PETER J. WALLISON holds the Arthur F. Burns Chair in Financial Policy Studies at the American Enterprise Institute. Previously he practiced banking, corporate, and financial law at Gibson, Dunn & Crutcher in Washington, D.C., and in New York. He also served as White House Counsel in the Reagan Administration. A graduate of Harvard College, Mr. Wallison received his law degree from Harvard Law School and is a regular contributor to the Wall Street Journal, among many other publications. He is the editor, co-editor, author, or co-author of numerous books, including Ronald Reagan: The Power of Conviction and the Success of His Presidency and Bad History, Worse Policy: How a False Narrative about the Financial Crisis Led to the Dodd-Frank Act.
The following is adapted from a speech delivered at Hillsdale College on November 5, 2013, during a conference entitled “Dodd-Frank: A Law Like No Other,” co-sponsored by the Center for Constructive Alternatives and the Ludwig Von Mises Lecture Series.
The 2008 financial crisis was a major event, equivalent in its initial scope—if not its duration—to the Great Depression of the 1930s. At the time, many commentators said that we were witnessing a crisis of capitalism, proof that the free market system was inherently unstable. Government officials who participated in efforts to mitigate its effects claim that their actions prevented a complete meltdown of the world’s financial system, an idea that has found acceptance among academic and other observers, particularly the media. These views culminated in the enactment of the Dodd-Frank Act that is founded on the notion that the financial system is inherently unstable and must be controlled by government regulation.
We will never know, of course, what would have happened if these emergency actions had not been taken, but it is possible to gain an understanding of why they were considered necessary—that is, the causes of the crisis.
Why is it important at this point to examine the causes of the crisis? After all, it was five years ago, and Congress and financial regulators have acted, or are acting, to prevent a recurrence. Even if we can’t pinpoint the exact cause of the crisis, some will argue that the new regulations now being put in place under Dodd-Frank will make a repetition unlikely. Perhaps. But these new regulations have almost certainly slowed economic growth and the recovery from the post-crisis recession, and they will continue to do so in the future. If regulations this pervasive were really necessary to prevent a recurrence of the financial crisis, then we might be facing a legitimate trade-off in which we are obliged to sacrifice economic freedom and growth for the sake of financial stability. But if the crisis did not stem from a lack of regulation, we have needlessly restricted what most Americans want for themselves and their children.
It is not at all clear that what happened in 2008 was the result of insufficient regulation or an economic system that is inherently unstable. On the contrary, there is compelling evidence that the financial crisis was the result of the government’s own housing policies. These in turn, as we will see, were based on an idea—still popular on the political left—that underwriting standards in housing finance are discriminatory and unnecessary. In today’s vernacular, it’s called “opening the credit box.” These policies, as I will describe them, were what caused the insolvency of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, and ultimately the financial crisis. They are driven ideologically by the left, but the political muscle in Washington is supplied by what we should call the Government Mortgage Complex—the realtors, the homebuilders, and the banks—for whom freely available government-backed mortgage money is a source of great profit.
The Federal Housing Administration, or FHA, established in 1934, was authorized to insure mortgages up to 100 percent, but it required a 20 percent down payment and operated with very few delinquencies for 25 years. However, in the serious recession of 1957, Congress loosened these standards to stimulate the growth of housing, moving down payments to three percent between 1957 and 1961. Predictably, this resulted in a boom in FHA insured mortgages and a bust in the late ’60s. The pattern keeps recurring, and no one seems to remember the earlier mistakes. We loosen mortgage standards, there’s a bubble, and then there’s a crash. Other than the taxpayers, who have to cover the government’s losses, most of the people who are hurt are those who bought in the bubble years, and found—when the bubble deflated—that they couldn’t afford their homes. (more…)
Book Review: ‘The Map and the Territory,’ by Alan Greenspan
Alan Greenspan argues that Wall Street didn’t predict the 2008 crisis because it paid scant attention to the insights of behavioral economics.
Burton G. Malkiel
Oct. 22, 2013
EXCERPT FROM THIS ARTICLE: Bubbles and crashes will always be characteristics of free-market systems, but they need not lead to economic crises. In 1987 the stock market fell over 20% in a single day, but the effect on economic activity was minimal because holders of common stock weren’t highly leveraged. The bursting of the Internet bubble in early 2000 left only a mild imprint on the financial system and the real economy for the same reason. The crash of the housing bubble was devastating because the toxic mortgage-backed assets were held by highly leveraged institutions, and this debt was short-term rather than “permanent” and thus especially susceptible to “runs” where lenders were unwilling to “roll over” their short-term loans. “It was the capital impairment on the balance sheets of financial institutions that provoked the crisis,” Mr. Greenspan writes. In his view, the answer is not more regulation but more capital.
“The Map and the Territory” ranges beyond the market crisis and predictive models. Mr. Greenspan offers a conservative but balanced discussion, for instance, of the need to restrain the growth of entitlement spending. In his section on income inequality he emphasizes the role of globalization and the rise in stock-based compensation, as well as the failure of our education system to produce skills for the workforce that match the needs of the economy. He says that immigration reform, by loosening the requirements for H-1B visas, would allow us to draw on a large pool of skilled workers abroad and thus stabilize income inequality. At the moment, immigration restrictions protect, and thus subsidize, high-income earners from global wage competition.
The financial crisis of 2008 and the deep recession that followed forced each of us—perhaps most notably, Alan Greenspan —to question the fundamental assumptions about risk management and economic forecasting. Mr. Greenspan, the nation’s chief forecaster as chairman of the Federal Reserve Board, steered the nation through almost two decades of prosperity and relative stability, retiring from the Fed in 2006 with an unparalleled reputation for prescience. And then came the economic crisis, and no one’s reputation for prescience survived.
In prepared remarks before a congressional hearing a month after Lehman’s September 2008 bankruptcy, Mr. Greenspan declared: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity (myself especially) are in a state of shocked disbelief.” He was hardly alone in failing to predict the economic tsunami. Equally clueless were government officials, Wall Street practitioners and professional economists. In “The Map and the Territory,” Mr. Greenspan tries to explain what went wrong and offers suggestions for how we can do a better job. (more…)
So the Syria “crisis” is reaching its culmination. Syria’s WMD’s are likely to be placed under the control of its patron, Russia, perhaps even with the cooperation of other disinterested, responsible states such as Iran, Cuba, and Venezuela. The world’s only superpower, for its part, will loiter on the curb outside, asking hurried questions while the big boys come and go, stepping aside quickly to avoid being shoved into the gutter by their bodyguards.
This situation is the sole handiwork of Mr. Barack H. Obama, successor in office to Washington, Lincoln, Truman, and Reagan. Pondering the better part of a day, I can think of no previous episode to compare it with. It has similarities to the isolationism of the 1920s, with the United States reduced to irrelevance on the global fringes, but that was a deliberate result of policy, while this… this product of ineptness coupled with ideology, is something you can scarcely put a name to.
There are three-and-a-half years of agony lying ahead. It won’t be pleasant, but there is a saving grace. Barack Obama and his childishness, incompetence, and fanatical fixation on dead political ideas constitute the apotheosis of a longer-term conundrum, that of a liberal/left that has infiltrated this country’s institutions to a point that state power and interference with individual liberties increases steadily no matter who is in office.
Obama offers us a chance to reject all that decisively. I want every single train of events set in motion by Obama, his administration, and his supporters, down to the last halfwit college undergrad, to play out in full. I want every disaster that fool and his parade of twitches have triggered to blossom in bleak completion. I want to see all their trains collide, all their ships sink, all their airships burnt to cinders.
We’re talking tragedy and retribution, in the absolute Greek sense — the Furies howling at midnight. Maybe that’s what it takes to cleanse this nation of this doctrinal pestilence. I want to see every Row A voter reduced to remorse. I want to see their noses rubbed in it. I want to hear each victim of this regime cry out to heaven for vengeance. If all this comes to pass, we may even see Democrats, fearful for their own political hides, wanting to be rid of him.
But if Obama were impeached, none of this would happen. Instead the focus would shift to Congress and the GOP, who then would be blamed for everything that occurs, no matter who — likely Smilin’ Joe Biden — inhabits the Oval Office. When the disasters come — and they will (most of them are on track at this moment and can’t be turned around except through drastic action which Obama and all other visible Democrats are incapable of) — they will be dumped into the laps of the Republicans. No other group in modern history has proven more adept at shifting blame than the liberal left, just as no other political party has proven more apt to stumble into the spotlight at the worst possible moment than the GOP. (more…)
Affordable-housing goals established in the 1990s led to a massive increase in risky, subprime mortgages.
By
PHIL GRAMM
AND MIKE SOLONMr. Gramm, a former Republican chairman of the Senate Banking Committee, is senior partner of US Policy Metrics and a visiting scholar at the American Enterprise Institute. Mr. Solon, a former economic policy adviser to Senate Republican leader Mitch McConnell, is a partner at US Policy Metrics.
EXCERPT FROM THIS ARTICLE: Effective in January 1993, the 1992 housing bill required Fannie and Freddie to make 30% of their mortgage purchases affordable-housing loans. The quota was raised to 40% in 1996, 42% in 1997, and in 2000 the Department of Housing and Urban Development ordered the quota raised to 50%. The Bush administration continued to raise the affordable-housing goals. Freddie and Fannie dutifully met those goals each and every year until the subprime crisis erupted. By 2008, when both government-sponsored enterprises collapsed, the quota had reached 56%. An internal Fannie document made public after the financial crisis (“HUD Housing Goals,” March 2003) clearly shows that by 2002 Fannie officials knew perfectly well that these quotas were promoting irresponsible policy: “The challenge freaked out the business side of the house [Fannie] . . . the tenseness around meeting the goals meant that we . . . did deals at risks and prices we would not have otherwise done.” The mortgage market shows the dramatic results of this shift in policy. According to the nonprofit National Community Reinvestment Coalition, total CRA lending rose to $4.5 trillion in 2007 from $8 billion in 1991. The American Enterprise Institute’s Ed Pinto found that in 1990 80% of the residential mortgage loans acquired by Fannie and Freddie were solid prime loans with healthy down payments and a well-documented capacity by borrowers to make mortgage payments. By 1999 only 45% of their acquisitions met this standard. That number fell to 15% by 2007. By 2008, roughly half of all outstanding mortgages in America were high-risk loans. In 1990, very few subprime loans were securitized. By 2007 almost all of them were.
Simply put, the financial crisis of 2008 was caused by a lot of banks making a lot of loans to a lot of people who either could not or would not pay the money back. But this explanation raises two key questions. Why did private lenders, whose job it was to assess credit risk, make those loans? And why did the army of financial regulators, with massive enforcement powers, allow 28 million high-risk loans to be made?
There’s a strong case that the answers can be traced to Sept. 12, 1992. On that day presidential candidate Bill Clinton proposed, in his campaign book “Putting People First,” using private pension funds to “invest” in government priorities, such as affordable housing, to “generate long-term, broad based economic benefits.” Seldom has such a radical proposal been so ignored during a campaign only to later lead to such devastating consequences. After his election, President Clinton tapped Labor Secretary Robert Reich to lead the effort to extract, as Mr. Reich put it in 1994 congressional testimony, “social, ancillary, economic benefits” from private pension investments. Mr. Reich called on pension funds to join the administration’s “Economically Targeted Investment” effort. Housing and Urban Development Secretary Henry Cisneros assured participants that “pension investments in affordable housing are as safe as pension investments in stocks and bonds.”
Republicans lost the election by failing to pin the Great Recession on Democratic housing policies mandating affirmative-action lending. They’ll lose even worse if they adopt Democratic racial politics.
Democrats have perfected the dark art of identifying and dividing Americans by race and class and promising favored groups special economic “rights” and entitlements. Republicans will always lose to them in a pandering contest.
Republicans win — and win big — when they transcend tribal politics and appeal to all Americans as individuals, as Ronald Reagan did in 1980. They also win when they shoot straight with voters, using hard facts and logic to explain tough issues.
Mitt Romney failed to do this. He made a strategic mistake by not re-emphasizing the origins of the mortgage crisis and recession. By letting stand President Obama’s false narrative that “Wall Street fat cats” like him caused the mess that Obama couldn’t get us out of, Romney became a victim of that very narrative.
The Republican National Committee thinks the long primary season doomed Romney. In fact, the primaries offered a raft of free airtime to sort fact from fiction about why so many Americans lost their jobs, incomes, home equity and retirement.
Only, Romney never took advantage of it.
He had numerous prime-time chances to explain to voters that Washington, not Wall Street, was responsible for the vast majority (70%) of the 28 million subprime and other weak home loans that went bust in 2008 (by virtue of the “affordable housing” quotas government enforced through HUD-regulated Fannie Mae, Freddie Mac and the FHA and through the Community Reinvestment Act).
He could have easily documented how the government ordered lenders to “target” low-income minorities directly in marketing efforts to satisfy regulators; how the lines between subprime and prime were “blurred,” intentionally, on government orders; and how Obama doubled down on these reckless housing policies, even reappointing many of the original architects of President Clinton’s disastrous minority homeownership strategy.
Once lower affirmative-action lending standards — nothing down, weak credit — were incorporated into Fannie’s and Freddie’s automated underwriting programs, they became the standard across the entire mortgage industry for all borrowers. They also contaminated the mortgage-backed securities industry.
During those 20 televised debates, Romney could have at least forced some national media coverage about the government’s role in the crisis. It could have changed public opinion just enough to win the election.
He didn’t. Instead, exit polls show a majority of voters blamed Republicans and Wall Street even for Obama’s jobless recovery (more…)
‘It’s easier for government to control a few large institutions’
By Brett M. Decker– Brett M. Decker, former Editorial Page Editor for The Washington Times, was an editorial page writer and editor for the Wall Street Journal in Hong Kong, Senior Vice President of the Export-Import Bank, Senior Vice President of Pentagon Federal Credit Union, speechwriter to then-House Majority Whip (later Majority Leader) Tom DeLay and reporter and television producer for the legendary Robert
Friday, May 11, 2012
Decker: You told me you couldn’t create your company in today’s environment. That’s quite a startling statement about such a successful business. Why not?
Allison: BB&T grew through local decision-making and personalized service focused on small businesses and the middle market. The current regulatory environment not only imposes extraordinary cost on smaller financial institutions, it makes it difficult to treat each customer as a special individual. Personalized service is now considered by the regulators to be “disparate” treatment. Small-business lending is part science and part art. It is extraordinarily difficult to execute a personalized value proposition with bank examiners micromanaging every decision.
Decker: Banks are used as whipping boys to impute blame for the collapse of the housing market, but government played a central role in the mortgage crisis. Can you explain how Washington intervention manipulated the market with such disastrous results?
Allison: Government policy is the primary cause of the financial crisis. The Federal Reserve “printed” too much money in the early 2000s to avoid a mild recession, which led to a massive misinvestment. The misinvestment was focused in the housing market due to the affordable housing (subprime) lending policies imposed by Congress on the giant Government Sponsored Enterprises (Freddie Mac and Fannie Mae), which would never have existed in a free market. When Freddie and Fannie failed, they owed $5.5 trillion and had $2 trillion in subprime loans. Because Freddie/Fannie had such a dominate share of home-mortgage lending in the United States (75 percent), they drove down the lending standards for the whole industry. (more…)
EXCERPT FROM THIS ARTICLE: The Departments of Defense, State and Justice are authorized by the Constitution and are generally accepted legitimate federal government functions. Most of the rest ought to be done at the state and local levels or by the private sector. The current spending and debt crisis eventually will force debate on the role of the federal government — which programs necessitate taxpayer funding and which can be eliminated. The time is closer than most think — just ask any Greek citizen or resident of Stockton, Calif.
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The current debate about the debt vote is minor league compared to what will happen when the government literally cannot spend more than it is taking in. That time may be nearer than you think. It is true that the U.S. government can always “print” money to pay its bills, but at some point, printing more money becomes self-defeating because the resulting increase in the government bond interest rate and required interest payment will spiral out of control. At that point, the government will be forced to operate on a pay-as-you-go basis, as any individual or business is forced to do when they can no longer get credit. Several California cities are now in this situation.
The U.S. government now receives about $200 billion a month in revenue and spends about $320 billion a month. Any responsible business or individual faced with a situation where receipts are only 60 percent of expenditures would make changes before their credit was cut off or, at the very minimum, have a plan for which bills to pay first — but not the U.S. government.
It appears that President Obama is once again going to produce a budget that assumes very high levels of deficit spending can go on forever. It also appears that Senate Democrats will continue to not bother to pass a budget. Note that the purpose of a budget is to allocate scarce resources (your money) and to make sure that spending does not exceed the funds that are available. Senate Majority Leader Harry Reid is the ultimate spoiled child, accusing the taxpayers of engaging in child abuse by not giving him an unlimited allowance. (more…)
If there’s a crisis on Jack Lew’s Treasury watch, buy gold.
Introducing Jack Lew to the Senate Finance Committee on Wednesday, New York Democrat Chuck Schumer said the Treasury nominee has an “uncanny ability to delve into a subject” and “master it.” Americans can only hope, because you wouldn’t know it based on the little that Mr. Lew claims to have known about what happened during his tenure at CitigroupC +0.73%from 2006-2008.
Mr. Lew’s confirmation hearing was a substance-free zone, including his own job history. He was a senior executive at the giant failing bank before and during the financial crisis, but over several hours Wednesday he gave the impression he was there mostly to cash a paycheck.
And when Orrin Hatch (R., Utah) ticked off the problems that afflicted the two Citi divisions that Mr. Lew oversaw as chief operating officer, the nominee seemed to know less about them than Mr. Hatch. “I don’t recall specific conversations” about any of several Citi-run hedge funds that were imploding at the time, said Mr. Lew. “I was aware there were funds that were in trouble.”
Citigroup funds with high leverage crashed and burned, requiring a taxpayer bailout while sparking fierce debates at Citi over whether customers had been adequately informed. But the COO who oversaw legal affairs for some of these units says he formed no opinion.
BloombergU.S. treasury secretary nominee Jacob “Jack” Lew
Mr. Lew seems to have been equally disengaged about his own investments. He said he didn’t know why the venture-capital fund in which he had invested was based in the Cayman Islands or whether its location had resulted in any tax benefits. He did aver that Congress could always have banned such tax shelters before he had invested in one.
As for other lessons, Mr. Lew said that his experience at the bank and at New York University, where he was the highest paid administrator before joining Citi, had “proven to me that working collaboratively to solve problems is a universal challenge.” That’s good, because based on his knowledge of finance, he’s going to need a lot of collaboration.
Ohio Democrat Sherrod Brown tried to draw out Mr. Lew on one of the Senator’s favorite subjects: The fact that too-big-to-fail banks can borrow at lower rates than small banks because of the implied government backing. Mr. Lew rambled before saying that he was “not familiar with the specific issue.”
Mr. Brown then asked if the government should stop providing this subsidy to the giant banks. Mr. Lew avoided answering and then said that “I’m being a little hesitant” because he doesn’t believe in intervening in the markets “on a regular basis.” This is the man who will run the Financial Stability Oversight Council.
As for policy, Mr. Lew said that any tax reform must raise more net revenue and suggested that while the U.S. statutory corporate tax rate is high, the effective rate is “much lower.” Ohio’s Rob Portman had to instruct him that the U.S. effective rate is much higher than the developed country average.
The overall performance reinforced the view that Mr. Lew was chosen mainly for his experience as a political hammer for the White House. In his introduction of Mr. Lew, former Senator Pete Domenici recounted that former Treasury Secretary Robert Rubin had praised Mr. Lew as a quick study. Maybe Mr. Rubin can get an office at Treasury and help break the rookie in.