ORDOS, China—For a sense of the sharp policy shift China’s leaders have to orchestrate to avoid the world’s second-largest economy landing with a hard thud, look no further than this Inner Mongolia desert town, where construction cranes have come to an abrupt standstill.

Just as a European crisis and a weak U.S. recovery are hurting Chinese exporters, the confidence that had sustained China’s property boom is evaporating, causing a double whammy for growth: fading demand overseas and at home at the same time.

The construction slump couldn’t have come at a worse moment for China’s factories. A key manufacturing measure Thursday, the official purchasing-managers index, fell to 49 in November, below the 50 mark that separates expansion from contraction and the lowest since the financial crisis in February 2009.

On Friday, China’s central bank for the first time acknowledged that the country’s housing prices have reached a turning point, citing a decline in property investment, land-transaction volumes and prices.

With both the real-estate and export sectors in trouble, the warning light on China’s growth is flashing red. Like in the last crisis, China’s leaders have been quick to react but this time around their options are limited. (more…)

Former House Speaker Newt Gingrich touted the virtues of Freddie Mac’s business model in an interview published by the company in April 2007, remarks that contrast with the candidate’s recent statements that he had warned the company of impending financial disaster.

The interview was featured on Freddie Mac’s website for several months in 2007 when he was a paid consultant to the company and Freddie Mac was struggling to address mounting financial problems as the housing boom was turning to bust.

At the time, critics were complaining that Freddie Mac and its larger cousin, Fannie Mae, benefited from an unfair competitive advantage because of the perception their debt had an implicit government guarantee. That allowed the mortgage-finance companies, formerly known as government-sponsored enterprises, or GSEs, to borrow at lower rates than private-sector competitors.

“While we need to improve the regulation of the GSEs, I would be very cautious about fundamentally changing their role or the model itself,” Mr. Gingrich said in the website interview. (more…)

Few House Members have made a bigger legislative mark, and arguably no one so expensively. Mr. Frank deserves to be forever remembered—and we’ll help everyone remember him—as the nation’s leading protector of Fannie Mae and Freddie Mac before their fall. For years Barney helped block meaningful reform of the mortgage giants while pushing an “affordable housing” agenda that helped to enlarge the subprime mortgage industry.

“I do think I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision],” Mr. Frank said on September 25, 2003, in one of his many legendary rhetorical hits. “I want to roll the dice a little bit more in this situation towards subsidized housing.” The dice came up snake-eyes for the housing market and U.S. economy.

Democracy can be unfair, and for his sins Mr. Frank was rewarded with the chairmanship of the Financial Services Committee in 2009 and an opening to remake the U.S. financial industry. It was like asking Charlie Sheen to teach an anger management class. The result was Dodd-Frank, which didn’t solve the “too big to fail” problem but did make banks even more subject to the wishes of Washington. The crony capitalism exemplified by Fannie and Freddie became more broadly embedded in U.S. financial markets. (more…)

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…)

Campaigning last week in Nevada, the epicenter of the housing bust, Mr. Romney was asked by the Las Vegas Review-Journal editorial board what he would do about housing and foreclosures. His reply:

“One is, don’t try and stop the foreclosure process. Let it run its course and hit the bottom. Allow investors to buy homes, put renters in them, fix the homes up. Let it turn around and come back up. The Obama Administration has slow-walked the foreclosure processes that have long existed, and as a result we still have a foreclosure overhang.”

How’s that for refreshing? After five years of politicians trying without success to levitate the housing market by postponing foreclosures, Mr. Romney dared to tell the truth. Parts of the U.S., including Nevada, still have too many homes, and that supply needs to be sold off and fixed up so the market can find a bottom before home prices can start to rise again. The faster that process proceeds, the faster the recovery will take hold.

(more…)

European nations, flirting with recession, can’t agree on how to climb out from under their pile of debt. The U.S. is careening toward a budget fight that threatens to shut down the government. China’s mammoth economy may be downshifting.

And across the financial markets, a sea change is taking place. Investors are abandoning the time-tested “stocks for the long run” optimism that dominated since the late 1980s. Instead, there is a widening belief that the mess left behind by the housing bubble and financial crisis will be a morass to contend with for years.

In a historic retreat, investors world-wide during the three months through August pulled some $92 billion out of stock funds in the developed markets, according to data provider EPFR Global—an exodus that more than reversed the total amount of money investors had put into those funds since stocks bottomed in 2009. The withdrawals matched the worst three-month period during the depths of the financial crisis.

That reversal showed no sign of abating in September. In the first three weeks another $25 billion was withdrawn from developed-market stock funds. Last week the Dow Jones Industrial Average suffered its worst one-week decline since October 2008. It is down 16% from its late-April peak. Investors are also showing less optimism toward emerging-market countries. (more…)