How The Meltdown Started

Barney Frank is probably the last guy who should be out there talking about how Republicans (and deregulation) caused the current fiscal crisis.  The guy is flat-out lying through his teeth.  This whole mess wasn’t started by Republicans at all.  It was started by Democrats.  And Democrats guaranteed the failure of both Fannie Mae and Freddie Mac.

And make no mistake, that’s where all of this started in the first place: Fannie Mae and Freddie Mac.

For those of you not intimately aware of what Fannie Mae and Freddie Mac are, let me explain them to you.  They are known was Government Sponsored Enterprises (aka: GSE), which means that they are pseudo-government programs that act under the veil of private enterprise.  And you’ll hear Democrat sycophants tell about how these were “free market entities” that failed.  This too is a lie, and I’ll follow up more with that in a bit.

Fannie Mae was once a government program – created in 1938 during the reign of America’s first socialist president, FDR – used to buy-up loans to provide some liquidity to the free market.  It was transformed into a GSE in 1968 by Lyndon Johnson so as to remove the entity from the country’s budget.  Freddie Mac soon followed – two years later – so as to prevent Fannie Mae from being a monopoly.

Can you see the odd logic involved here already?  Two GSEs, neither of which were spawned by the free market, popping up so as to provide “competition”?  However, I digress…

Now the notion is that Freddie Mac and Fannie Mae are private sector institutions – but this is blatantly false.  A 1995 Congressional Budget Office report (CBO) pulled the covers off the two institutions, and showed them not only receiving “indirect” subsidies, but also having an “implicit guarantee” that the federal government would bail them out if they got in over their heads:

Those assumptions permit the funding subsidy on debt issues to be developed from the estimates for the 1991-1994 period, in which savings were 105 basis points on callable debt and 46 basis points on noncallable debt. For all debt funding, the weighted-average savings were about 70 basis points (see Table 6 for the calculated subsidy values for debt securities for both Fannie Mae and Freddie Mac).  Duringthe 1991-1995 period, that component of the taxpayer subsidy to the housing GSEs rose from $0.9 billion to $2.6 billion per year.

For mortgage-backed securities, the cost savings from GSE status is 40 basis points based on a variety of estimates that place the yield on MBSs issued by GSEs at 25 to 60 basis points lower than the yield on the highest-rated fully private issues.  That estimate is approximate because of differences in structure between private MBSs and those issued by GSEs. For example, the two types of securities differ in the method of allocating credit risk between issuer and investor. In addition, as is also true for the debt subsidy rate, those spreads change with market conditions and–more recently–with the growing acceptance of private MBSs.

The estimated value of GSE status for cost savings on mortgage-backed securities is $3.8 billion in 1995, a $1.2 billion increase from 1991. Total cost savings on debt and MBSs combined from the GSE status now totals $6.5 billion per year.

The government’s free grant of credit enhancement is one way of thinking about the meaning and value of the status of government-sponsored enterprise (GSE) to Fannie Mae and Freddie Mac. Under that approach, the implicit federal guarantee is treated as an asset that is not recognized on the books of the housing GSEs. The gift of that asset to the enterprises raises the total stock of their assets and increases their equity–or the difference between the value of their assets and liabilities. However, free credit enhancement and an equal addition to equity is only one of several ways of specifying the relationship between the government and the GSEs.

You see, the federal government was injecting taxpayer money into these two institutions to subsidize low interest rates on specific mortgages.  Something they won’t do with free market entities.  That “implicit guarantee” is now an “explicit guarantee” as the federal government is bailing out these institutions…as the free market companies predicted.

So the notion that this is a free market meltdown is a complete myth.  But wait, there’s more. 

Providing low-cost loans wasn’t good enough for the government (read: Democrats).  No, they had to expand this program.  The first expansion was under Jimmy Carter.

The next expansion of low-income loans came during the Clinton Administration, as evidenced by a 1999 New York Times Article:

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets — including the New York metropolitan region — will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates — anywhere from three to four percentage points higher than conventional loans.

Yes, pressured by the CLINTON Administration, Fannie Mae started opening up the subprime spigot.  What’s more is that the current mess was predicted back then by the American Enterprise Institute:

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.

“From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. “If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

And who was in charge of Fannie Mae at that time?

“Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements,” said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer. “Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”

You may remember who Franklin D. Raines is: an adviser to the Barack Obama Campaign.  He was also in the Carter Administration as Associate Director for Economics and Government in the Office of Management and Budget, and Assistant Director of the White House Domestic Policy Staff.  Under the Clinton Administration he was Director of the U.S. Office of Management and Budget.  He’s Democrat through and through.

It was under Raines’ control that Fannie Mae started falling apart.  Financial mismanagement led to his retirement in 2004, after which the OFHEO (Office of Federal Housing Enterprise Oversight) – Fannie Mae’s and Freddie Mac’s “special” oversight institution – went after him for the all the money he made during that time.  You see, the management of Fannie Mae was trying to hide all of their losses and debts (ala Enron) so as to show high earnings.  This then lead to nice, fat bonus checks for the Fannie Mae management (who also included many notable Democrats such as Jamie Gorelick, who was also a Clinton appointee).

By the way, this is another area where the two GSEs have an advantage over their free market cousins: they are exempt from SEC licensing and regulation.

But as for Barney Frank’s accusation that it was lax regulatory oversight of Fannie Mae and Freddie Mac, that’s a lie as well.  In fact, as early as 2003, regulators released a report about Freddie Mac that pointed out the abuses of the GSE:

Federal regulators released a scathing report Wednesday on the corporate culture that fostered improper accounting at Freddie Mac, the same day that they announced that the company had agreed to pay a $125 million penalty and to take measures to prevent future misconduct.

The settlement and the report may help Freddie Mac, the nation’s second-largest buyer of home mortgages behind its corporate sibling, Fannie Mae, to recover from an accounting scandal that surfaced early this year. But some of the report’s recommendations suggest that regulators may impose new restrictions on the company. They also suggest that regulators will now shift their focus to the Wall Street firms that engaged in certain transactions with the company and to accounting at Fannie Mae.

The report by the Office of Federal Housing Enterprise Oversight does not shed much new light on the transactions at the center of the improper accounting, which sought to smooth out earnings volatility, but it is much harsher than previous reports in its assessment of Freddie Mac’s executives and board members.

“Freddie Mac cast aside accounting rules, internal controls, disclosure standards, and the public trust in the pursuit of steady earnings growth,” the report states.

In addition, it says, “senior management and the board failed to establish and maintain adequate internal control systems.”

So, it isn’t Republicans and their “deregulation” at all.  It was  the willingness of Democrats to ignore the reports of the regulators.

“Democrats?” you may ask.  “Republicans were in control of Congress during 2003, not Democrats!  They are the ones to blame!”  Not so.

The fact was, the Bush administration, in 2003, tried to get a bill through Congress that would have stemmed the bleeding, so to speak.  The New York Times reported on this bill, back in September 2003:

The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry.

The new agency would have the authority, which now rests with Congress, to set one of the two capital-reserve requirements for the companies. It would exercise authority over any new lines of business. And it would determine whether the two are adequately managing the risks of their ballooning portfolios.

The plan is an acknowledgment by the administration that oversight of Fannie Mae and Freddie Mac — which together have issued more than $1.5 trillion in outstanding debt — is broken. A report by outside investigators in July concluded that Freddie Mac manipulated its accounting to mislead investors, and critics have said Fannie Mae does not adequately hedge against rising interest rates.

”There is a general recognition that the supervisory system for housing-related government-sponsored enterprises neither has the tools, nor the stature, to deal effectively with the current size, complexity and importance of these enterprises,” Treasury Secretary John W. Snow told the House Financial Services Committee in an appearance with Housing Secretary Mel Martinez, who also backed the plan.

Mr. Snow said that Congress should eliminate the power of the president to appoint directors to the companies, a sign that the administration is less concerned about the perks of patronage than it is about the potential political problems associated with any new difficulties arising at the companies.

The administration’s proposal, which was endorsed in large part today by Fannie Mae and Freddie Mac, would not repeal the significant government subsidies granted to the two companies. And it does not alter the implicit guarantee that Washington will bail the companies out if they run into financial difficulty; that perception enables them to issue debt at significantly lower rates than their competitors. Nor would it remove the companies’ exemptions from taxes and antifraud provisions of federal securities laws.

The proposal is the opening act in one of the biggest and most significant lobbying battles of the Congressional session.

After the hearing, Representative Michael G. Oxley, chairman of the Financial Services Committee, and Senator Richard Shelby, chairman of the Senate Banking Committee, announced their intention to draft legislation based on the administration’s proposal. Industry executives said Congress could complete action on legislation before leaving for recess in the fall.

”The current regulator does not have the tools, or the mandate, to adequately regulate these enterprises,” Mr. Oxley said at the hearing. ”We have seen in recent months that mismanagement and questionable accounting practices went largely unnoticed by the Office of Federal Housing Enterprise Oversight,” the independent agency that now regulates the companies.

And what did Barney Frank say at the time?

”These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,” said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ”The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.”

The bill, however was doomed to failure.  The article in question even hints at this:

Significant details must still be worked out before Congress can approve a bill. Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing.

The bill went down in flames.  Not on a straight up-and-down vote in Congress, but in committee.  You see, the Senate rules were changed by the Democrats during the Clinton Administration, requiring a two-thirds majority to get the bill out of committee.  This is how Democrats were able to “filibuster” Bush’s judicial nominees.  Since the Republicans did not have an overwhelming majority in either the House or the Senate, a Democrat party-line vote was enough to kill the measure (and another one floated in 2005) before it reached the floor.

Even the Washington Post – another liberal rag – has started to sniff out the real culprits here.  In a September 2008 article, they lay down the case that Democrats are up to their necks in dirt:

Taxpayers face a tab of as much as $200 billion for a government takeover of Fannie Mae and Freddie Mac, the formerly semi-autonomous mortgage finance clearinghouses. And Sen. Christopher Dodd, the Democratic chairman of the Senate Banking Committee, has the gall to ask in a Bloomberg Television interview: “I have a lot of questions about where was the administration over the last eight years.”

We will save the senator some trouble. Here is what we saw firsthand at the White House from late 2002 through 2007: Starting in 2002, White House and Treasury Department economic policy staffers, with support from then-Chief of Staff Andy Card, began to press for meaningful reforms of Fannie, Freddie and other government-sponsored enterprises (GSEs).

The crux of their concern was this: Investors believed that the GSEs were government-backed, so shouldn’t the GSEs also be subject to meaningful government supervision?

This was not the first time a White House had tried to confront this issue. During the Clinton years, Treasury Secretary Larry Summers and Treasury official Gary Gensler both spoke out on the issue of Fannie and Freddie’s investment portfolios, which had already begun to resemble hedge funds with risky holdings. Nor were others silent: As chairman of the Federal Reserve, Alan Greenspan regularly warned about the risks posed by Fannie and Freddie’s holdings.

President Bush was receptive to reform. He withheld nominees for Fannie and Freddie’s boards — a presidential privilege. While it would have been valuable politically to use such positions to reward supporters, the president put good policy above good politics.

In subsequent years, officials at Treasury and the Council of Economic Advisers (especially Chairmen Greg Mankiw and Harvey Rosen) pressed for the following: Requiring Fannie and Freddie to submit to regulations of the Securities and Exchange Commission; to adopt financial accounting standards; to follow bank standards for capital requirements; to shrink their portfolios of assets from risky levels; and empowering regulators such as the Office of Federal Housing Oversight to monitor the firms.

The administration did not accept half-measures. In 2005, Republican Mike Oxley, then chairman of the House Financial Services Committee, brought up a reform bill (H.R. 1461), and Fannie and Freddie’s lobbyists set out to weaken it. The bill was rendered so toothless that Card called Oxley the night before markup and promised to oppose it. Oxley pulled the bill instead.

During this period, Sen. Richard Shelby led a small group of legislators favoring reform, including fellow Republican Sens. John Sununu, Chuck Hagel and Elizabeth Dole. Meanwhile, Dodd — who along with Democratic Sens. John Kerry, Barack Obama and Hillary Clinton were the top four recipients of Fannie and Freddie campaign contributions from 1988 to 2008 — actively opposed such measures and further weakened existing regulation.

The president’s budget proposals reflected the nature of the challenge. Note the following passage from the 2005 budget: Fannie, Freddie and other GSEs “are highly leveraged, holding much less capital in relation to their assets than similarly sized financial institutions. . . . A misjudgment or unexpected economic event could quickly deplete this capital, potentially making it difficult for a GSE to meet its debt obligations. Given the very large size of each enterprise, even a small mistake by a GSE could have consequences throughout the economy.”

That passage was published in February 2004. Dodd can find it on Page 82 of the budget’s Analytical Perspectives.

The administration not only identified the problem, it also recommended a solution. In June 2004, then-Deputy Treasury Secretary Samuel Bodman said: “We do not have a world-class system of supervision of the housing government-sponsored enterprises (GSEs), even though the importance of the housing financial system that the GSEs serve demands the best in supervision.”

Bush got involved in the effort personally, speaking out for the cause of reform: “Congress needs to pass legislation strengthening the independent regulator of government-sponsored enterprises like Freddie Mac and Fannie Mae, so we can keep them focused on the mission to expand home ownership,” he said in December. He even mentioned GSE reform in this year’s State of the Union address.

How did Fannie and Freddie counter such efforts? They flooded Washington with lobbying dollars, doled out tens of thousands in political contributions and put offices in key congressional districts. Not surprisingly, these efforts worked. Leaders in Congress did not just balk at proposals to rein in Fannie and Freddie. They mocked the proposals as unserious and unnecessary.

Rep. Barney Frank (D-Mass.) said the following on Sept. 11, 2003: “We see entities that are fundamentally sound financially. . . . And even if there were a problem, the federal government doesn’t bail them out.”

Sen. Thomas Carper (D-Del.), later that year: “If it ain’t broke, don’t fix it.”

As recently as last summer, when housing prices had clearly peaked and the mortgage market had started to seize up, Dodd called on Bush to “immediately reconsider his ill-advised” reform proposals. Frank, now chairman of the House Financial Services Committee, said that the president’s suggestion for a strong, independent regulator of Fannie and Freddie was “inane.”

Sen. Dodd wonders what the Bush administration did to address the risks of Fannie and Freddie. Now, he knows. The real question is: Where was he?

What happened to Freddie Mac and Fannie Mae started a domino effect.  AIG put out insurance on those loans should they go into default, which a fair number of them did.  Thus, AIG tanked.  In fact, most of the companies involved with these subprime loans started to fall apart.  Things were rosy when property values were riding high on the Housing Bubble, because if the people who too out the loans defaulted, the lender could usually break-even (at the minimum) or make a profit (optimal) by selling off the property.  When housing prices declined (which happens in a free market), these entities started taking on huge losses.

What goes up, sometimes comes down.  That’s how things work in a free market.  Maybe someone should inform Barney Frank of this…well…when he’s not scheming of a way to blame his blatant stupidity on Republicans.

Mind you, all of this liberal “blame Republican” claptrap is coming from a guy who had “no idea” his male lover was running a prostitution ring out of his apartment.

So what’s the Democrat soultion to this problem?  Shoveling money to their left-wing advocacy groups:

The housing bill signed Wednesday by President George W. Bush will provide a stream of billions of dollars for distressed homeowners and communities and the nonprofit groups that serve them.

One of the biggest likely beneficiaries, despite Republican objections: Acorn, a housing advocacy group that also helps lead ambitious voter-registration efforts benefiting Democrats.

Acorn — made up of several legally distinct groups under that name — has become an important player in the Democrats’ effort to win the White House. Its voter mobilization arm is co-managing a $15.9 million campaign with the group Project Vote to register 1.2 million low-income Hispanics and African-Americans, who are among those most likely to vote Democratic. Technically nonpartisan, the effort is one of the largest such voter-registration drives on record.

The organization’s main advocacy group lobbied hard for passage of the housing bill, which provides nearly $5 billion for affordable housing, financial counseling and mortgage restructuring for people and neighborhoods affected by the housing meltdown. A third Acorn arm, its housing corporation, does a large share of that work on the ground.

Acorn’s multiple roles show how two fronts of activism — housing for the poor and voter mobilization — have converged closely in this election year. The fortunes of both parties will hinge in part on their plans for addressing the fall of the nation’s housing market and the painful economic slowdown. Some of the places buffeted worst by mounting foreclosures are states whose voters could swing the election. Five battleground states where Acorn has registration drives were among the top 10 states for foreclosure rates as of June: Colorado, Florida, Nevada, Michigan and Ohio.

Partly because of the role of Acorn and other housing advocacy groups, the White House and its allies in Congress resisted Democrats’ plans to include money for a new affordable-housing trust fund and $4 billion in grants to restore housing in devastated neighborhoods. In the end, the money stayed in the bill; the White House saw little choice.

What most riles Republicans about the bill is the symbiotic relationship between the Democratic Party and the housing advocacy groups, of which Acorn is among the biggest. Groups such as the National Council of La Raza and the National Urban League also lobby to secure government-funded services for their members and seek to move them to the voting booth. Acorn has been singled out for criticism because of its reach, its endorsements of Democrats, and past flaws in its bookkeeping and voter-registration efforts that its detractors in Congress have seized upon.

Yes.  We need more government intervention into the free market.  We need the Democrats to “handle” the economy.  It’s served us so well up to now.


3 Responses to How The Meltdown Started

  1. ihatedemocrats says:

    a long read (it took most of my lunch) but definately well written and well said!

  2. ihatedemocrats says:

    when i say ihatedemocrats, that is not just politicians but particularly the media. it drove me crazy last night listening to the democrats blaming the republicans (ireallyhatenancypelosi) and the media spouting along with them. i hope and pray that the most-powerful people in the world does NOT become: 1. Barack Obama, 2. Joe Biden, 3. Nancy Pelosi.

    i don’t know what happens by doing nothing (but i don’t fear it) , … but i am philosophically opposed to government intervention/ socialism (that i fear!). i actually kinda cheered (to myself, my coworkers would think me weird) when the House failed to approve the bail out. i’m sure some form of bail out will come forth in the next few days but the democrats should be shown for who they really are.

  3. unknownconservative says:

    Thank you for your compliment.

    If you liked this, you’ll LOVE my latest post on how the FDIC basically brought down private lending institutions with the Community Resource Act.

    The CRA was the justification that Fannie Mae and Freddie Mac used to float all of the bad debt that eventually sank the two entities. Well…bad debt and fiscal mismanagement by liberal social engineers…

    You get the picture.

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