Conservative's Conscience

2008 Crisis in the U.S. Financial System, Part Two of Two

There ain't no such thing as a free lunch. -- Robert A. Heinlein, The Moon is a Harsh Mistress, 1966, G.P.Putnam's Sons, NY

Some people forgot a basic rule of existence: There ain't no such thing as a free lunch.  And they became a part of the 2008 problem.

But the assumption is made here, perhaps rashly, that failure related to buyer ignorance or misdirected guile is a small part of the problem.  The major parts of it are:

o       Unremitting government pressure, primarily under the Community Reinvestment Act (CRA) to make troublesome loans or, alternatively, to be charged with racism and forced to forgo expansion plans because of that charge.

• The availability of Fannie Mae and Freddie Mac as a dumping ground for loans and as a bottomless source of liquidity out of which more lending could be made.
• The flooding of financial markets with Fannie/Freddie asset-based securities that were rendered valueless because of the housing crash.
• The unflagging support given by the creators and friends of Fannie/Freddie that made impossible the improved regulation of both, long before the housing crash took place.   
• Greed, symbolized by the payment of indecent wages and fringes to the executives of Fannie/Freddie and to Wall Street executives.

A relevant piece of legislation became law under President G.H.W. Bush in 1989 -- The Financial Institutions Reform and Enforcement Act.   Jim Wright and Tom Foley controlled the House; George Mitchell, the Senate -- Democrats all.  The bill was passed in the aftermath of the Savings and Loan debacle and it refined federal auditing procedures over banks, increasing even more the pressures under which they were forced to operate.

Just before Republicans took control of Congress in 1994, President Clinton signed into law the 1994 Riegle-Neal Interstate Banking and Efficiency Act, which added even more pressure on banks to make loans approved by the feds.

Franklin Raines, formerly associated with both the Carter and the Clinton administrations was Fannie's Chairman in 1999.  Under pressure from Democrats, he lowered lending standards to include those whose credit is not good enough to qualify for conventional loans -- in effect, sub-prime lending became approved lending under federal standards.

Frequently made warnings about the real value of Fannie/Freddie assets were regularly pushed aside by major players.  For example, Rep. Barney Frank said in 2000 that concerns were overblown; in 2002, he said Fannie/Freddie were great assets; in 2003, he said American people did not face a crisis. 

Richard Syron, former Chairman of Freddie Mac, ignored warnings of regulators and his own risk officer (who resigned). 

Alan Greenspan in 2005 warned for the second time about looming problems at Fannie/Freddie.  Republicans, including John McCain, supported tighter regulations for Fannie/Freddie but were defeated by Democrats led by Senators Dodd and Schumer.

Fannie/Freddie were taken over by the federal government in September 2008 -- the potential cost to taxpayers is $200 billion.

Now, after seeing several failures of gigantic financial institutions, the government has pledged to buy $700 billion in toxic assets from banks who cannot lend with such junk on their balance sheets.  In effect, the banking industry is being federalized; in effect, American democracy is headed for the men's room.  The hope is that liquidity will be restored.  Confidence is not universal.

There are lessons in all of this.

• After the Great Depression, Fannie Mae should have been closed.  If there is a need for a secondary mortgage market, the private sector will fill it.
• Social objectives should never be allowed to weaken good business procedure.  There are good reasons for down-payment requirements and for income tests and they should not be abandoned because somebody yells "unfair."
• The time to buy a house is when one can afford it.  To try to hasten that time through undue government intervention ultimately benefits nobody.  Renting is not shameful. 
• To the extent that FHA, Veteran or other loans waive or lower down-payment requirements, to the same extent the check on capacity to pay must be intensified. 

Scoundrels are involved in this drama whose actions should be examined and, where possible, prosecuted. 

Names like Barney Frank and Chris Dodd come to mind.  Rep. Frank, a cheerleader for Fannie Mae, was also a long-time intimate of a Fannie executive, Herb Moses.  Was he unduly lenient toward Fannie?

How could Chris Dodd be objective when, at the same time, he was a major beneficiary of political donations from Fannie's employees  and, according to press reports, received favorable mortgage loan treatment from Countrywide Financial Corp. (under investigation)? 

And how about the golden parachutes given to executives from Fannie/Freddie and from private sector firms who left a shambles behind?

Warning!  This mess began when politicians in charge agreed that home ownership is a right.  Their subsequent intrusion into the public sector with rules and regulations that forced modifications of sound business practices are the ultimate cause of the current crisis. 

Leaders of the same ilk are now moving with force into two other major sectors of the economy: health care and energy.  Their "we-know-best" attitude applied in these two fields will, if successful, have the same disastrous effect. 

The ultimate lessons?  Government must back off; lenders must be prudent.  And borrowers must remember the maxim of survival: There ain't no such thing as a free lunch.