Dienstag, September 23, 2008

Understanding The Mess...

This from the WSJ does a good job of clearing the air.

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.

Hence it was Fannie Mae and Freddie Mac who brought this about: why?

It is important to understand that, as GSEs, Fannie and Freddie were viewed in the capital markets as government-backed buyers (a belief that has now been reduced to fact). Thus they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities.

This is a very important point: they were the market makers in this segment: what they wanted, they got, since it was the simplest and fastest way of doing business.

Their buying patterns and interests were followed closely in the markets. If Fannie and Freddie wanted subprime or Alt-A loans, the mortgage markets would produce them. By late 2004, Fannie and Freddie very much wanted subprime and Alt-A loans. Their accounting had just been revealed as fraudulent, and they were under pressure from Congress to demonstrate that they deserved their considerable privileges. Among other problems, economists at the Federal Reserve and Congressional Budget Office had begun to study them in detail, and found that -- despite their subsidized borrowing rates -- they did not significantly reduce mortgage interest rates. In the wake of Freddie's 2003 accounting scandal, Fed Chairman Alan Greenspan became a powerful opponent, and began to call for stricter regulation of the GSEs and limitations on the growth of their highly profitable, but risky, retained portfolios.

Hence it became critical for those in the pocket of Fannie Mae and Freddie Mac to fight any sort of reforms: as far as they were concerned, it was killing the goose that laid the golden eggs...

But wait: that paragraph says more: despite their ability to borrow at subsidized rates, they did not, in fact, reduce mortgage interest rates in a meaningful way. Where did that money go? We now know the answer: it went to pay political appointees salaries way above their nominal pay scale, and it went to lobbying efforts, aka bribery.

If they were not making mortgages cheaper and were creating risks for the taxpayers and the economy, what value were they providing? The answer was their affordable-housing mission. So it was that, beginning in 2004, their portfolios of subprime and Alt-A loans and securities began to grow. Subprime and Alt-A originations in the U.S. rose from less than 8% of all mortgages in 2003 to over 20% in 2006. During this period the quality of subprime loans also declined, going from fixed rate, long-term amortizing loans to loans with low down payments and low (but adjustable) initial rates, indicating that originators were scraping the bottom of the barrel to find product for buyers like the GSEs.

This is where the Fannie Mae and Freddie Mac gamed the system: in order to stay afloat, they increased the risk to the entire economy.

The strategy of presenting themselves to Congress as the champions of affordable housing appears to have worked. Fannie and Freddie retained the support of many in Congress, particularly Democrats, and they were allowed to continue unrestrained. Rep. Barney Frank (D., Mass), for example, now the chair of the House Financial Services Committee, openly described the "arrangement" with the GSEs at a committee hearing on GSE reform in 2003: "Fannie Mae and Freddie Mac have played a very useful role in helping to make housing more affordable . . . a mission that this Congress has given them in return for some of the arrangements which are of some benefit to them to focus on affordable housing." The hint to Fannie and Freddie was obvious: Concentrate on affordable housing and, despite your problems, your congressional support is secure.

The key word is Congress, particularly Democrats, who allowed them to dig the hole deeper and deeper without restraint: Congress failed in its oversight role, and the blame must be placed where it belongs: the Right Honorable Representative Barney Frank, Democrat from Massachusetts, as the Chair of the House Financial Services Committee. He is the main culprit at this point.

In light of the collapse of Fannie and Freddie, both John McCain and Barack Obama now criticize the risk-tolerant regulatory regime that produced the current crisis. But Sen. McCain's criticisms are at least credible, since he has been pointing to systemic risks in the mortgage market and trying to do something about them for years. In contrast, Sen. Obama's conversion as a financial reformer marks a reversal from his actions in previous years, when he did nothing to disturb the status quo. The first head of Mr. Obama's vice-presidential search committee, Jim Johnson, a former chairman of Fannie Mae, was the one who announced Fannie's original affordable-housing program in 1991 -- just as Congress was taking up the first GSE regulatory legislation.

In other words, Obama is part of the problem, not part of the solution: McCain is part of the solution. And why is this even a contest?

In 2005, the Senate Banking Committee, then under Republican control, adopted a strong reform bill, introduced by Republican Sens. Elizabeth Dole, John Sununu and Chuck Hagel, and supported by then chairman Richard Shelby. The bill prohibited the GSEs from holding portfolios, and gave their regulator prudential authority (such as setting capital requirements) roughly equivalent to a bank regulator. In light of the current financial crisis, this bill was probably the most important piece of financial regulation before Congress in 2005 and 2006. All the Republicans on the Committee supported the bill, and all the Democrats voted against it. Mr. McCain endorsed the legislation in a speech on the Senate floor. Mr. Obama, like all other Democrats, remained silent.

Let's see: the Republican controlled Senate Banking Committee tried to reform both Fannie Mae and Freddie Mac, and the vote went along clear party lines, with the Democrats voting against it.

Now can anyone tell me why we should be listening to any Democrat on how to deal with the problem that they created? The Democrats have lost complete and total moral, political and whatever other authority that they may have at one time commanded regarding this, and to listen to them would be, plain and simple, folly of the worst kind.

Now the Democrats are blaming the financial crisis on "deregulation." This is a canard. There has indeed been deregulation in our economy -- in long-distance telephone rates, airline fares, securities brokerage and trucking, to name just a few -- and this has produced much innovation and lower consumer prices. But the primary "deregulation" in the financial world in the last 30 years permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable in this storm.

It's not a canard, it is an outright lie and an attempt to save their sorry butts. The problem wasn't deregulation, but the fact that those who were regulated subverted the regulators - the House Financial Services Committee - and that the Democrats blew it. Big, big time.

As a result, U.S. commercial banks have been able to attract more than $100 billion of new capital in the past year to replace most of their subprime-related write-downs. Deregulation of branching restrictions and limitations on bank product offerings also made possible bank acquisition of Bear Stearns and Merrill Lynch, saving billions in likely resolution costs for taxpayers.

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.

This is the truth, folks: every single US taxpayer should ask the Democrats why they, the tax payers, should now pay for a politically motivated boondoggle of the worst kind. This is costing real money and is going to have real, long-term negative effects on growth, leading to lower wealth for everyone.

Except those who have profited. The system was gamed, but let's make sure that those who made that possible at least pay the price.

Get out there and vote Republican: you deserve nothing less.

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