Tuesday, September 23, 2008

We Really Can Put Most of the Blame On The Dems



Well, the Jury is in. Kevin Hasset astutely points out in 2005, a serious bill to reform Fannie Mae and Freddie Mac was proposed, but the Democrats wouldn't even allow a vote on it. Not even a vote! This bill would've disallowed all of the bad loans that Fannie and Freddie were to buy in the years hence. The crisis could have been avoided.

So are there any individuals to blame? Yes: Frank Raines, CEO of Fannie Mae at the time and current economic adviser to Barrack Obama; Barney Frank, chairman of the House Financial Services Committee, ardently defended these corrupt companies. A lot of other top Democrats are to blame as well. And yes, Republicans too, but at least they all voted to reform Fannie while the Dems, to a person, voted no to.

So this is not a failure of capitalism or Greenspan's fault (read on, you'll see Greenspan also warned against disaster), though it is being portrayed in the media this way. This is not George Bush's fault - he opposed Fannie and Freddie from the start of his administration and even refused to put government officials on the boards of those companies, as a way of taking away implicit government support.

Look at this quote from a CNBC article from 2007:
"The administration of George W. Bush has said the combined $1.4 trillion investment holdings of the two government-sponsored companies are dangerously bloated and should be curbed."

This is a problem caused by Democrats starting and then protecting at all costs Fannie and Freddie.

Who are Fannie Mae and Freddie Mac, and what do they do?
Put simply: they buy mortgages from the lenders who originate them. This frees up the lender to go lend again and again, knowing that they'll be able to sell their loans to Fannie or Freddie. This creates "liquidity" - the ability to convert an asset into cash by selling it in a functioning market.

The very reason for the panic right now is that all the buyers dried up - no one wanted to buy these bad loans, either from the lenders or from Fannie or Freddie. After that, Fannie and Freddie, and even several other lenders who instantly went out of business in 2007, were on the hook to guarantee these bundles of loans.

I'm sorry - what part of free-market capitalism has Government Sponsored Enterprises like Fannie Mae and Freddie Mac? They weren't created by markets, but by the Government. That's called social engineering, not capitialism.

And now we know that Fannie and Freddie were buying these bad loans all while paying their CEO's $100 MILLION or so for about 7 years of work. All that money, as noted before, gave Fannie and Freddie increasing power as they bribed their way into permanence through millions in campaign contributions. And they also intimidated anyone who stood in their way, and this is documented behavior.

It's amazing how many of these bubbles occur because of outright lying. Speculators lying on their loans, stating it's a primary residence when it's only a flipper investment. Fannie and Freddie lying about how much in profits they had. If they hadn't lied, just maybe the investment world would have taken a closer look at all of the bad loans they were buying, and everyone could have slowly gotten out. Also, as you'll see below, the whole worst part of the crisis - these last few years - would have never occurred if the Democrats hadn't blocked efforts to reform Fannie and Freddie. Again, the Dems wouldn't even allow a vote on it. Now that's democracy for the little guy, isn't it?

Now, on to some enlightening quotes from some articles...

How the Democrats Created the Financial Crisis: Kevin Hassett
explains that the Republicans tried to reign in Freddie and Fannie, but the Dems blocked it. Thus, with Fannie and Freddie buying all of these bad loans, the cycle just continued until massive defaults started occuring on home loans.

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.

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.

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.

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.''

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...

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.

And here are some quotes from a great article at the WSJ: Blame Fannie Mae and Congress For the Credit Mess, where the authors point out that this buying of subprime loans was all in the name of "affordable housing", which was a clever survival scheme invented after Fannie Mae's accounting scandal.

Many monumental errors and misjudgments contributed to the acute financial turmoil in which we now find ourselves. Nevertheless, the vast accumulation of toxic mortgage debt that poisoned the global financial system was driven by the aggressive buying of subprime and Alt-A mortgages, and mortgage-backed securities, by Fannie Mae and Freddie Mac. The poor choices of these two government-sponsored enterprises (GSEs) -- and their sponsors in Washington -- are largely to blame for our current mess.

How did we get here? Let's review: In order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie Mae and Freddie Mac committed to increased financing of "affordable housing." They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.

If the Democrats had let the 2005 legislation come to a vote, the huge growth in the subprime and Alt-A loan portfolios of Fannie and Freddie could not have occurred, and the scale of the financial meltdown would have been substantially less. The same politicians who today decry the lack of intervention to stop excess risk taking in 2005-2006 were the ones who blocked the only legislative effort that could have stopped it.


And here is an interview with Peter Wallison, on the whole mess and his insider's view of the meltdown. Fannie Mae successfully put him out of a job when they refused to do business with the company whose board he was on, because he was critical of Fannie Mae.



Wallison explains the history of Fannie and Freddie (New Deal, and Lyndon Johnson), how Fannie intimidated its critics, and how he saw a long time ago that Fannie's business model was unsustainable.


And finally, some perspective from Larry Kudlow...
Well, it’s time for some perspective. The world is not coming to an end. The stock market has tumbled, but it’s still over 10,000. In late 2002 it was 7,500 and in mid-1982 it was 750. Are things really that bad?

With home prices falling, foreclosures and defaults are at the root cause of the run against all manner of mortgage-related bonds held by the banks. But as investment guru Don Luskin points out, foreclosures today are less than 3 percent. During the 1930s they were 50 percent. Or how about the unemployment rate? Today it’s 6.1 percent. Back in 1982 it was near 11 percent and for most of the 1930s it was over 20 percent.

As the oil bubble pops the underlying inflation rate is somewhere between 2 and 3 percent — quite unlike the double-digit hyperinflation of the 1970s. Home prices themselves have fallen between 10 and 20 percent, but they’re still about 50 percent higher than at the start of the decade.

And there are constructive policy measures that can help fix the market’s problems.

Investor Zachary Karabell writes persuasively in the Wall Street Journal that “mark-to-market accounting in the aftermath of the Enron scandal makes no sense at all.” Many banks have taken huge losses on mortgage-backed securities and their derivatives because the SEC insists on mark-to-market. But Karabell asks: Why knock down these bond values, sometimes by as much as 100 percent, when the underlying home values embedded in the mortgages have only dropped 10 to 20 percent? And in the long run, the housing market will recover, as it always does.


More keen analysis at The Pantheon Journal.

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