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September 24, 2008
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.
CONT-
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 roadblock 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.
Posted by Post Scripts at September 24, 2008 4:09 PM
Comments
From an interview with James Galbraith in Harpers:
"2. What are the political origins of the crisis?
"There’s a Republican talking point going around that lays the blame on Fannie Mae and Freddie Mac, and hence the Democrats. There were big problems in the way Fannie and Freddie were run, but they were very small players in the subprime market. And Fannie and Freddy had standards. They checked on borrowers’ credit and they weren’t giving out subprime, low-doc, or no-doc inflated appraisal loans. The overwhelming responsibility for the crisis is the failure to regulate financial markets, and that is a failure of the Bush Administration. They sent very clear signals that they were in favor of deregulating the industry. All of three weeks ago, Mitt Romney said at the Republican convention that we should take a weed whacker to regulation. Two weeks ago, Governor Palin told Charles Gibson of ABC that her philosophy of economic policy was to “get government out of our hair.” A few months ago, ancient history by now, McCain said, “I’m a deregulator.” That’s been a consistent Republican theme.
"5. The Democrats say they are not going to give the administration a blank check, but there’s a lot of pressure to do something. What sort of conditions should be attached to a bailout?
"The Democrats have a strong hand. The voters weren’t born yesterday; they understand that it’s a Republican administration in power. Some of the problems are difficult to solve. Executive compensation is clearly a legitimate concern; it’s incredible that Lehman Brothers set aside a $2.5 billion bonus pool as it was going into bankruptcy. On the other hand, what do you do about it? If you tell these people they have to work for $400,000 a year–that’s a lot of money to you and me, but a lot of them are going to say, “See you on the ski slopes, pal.” But what Congress can do is make sure the companies have to turn over any information that the Treasury wants from the companies, including the computer code. If the government is going to buy assets of dubious value, it needs to know that the companies aren’t selling it the worst of the worst, just as you have the right to inspect a used car before buying it."
$2.5 BILLION ! Geez. These boys got balls or what?
Posted by: Libby | September 24, 2008 4:33 PM
They almost believe you, Herr Goebbels.
Could you please repeat that--a thousand times?
Posted by: Quentin--The Uncomfortable Truth | September 24, 2008 6:14 PM
Go ahead and try to pass the buck. Ignore the many posts that demonstrate democrat culpability. It won't work...too many of us can find evidence.
"And Fannie and Freddy had standards."
They had standards alright...lots of bundling and cooked books to inflate the bottom line so Raines could cut himself a big fat check.
"The overwhelming responsibility for the crisis is the failure to regulate financial markets,"
The overwhelming evidence is that the regulation was compromised by Mr. Clinton using the law Carter put in place...and pressure was put on banks to loan to people that had no business getting the loans. The pressure is a clear abuse of power.
"that is a failure of the Bush Administration"
Sorry presidents don't write laws...it is a failure of Congress that 1. saw democrats block a republican proposal that would have fixed this problem before it imploded and 2. ignored 17 warnings by President Bush and his administration.
Romney:"we should take a weed whacker to regulation"
We SHOULD take a weed whacker to the regulation that allowed this to happen...regulation that set the standard for lending was sponsored and protected by Democrats!
"voters weren’t born yesterday"
No but they have been lied to, repeatedly. Mr. Galbraith said absolutrely nothing substantial in his invective against Bush and the Republicans as I have demonstrated. He used lots of words but offered no proof, not a single morsal.
"Executive compensation is clearly a legitimate concern"
Especially executive compensation from cooked books!
The truth is executive compensation has absolutely NOTHING to do with this problem. It is a seperate issue.
Reading what is said isn't enough...we also must comprehend to determine what has been said. Galbraith had absolutely zero to say.
From the original post: "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."
That offers information to prove the point. It's interesting to note that Obama was second in compensation but took second place in only a couple of years...he should be on top.
For all of the Liberals screaming about lobbyists and making loads of money this should be a wake up call. Your team is chock full of players in the lobby game, the investment game, and the corporate game and they work through politics to make it.
Making a bunch of honest bucks is fine by me no matter how big the pile...but making bucks like this, through fraud, power politics, and lousy regulatuion is really slimey.
Posted by: Tina | September 24, 2008 9:06 PM
"No but they have been lied to, repeatedly. Mr. Galbraith said absolutrely nothing substantial in his invective ..."
I'm sure all the quotes can be verified. And the $2.5 billion. The eight years ... they are also incontrovertable.
And you know, if all those Countrywide loans had been fixed rather than adjustable ... all those millions would still be in their houses and we would not be where we are. Greed, honey. Greed. The hallmark of this Administration.
You can deny it til Hell freezes ... ain't nobody listening.
Posted by: Anonymous | September 24, 2008 11:04 PM
Anonymous wrote, "I'm sure all the quotes can be verified."
Quotes about nothing are meaningless.
"And the $2.5 billion"
That I don't know enough to comment on beyond this. The government has played a part in many of the business failutes we have seen. they change rules in the middle of the stream and they have in this case, as we've seen, used power to pressure practices that were very risky and dangerous. I can't blame people for attempting to protect themselves from the fallout...it ALL leads back to bad actors in government. Having said that if it caan be shown that these guys did something illegal they should also fry.
"The eight years"
Eight years of the president and republicans warningthis was coming and Democrats like Barney Frank and Chris Dodd and Barack Obama blocking and pecause they were poo pooing oversight because they were benefitting with sweetheart loans for themselves through Country Wide and lobbying cash...and of course those fat bonuses from the cooked books. Eight years of DEMOCRATRS behaving selfishly, greedily, and with absolutely terrible ethical "oversight".
Greed and unethical behavior is the hallmark of the Democrats.
You can deny that till he** freezes...THE FACTS speak to anyone of any party that has the courage and integrity to see and aknowledge it.
Posted by: Tina | September 25, 2008 9:02 AM