By Bill Wilson
Correction: AIG did not insure, and credit ratings agencies did not examine Fannie Mae and Freddie Mac mortgage-backed securities with the same scrutiny as other securities, as was previously reported. Instead, Fannie and Freddie MBS were given AAA ratings on the basis of their implicit government backing, and AIG only insured private non-Freddie and Freddie MBS, according to sources familiar with the mortgage industry. Taxpayers, as it turns out, were ultimately Fannie and Freddie’s MBS insurance.
As the Senate begins debate on Senator Chris Dodd’s (D-CT) financial “reform” bill, what is missing from the bill is nearly as bad as what it contains.
First, a brief examination of some of its key provisions is obliged: as reported by NPLC.org, it creates a Financial Stability Oversight Council to put into receivership — i.e. take over — any financial institution it deems “too risky”; it puts the Federal Reserve in charge of a Consumer Financial Protection Bureau with sweeping powers to regulate any institution with a portfolio exceeding $10 billion; it creates a permanent revolving $50 billion bailout fund; and “[u]pon a consensus by the Fed, the Treasury Department and Federal Deposit Insurance Corporation (FDIC), unstable institutions would be turned over to the FDIC.”
In short, the legislation is an extensive takeover of the nation’s entire financial system; a classic case of the “cure” being worse than the disease. Namely, because it fails to address the root causes of the financial collapse of 2007 and 2008. Instead, it barely treats the symptoms of the problems — all of which government created.
For example, the bill neither repeals the Community Reinvestment Act nor the Clinton-era regulations that executed it forcing banks to offer mortgages to lower-income Americans. This essential weakening of credit was hailed at the time by then-HUD Director Andrew Cuomo as an end to “discrimination in lending,” but we now know was one of the principal causes of Americans receiving mortgages they could never afford.
Last year alone, there were 3.9 million foreclosure filings, as reported by Business Week, surpassing 2008’s 3.2 million foreclosures. And the pain is hardly over yet. RealtyTrac Senior Vice President Rick Sharga and Trulia CEO Pete Flint forecast as many as 4 million foreclosures in 2010.
In the meantime, since the crisis began, all of government’s energies have been spent attempting to “loosen” credit: the Federal Funds Rate that banks borrow from one another is at 0 to 0.25 percent and the Federal Reserve has more than doubled the money supply since 2007.
Which brings us to the Federal Reserve’s easy money policies. The Dodd bill will do nothing at all to rein in the Fed’s ability to arbitrarily set artificially-low interest rates and to fire up the nation’s printing presses for its lending sprees. Instead, it promotes the central bank with even more power to regulate financial institutions.
Remember, the Fed’s lower-than-justified interest rates played a critical role in causing the housing boom to begin with. The Community Reinvestment Act regulations were bad enough, but on their own they would have never resulted in the record expansion of mortgages that was seen. The capital the Fed provided to the banking system did that. In 1990, outstanding mortgage debt held was $3.805 trillion. By the end of 2007, total mortgage holdings had risen to $14.568 trillion, a monumental 282 percent jump of $10.763 trillion in new mortgages.
Now, we know that Congress was putting pressure on the Fed to keep interest rates down. As reported by Reuters, “Former Federal Reserve Chairman Alan Greenspan chastised critics on Wednesday by pointing out that Congress pushed the U.S. central bank to make sure lending to poorer Americans kept rising in the 2000s.”
Said Greenspan, “If the Fed as a regulator had tried to thwart what everyone perceived as a fairly broad consensus that the trend was in the right direction, homeownership was rising and that was an unmitigated good, then Congress would have clamped down on us.”
In short, Greenspan’s excuse was “Congress made me do it.” To a degree, it appears to be a cop-out, but there is some substance there. First off, the Senate has its role in confirming members of Federal Reserve’s Board of Governors, and both houses of Congress share key oversight responsibilities of the nation’s monetary policy.
In other words, the Fed is not as independent as is pretended. Greenspan pointed out that “[t]here’s a presumption that the Federal Reserve’s an independent agency, and it is up to a point, but we are a creature of the Congress and if … we had said we’re running into a bubble and we need to retrench, the Congress would say ‘we haven’t a clue what you’re talking about’.”
Indeed, Congress was in on the racket. For example, promoting lending to lower-income Americans was a means of cultivating individual members’ political constituencies.
Making matters worse, Congress repeatedly resisted attempts to rein in mortgage giants Fannie Mae and Freddie Mac, meanwhile taking lush campaign donations from company employees, as reported by OpenSecrets.org.
We now know that Fannie and Freddie were responsible for securitizing about $4.7 trillion in mortgages — and then went on to sell them all over the world. As reported by the New York Times, that included some $1.5 trillion that was sold to foreign investors. And, as more securities were sold, more mortgages were underwritten by Fannie and Freddie.
Unfortunately, the Dodd bill fails to address reining in Fannie and Freddie at all. Instead it leaves the federal government in complete ownership of the Government Sponsored Enterprises, while the Treasury denies that that taxpayers backing up the mortgage giants, as ALG News has previously reported.
Congress now pretends that simply regulating the derivatives trade and credit rating agencies will solve the problem. However, since the derivatives were not cause the crisis, but instead were a victim, restricting their trade will not prevent it from happening again. To be certain, insurance giant AIG got in on the action, selling insurance policies on securities from other underwriters besides Fannie and Freddie, a multi-trillion dollar industry, and made a series of bad bets.
But this was not the true cause of the crisis, as reported by American Enterprise Institute’s Peter Wallison. Writes Wallison, “New research by Edward Pinto, a former chief credit officer for Fannie Mae and a housing expert, has found that from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A.”
Critically, Wallison writes that “this misrepresentation was a principal cause of the financial crisis.” Indeed. Because the securities were mislabeled, the anticipated default rates were miscalculated by the holders of securities and the companies that insured them. The rest was a predictable catastrophe.
So how could that happen? Wallison states that “Why Fannie and Freddie did this is still to be determined. But the leading candidate is certainly HUD’s affordable housing regulations, which by 2007 required that 55 percent of all the loans the agencies acquired had to be made to borrowers at or below the median income, with almost half of these required to be low-income borrowers.”
So, loose lending and easy money, coupled with securitizing bad mortgages and selling them around the world as if they were as good as gold with the implicit backing of U.S. taxpayers was the problem. It was a house of cards, a system that was designed as if the housing boom would never end. But when it did, and when the wave of foreclosures began, the pain was unmitigated.
So, rather than bringing the Fed, Fannie, and Freddie and the HUD regulations that helped cause the crisis to heel, and rather than accepting that the housing bubble was entirely government-created, Congress has almost completely avoided addressing a single one of the root causes of the financial crisis.
Instead, Congress sticks to the myth that the “free market” caused the crisis and promotes the de facto takeover of the nation’s entire financial system. This is an example of avoiding responsibility by punishing others for one’s own misdeeds and in the meantime seizing unbridled power. And members must not be allowed get away with it.
Bill Wilson is the President of Americans for Limited Government.
