Published on The Weekly Standard (

BOOK REVIEW – HIDDEN IN PLAIN SIGHT:  What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again
   by Peter J. Wallison

Mortgage Madness

Blame for the 2008 financial collapse is, and should be, widespread.

Jay Cost

June 1, 2015, Vol. 20, No. 36
EXCERPT FROM THIS ARTICLE:  Wallison ends on a distressing note. He asserts that because experts have embraced a false narrative about the crisis, the remedy of Dodd-Frank will not protect us from the next calamity. Actually, it’s worse than this. The answer to the financial crisis may have been hidden in plain sight, but the failure to see it was willful. A powerful coalition of interest groups dominated housing policy for a generation, and they still do—despite the damage that policy caused in the Great Recession.

In The Semisovereign People, political scientist E. E. Schatt-schneider argues that “political conflict is not like an intercollegiate debate in which the opponents agree in advance on a definition of the issues. As a matter of fact, the definition of the alternatives is the supreme instrument of power. .  .  . He who determines what politics is about runs the country.” Schattschneider calls the organized effort to ensure that some alternatives remain illegitimate “the mobilization of bias.”

Peter J. Wallison must be quite familiar with this idea. A longtime critic of Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSE) tasked with injecting liquidity into the secondary mortgage market, he has offered warnings about these agencies that have fallen on deaf ears for over a decade. When he and Edward Pinto, his colleague at the American Enterprise Institute, correctly pointed out that Fannie and Freddie were loaded up with the subprime mortgages that contributed to the financial collapse of 2008, and that maybe—just maybe—this had something to do with the mess, they were greeted with accusations of Hitlerism. “The Big Lie” is what Joe Nocera of the New York Times accused Wallison and Pinto of propagating. 

There are some ideas that simply cannot gain mainstream acceptance because they challenge essential priorities of the ruling elite. Accordingly, any connection drawn from Fannie and Freddie to the financial collapse must be squashed, because distributing federally subsidized credit to low- and middle-income (LMI) borrowers has been a backbone of the nation’s housing policy for nearly 20 years. All of this makes Wallison’s work intriguing to anybody inclined to question the status quo—even more so because he has written this excellent book in defense of his thesis.

Wallison argues that the existing explanations for the crisis are either wrong (overregulation) or insufficient (monetary policy in violation of the Taylor rule). This is easy pickings. Most accounts focus on the investment practices of the banks, to the exclusion of what they were actually invested in. It is almost as if they could have invested in anything and produced the same result, because they were so greedy, leveraged, unregulated—whatever. Wallison points out that the troubled institutions were all tangled up in the same sort of investment—mortgage-backed securities (MBS)—and while he avers that part of the crisis has to do with how these were traded, he places the MBS at the center of his analysis. 

This approach is straightforward and intuitive, and if it did not lead inexorably to a damning critique of a quarter-century’s worth of federal housing policy, it would probably be widely accepted. Wallison contends that the MBS market was dangerous because mortgage-lending standards had steadily declined since the mid-1990s. He traces this to the Department of Housing and Urban Development (HUD), which, after 1992, was empowered to create affordable housing goals for the GSEs. HUD did this with gusto, insisting that low- and moderate-income buyers become an ever-greater share of Fannie’s and Freddie’s books. In response to this, the GSEs lowered their lending standards; and because they were such a huge part of the market, everybody’s standards were lowered.

This had two powerful effects. First, it facilitated a housing market bubble that, as Wallison notes, was substantially larger and longer than any of its predecessors. Second, it increased the potential for defaults. Wallison demonstrates the commonsensical notion that as mortgage lending abandons “prime” standards, default rates rise. So long as the bubble was expanding, this was not a problem, as borrowers could refinance because of rising home values. But when the market turned, as it did in 2006, defaults rose, and banks that had invested in mortgage-backed securities were on the hook. 

This alone should not have been catastrophic, because (as Wallison notes) the housing market is a relatively small share of the domestic economy. Calamity arrived because of mistakes at the top: The Basel Accords lowered capital requirements for holding MBSs; the federal government was too slow to suspend mark-to-market rules, forcing firms to report huge accounting losses; the federal government’s response was ill-considered and unpredictable, especially its decision to bail out Bear Stearns while letting the much larger Lehman Brothers fall into bankruptcy.

Again, this is a perfectly intuitive thesis that does not exclude other proposed causes, although Wallison is rightly skeptical of some. He makes a compelling case, but it is such a technical issue that his should not be the final word. It should prompt open debate, discussion, and deliberation; instead, we’re treated to accusations of Hitlerism. 

Why all the fuss?

There is a diverse group of people—affordable housing advocates, primary lenders, real estate agents, home builders, and more—that does not want the public to consider the possibility that HUD’s policies had anything to do with the crisis. That Wallison makes the contrary argument, and that he does so in a persuasive manner, makes him dangerous. And what we have seen is a classic example of Schattschneider’s mobilization of bias: interests organizing to declare a certain viewpoint illegitimate before debate has actually begun. 

Wallison hints at the politics behind these arguments. His professional background, however, is in law and finance, and Hidden in Plain Sight follows accordingly. He does not spend much time focusing on the powerful interest groups with private stakes in housing policy. But considering the politics of affordable housing policy sharpens the story. Wallison often portrays the GSEs as operating at the behest of HUD, even accepting losses in pursuit of its LMI goals. But the relationship is quite complicated. Housing policy during 1992-2008 was dominated by a kind of bootleggers-and-baptists coalition: affordable housing advocates who wanted easy credit for LMI borrowers and private interests in pursuit of profit. The bargain they hammered out was for profit and affordability, risks be damned. This is why HUD could push the GSEs for ever more LMI loans but was simultaneously ignorant of the questionable practices used to achieve these goals.  

The GSEs were at the center of this coalition from the beginning, especially Fannie Mae. These were not strictly private firms, nor were they part of the public bureaucracy. Fannie and Freddie were instrumentalities of the government: privately owned companies with a public mandate that implied Uncle Sam would bail them out in case of trouble. This guarantee was extremely valuable: The Congressional Budget Office estimated that it was worth $23 billion by 2005; CBO also estimated that Fannie and Freddie kept about a third of this bounty for itself. 

This was the foundation of the interest-group alliance that formed. To protect this enormous federal rent, the GSEs aligned with affordable housing advocates, primary lenders, and home builders. They all had a shared interest in keeping oversight to a minimum. Thus, insofar as the GSEs accepted losses from LMI mortgages, it was only to protect their substantial cut of that $23 billion subsidy. 

Indeed, Fannie Mae was an integral player in writing the very law that HUD used to increase its affordable housing goals. It made sure, for instance, that HUD was hamstrung in developing capital requirements, that its regulators had to go to Congress for funds, and that oversight did not reside in a more competent department such as Treasury.  

Wallison is not writing about politics, so he only touches on these subjects intermittently. But bringing in politics makes for an even gloomier narrative: It is not merely that federal housing policy was short-sighted, providing loans to people who could not pay them back; it was designed this way by those who profited from the irresponsibility.

Where was Congress in all of this? It has an oversight role to play; why did it not play that role? The troubling answer: These groups, especially Fannie Mae, were experts at the inside game of influence peddling, and they effectively bought Congress off. As Franklin Raines, the former CEO of Fannie Mae, said in 1999: “We manage our political risk with the same intensity that we manage our credit and interest rate risks.” Indeed. The GSEs walked away basically unscathed from a massive accounting scandal in 2003—and later acquired substantially more subprime loans than anyone knew. That was not accidental. Their regulator was impotent because the GSEs and their allies leaned on Congress to make it so. Then they leaned on Congress to look the other way for the next two decades. 

Wallison ends on a distressing note. He asserts that because experts have embraced a false narrative about the crisis, the remedy of Dodd-Frank will not protect us from the next calamity. Actually, it’s worse than this. The answer to the financial crisis may have been hidden in plain sight, but the failure to see it was willful. A powerful coalition of interest groups dominated housing policy for a generation, and they still do—despite the damage that policy caused in the Great Recession.

Jay Cost, staff writer at The Weekly Standard, is the author of A Republic No More: Big Government and the Rise of American Political Corruption


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