recently, there were an entirely inexcusable number of underwriting lapses allowed and in fact, encouraged by Fannie and Freddie (including spurious sources of income and no down payments) that increased the demand for housing by allowing people that should not have been in the housing market, into the housing market. This drove up prices and led to the bubble and increasing speculation. Once it became apparent, that there was increasing risk popping up in mortgages, the financial innovations of derivatives (Wall Street enters now) popped up to help banks manage the risk and pass them on to folk supposedly more able handle the risk. These things were supposed to act as insurance and were valued based on the idea that traditional Fannie and Freddie were very risk-free and there was implied government oversight, regulation, and back-up.
It is no wonder that the FBI is now looking at Fannie and Freddie. It should also look at the democratic appointees and the senators and congressman that enabled them. When credible economist like Greg Mankiw came to the senate and congressional committees to warn of this problem in 2003, folks like Barney Frank yelled at him for worrying more about safety and soundness rather than housing for the little guy. The Wall Street Journal was all over this back then.
This is the same Barney Frank that is bloviating and stomping his foot about the inability of House Republicans to get with his program. Well, Congressman, it was your program that put us in this position to begin with so why would we trust you now?
House and Senate Democrats also had a chance in 2005 to increase oversight and regulation of Fannie and Freddie. John McCain was a co-sponsor of this bill called Federal Housing Enterprise Regulatory Reform Act of 2005. At the time McMcain made this comment that seems almost psychic now.
“If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.”
You know how Senator Obama is going around saying the Bush administration is the one that hates regulation and led to this? As a professional economist and Puma, may I just say this: liar, liar pants on fire!
WASHINGTON – Treasury Secretary John Snow urged Congress to restrain Fannie Mae and Freddie Mac, giving the Bush administration’s blessing to efforts to create a new regulator with broad power over the huge mortgage companies.
If you read the article, you’ll see that Allan Greenspan was also in front of congress and the senate begging for more oversight.
More from that article:
“The statements by Greenspan and Snow lent support to a new effort by Republican lawmakers to tighten controls on Fannie Mae and Freddie Mac, which hold or guarantee more than 45 percent of all mortgage loans in the country. Legislation recently proposed would set up a regulatory agency with the power to compel the companies to sell off any assets deemed not to be in line with their mission of making homeownership more widely available.
Notice the guarantee point. Wall Street and Banks rely on these instruments to be low risk basically because of that guarantee. This includes AIG and all the investment banks that just crashed. They undervalued the risk on these instruments because of the implicit guarantee.
My point here? Congressional republicans (who I usually find a source of great evil) are NOT the bad guys here for once. They tried but were told they were racist and that they hated poor people if they didn’t go along with the plan of extending house loans to people that basically could not afford them. Most of the blame for this financial crisis belongs squarely in Washington and the Democrats are relying on our extremely short memories. Since all of this comes under my teaching and research responsibilities, I cannot have a short memory. The MSM should start asking Biden, Obama, Frank, and Dodd some very tough questions. First Questions? Why didn’t you support regulating Fannie and Freddie back before all of this snowballed into a financial crisis? Why are you now saying that you always supported more oversight and regulation and Republicans and the Bush Administration did not when the record clearly shows it was the opposite?
I’d like to suggest one of the first CEOs to turn back his salary and face the FBI is Franklin Raines.
He turned Fannie Mae into a mortgage factory to get higher bonuses and was investigated for cooking the books. He is undoubtedly one of the folks that has interested the FBI. Another person is Jim Johnson. (You’ll recognize these names because they are both Obama friends and advisors).
In late 2004, Fannie Mae was under investigation for its accounting practices. The Office of Federal Housing Enterprise Oversight released a report on September 20, 2004, alleging widespread accounting errors, including shifting of losses so Raines and others could earn bonuses.
In June 2008, the Wall Street Journal reported that two former CEOs of Fannie Mae, James A. Johnson (1991-1998) and Franklin Raines (1999-2004) had received loans below market rate from Countrywide Financial. Fannie Mae was the biggest buyer of Countrywide’s mortgages. Don’t forget the three biggest recipient of FNMA money are Dodd, Kerry, and Obama. Dodd also appears to have a sweetheart mortgage deal. The Democrats are not the white knights in this mess. They would probably like to get this deal through as quickly as possible so voters do not find out that the bailout is not just a Wall Street Mess. It is a K Street and Washington-created mess. There is plenty of blame and greed to go around.
The very same people that created this mess are the ones writing the terms of the bail-out. Be afraid! Be very afraid! I never put a steak on the kitchen counter and leave the dog alone in the room with it. I would not leave the U.S. economy in the hands of these folks who are deciding the fineprint in a room with closed doors either.
Nice writing. You are on my RSS reader now so I can read more from you down the road.
So then, how do you address the issue of redlining?
EA: Let me first disclose that I used to work for banks and savings and loans back in the 1980s and that during the 90s I worked for the Federal Reseve Bank so I know both lending practices and regulatory practices.
To eliminate redlining, you need a regulator to go through loan applications in areas that have historical low approval rates and look for lows rejected based on something other than the ability of the recipient to pay the loan back. I live in the ninth ward for example and I got a Freddie Mac Loan … while at the time, my Bywater house was in a borderline neighborhood but I had perfect credit and a job. I had no trouble getting my loan approved. Fortunately, Bywater is a good example of urban renewal and I know have tons of equity in my house because it’s now revitalized. If i had been rejected, that loan would be an example of redlined. Banks actually try to avoid doing that now because of laws and have since the 70s.
What we have problems with now is that banks don’t put up branches in inner cities and pay day lenders have moved in to replace them … that is the major problem right now for the poor. They can’t get to checking accounts, etc. They’re forced into pay day lenders and check cashers.
Has there been any action (that has passed) on the federal level with respect to pay-day lenders? I know in New Mexico that has been an issue addressed at the state level.
In all of this there has to be an element of personal responsibility as well. I think something was lost in the 1980s. I remember a Ronald Reagan interview in which he tells a story about how a man invented something and became a millionaire. That, therefore, made the U.S. of A., the greatestestest country in the world. And everyone could be a millionaire. (Paraphrasing and snarking at the same time, but the point is valid.) People tend to ignore the part about how in a world of finite resources, the more one person has, the less there is for everyone else.
The whole reason regulations came about in the first place is because we KNOW people will try to rip each other off. We KNOW people lie and cheat and steal. What ever happened to prioritizing purchases and being responsible with your money? They came smack dab up against an onslaught of, “You can have it now.”
Most of the pay day lender loans and sites have been addressed at the state level only. My Senator Mary Landrieu worked on a Federal Level to keep them away from military familes. I think other than that, it is a state by state thing. I did some research on these guys about 2 years ago to help with that process, but I’ve moved on to other things since then …
The real problem here is that we have no way to get real, honest, information out to the general electorate. What they get from the media is half-assed, at best, and lies, at worst. I can keep talking to everyone who will listen, and work this stuff into general conversation with those people who want to know what the truth is, but I don’t think I have enough time to do much good before it is game over Pelosi and Reid and Obama.
I have made it a point to learn the underside, and the backstory, so I am passingly comfortable putting McCain in office. He and his wife have enough money that he doesn’t need to feather his nest. He has never been the sweetheart of the Senate, so I am not worried about his head being turned by attention. Also, he did see some of these problems and tried to forstall them. With Obama, the programs are wrong to begin with, we can’t afford them even if they were right, and we have no real idea where his priorities are, because he will sell anyone out for a few points in the polls.
I have to think this is all about Obama for Obama. He is interested in having wealth, power, and lots of attention. That is a custom made recipe for disaster in the Presidency. I keep telling my friends…I won’t jump for joy if McCain gets in, but I will breathe a sigh of releif.
Well, for anyone who has any money to spare, I humbly ask, “Will you please contribute to the McKinney/Clemente campaign?”
“People tend to ignore the part about how in a world of finite resources, the more one person has, the less there is for everyone else.”
This is only true if all of the finite resources are already in use.
Wealth is routinely created seemingly out of thin air by hard work.
Read a book on economics to dispel this nonsense.