Occupy Wall Street is denouncing banks and Wall Street for “selling toxic mortgages” while “screwing investors and homeowners.” And the federal government recently announced it will be suing mortgage originators whose low-quality underwriting standards produced ballooning losses for Fannie Mae and Freddie Mac.
Have they fingered the right culprits?
There is no doubt that reductions in mortgage-underwriting standards were at the heart of the subprime crisis, and Fannie and Freddie’s losses reflect those declining standards. Yet the decline in underwriting standards was largely a response to mandates, beginning in the Clinton administration, that required Fannie Mae and Freddie Mac to steadily increase their mortgages or mortgage-backed securities that targeted low-income or minority borrowers and “underserved” locations.
The turning point was the spring and summer of 2004. Fannie and Freddie had kept their exposures low to loans made with little or no documentation (no-doc and low-doc loans), owing to their internal risk-management guidelines that limited such lending. In early 2004, however, senior management realized that the only way to meet the political mandates was to massively cut underwriting standards.
The risk managers complained, especially at Freddie Mac, as their emails to senior management show. They refused to endorse the move to no-docs and battled unsuccessfully against the reduced underwriting standards from April to September 2004. Here are some highlights:
On April 1, 2004, Freddie Mac risk manager David Andrukonis wrote to Tracy Mooney, a vice president, that “while you, Don [Bisenius, a senior vice president] and I will make the case for sound credit, it’s not the theme coming from the top of the company and inevitably people down the line play follow the leader.”
Risk managers had already experimented with lower lending standards and knew the dangers. In another email that day, Mr. Bisenius wrote to Michael May (another senior vice president), “we did no-doc lending before, took inordinate losses and generated significant fraud cases. I’m not sure what makes us think we’re so much smarter this time around.” (more…)
Financial markets are in turmoil, investors are fleeing to safe havens, and the chances of another recession are rising. This would seem to be a moment when government should be especially careful to do no harm, to talk and walk softly, and to reassure business that Washington wants more private investment and hiring.
But this is not how our current government behaves. Day after day brings headlines of another legislative, regulatory or enforcement action that gives CEOs and investors reason to hunker down, retain as much cash as possible and ride out whatever storms are ahead. This is not the way to nurture an already fragile recovery, much less help the economy to endure shocks from Europe, natural disasters or a big bank failure.
Consider the headlines only from last week, a slow week by Washington standards, with Congress out of session and President Obama campaigning for three days before going on vacation. Even in the dog days of August, your government was hard at work undermining economic confidence.
• Monday: “Warren Buffett right about taxes, says Obama.” The week began with a one-two tax punch from Warren Buffett and President Obama. The Omaha stock-picker wrote an op-ed begging Congress to raise taxes on millions of Americans who make less than he does, and the President used the first stop of his bus tour, in Cannon Falls, Minnesota, to agree.
“I put a deal before the Speaker of the House, John Boehner, that would have solved this problem,” Mr. Obama said, “and he walked away because his belief was we can’t ask anything of millionaires and billionaires and big corporations in order to close our deficit.” So America’s main job creators are still on notice that a tax increase is in their future in 2013, if not sooner.
• Tuesday: “Federal mortgage role to be preserved: Obama is working to develop new housing policy.” A Washington Post story reported that Mr. Obama has directed a White House team to develop a housing plan that would keep the feds deeply involved in mortgage markets, with subsidies and loan guarantees, perhaps even preserving Fannie Mae and Freddie Mac. (more…)
President Obama has directed a small team of advisers to develop a proposal that would keep the government playing a major role in the nation’s mortgage market, extending a federal loan subsidy for most home buyers, according to people familiar with the matter.
The decision follows the advice of his senior economic and housing advisers, who favor maintaining the government’s role as an insurer of mortgages for most borrowers. The approach could even preserve Fannie Mae and Freddie Mac, the mortgage finance giants owned by the government, although under different names and with significant new constraints, said people knowledgeable about the discussions.
A decision to preserve a major government role would mark a big milestone in the effort to craft a new housing policy from the wreckage of the mortgage meltdown and could mean a larger part for Fannie and Freddie than administration officials had signaled. (more…)
As the economy continues to struggle, we are reminded of a course offered at Yale University titled “Grand Strategy.” Drawing on a weighty curriculum of history and philosophy, the course seeks to train future policy makers to tackle the complex challenges of statecraft in a comprehensive, systematic way. Clearly, U.S. economic policy is sorely lacking an effective grand strategy, and we are likely to endure high unemployment, weak economic performance and trying financial markets until such a strategy is articulated and pursued.
Policy makers should cease the barrage of ad hoc, short-term policy initiatives. Is increased federal spending across government agencies a grand strategy? How about checks in the mail to spur spending? Cash for clunkers to move auto inventories? Fast trains and faster Internet? Mortgage modification programs and fleeting tax credits to re-stoke home ownership?
Inducing consumers to do today what they would otherwise do tomorrow is hardly a grand strategy. Hundreds of billions in “stimulus” spending has stimulated little but more debt. Forty-eight months have passed since the onset of the financial crisis, 26 months since the recession technically ended. Yet job creation remains remarkably weak, and markets deeply uneasy.
We can’t go on like this.
The debt-limit debate caused policy makers to recognize what citizens already knew: We must put our fiscal house in order. Cutting spending is essential. But we will never cut our way to prosperity. (more…)
How Outsized Ambition, Greed, and
Corruption Led to Economic Armageddon
by Gretchen Morgenson & Joshua Rosner
Times Books, 352 pp., $30
To have served as the intellectual architect of the stalest presidential campaign of the modern-media era, to have lost a record number of states, to have gained a reputation for ruthlessness and secrecy in the process—only in Washington is that a recipe for success. Running the 1984 effort of his fellow Minnesotan, Walter Mondale, turned out to be the perfect entrée for James A. Johnson: He wound up a director of the Kennedy Center, chairman of the Brookings Institution, a board member of Goldman Sachs, an adviser to John Kerry in 2004, and—until derailed by scandal—the head of Barack Obama’s vice-presidential search team in 2008.
But if Johnson’s name winds up in history books, it will be for something else. It was he who transformed Fannie Mae (formerly the Federal National Mortgage Association) in the course of the 1990s. Fannie had been a sleepy vestige of the New Deal bureaucracy, meant to deepen the market for middle-class mortgages by purchasing qualifying loans from banks. Under the leadership of Johnson and his successor, former Clinton budget director Franklin Raines, it became the flagship of the subprime mortgage industry. Its executives earned eight-figure salaries. It held as much debt as the U.S. Treasury in 2005. It had a massive, ferocious lobbying organization. It proclaimed itself to be leading a righteous mission to spread affordable housing to minorities, poor people, and other “underserved” parts of the population. And in 2008, it had to be bailed out by the U.S. taxpayer, at a cost, so far, of several hundred billion dollars.
The upshot of Reckless Endangerment,by New York Times business journalist Gretchen Morgenson and economist Joshua Rosner, is that Johnson has as much claim as anyone to be the main villain of the financial crisis. (more…)
“The louder he talked of his honor, the faster we counted our spoons.”
— Emerson
The louder they talked about the disadvantaged, the more money they made. And the more the financial system tottered.
Who were they? Most explanations of the financial calamity have been indecipherable to people not fluent in the language of “credit default swaps” and “collateralized debt obligations.” The calamity has lacked human faces. No more.
Put on asbestos mittens and pick up “Reckless Endangerment,” the scalding new book by Gretchen Morgenson, a New York Times columnist, and Joshua Rosner, a housing finance expert. They will introduce you to James A. Johnson, an emblem of the administrative state that liberals admire.
The book’s subtitle could be: “Cry ‘Compassion’ and Let Slip the Dogs of Cupidity.” Or: “How James Johnson and Others (Mostly Democrats) Made the Great Recession.” The book is another cautionary tale about government’s terrifying self-confidence. It is, the authors say, “a story of what happens when Washington decides, in its infinite wisdom, that every living, breathing citizen should own a home.” (more…)
By Gretchen Morgenson and Joshua Rosner
(Times Books, 331 pages, $30)
‘The American people realize they’ve been robbed. They’re just not sure by whom,” write Gretchen Morgenson and Joshua Rosner in “Reckless Endangerment.” But Americans who read this outstanding history of the financial crisis will know, by the end, exactly who created the meltdown of 2008 and how they did it. This is a story, the authors say, “of what happens when Washington decides, in its infinite wisdom, that every living, breathing citizen should own a home.”
Gretchen Morgenson and Joshua Rosner, authors of Reckless Endangerment, explain the corrupt culture behind the housing crisis. (more…)
The identification of firms as too big to fail is a mad policy that will confer unfair marketplace advantages and put taxpayers on the hook for future bailouts.
With the comment period now closed on its proposed rule, the Financial Stability Oversight Council (FSOC) is getting ready to outline the terms for deciding which nonbank financial institutions might cause instability in the U.S. financial system if they fail. As its staff works away on decision criteria, they should be offered one word of advice: stop.
The council was set up by the Dodd-Frank Act and is made up of virtually all the federal government’s financial regulators. It is authorized to use such criteria as size, interconnectedness and “mix of activities” to decide whether, in effect, a nonbank financial institution is too big to fail.
The legislation already specifies that all banks or bank holding companies with assets of more than $50 billion are automatically included in this category, but the FSOC now must decide what other financial institutions—insurance companies, financial holding companies, securities firms, finance companies, hedge funds and private equity firms, among others—are also dangers to the financial system’s stability. Under the terms of Dodd-Frank, if firms are designated as potential sources of “instability,” they will be subject to “stringent” regulation by the Federal Reserve. (more…)
The 2008 financial crash originated with a housing bubble. Not long ago, the cheap money policies of the Federal Reserve, the infusion of trillions of dollars in new foreign investment, and the misguided policies of Freddie Mac and Fannie Mae all conspired to extend to millions of Americans lots of easy cash for inflated houses that they could hardly afford. Owning a house was seen as a “right” rather than the just rewards of household sacrifice, delayed gratification and budgetary discipline.
Builders, lenders, realtors and bureaucrats all got in on the easy-money Ponzi scheme — until a few noticed that the emperor had no clothes and that rather pedestrian homes were hardly worth what unqualified purchasers had paid for them. Financial hysteria followed when shaky borrowers began to miss exorbitant mortgage payments, walked away, and lenders panicked. The subsequent meltdown is history. (more…)
