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07.16.2010 0

The Mad Tea Party

There’s no escape now.

Yesterday, the Senate voted 60 to 39 to take over the nation’s financial system. The bill now proceeds to Barack Obama, who will sign it, and it shall be law. Included is a hidden, permanent bailout that will enable faceless bureaucrats to levy taxes, bail out privileged institutions, and to seize disfavored ones, redistributing their assets to favored constituencies, like unions.

While the American people, represented by tea parties and concerned citizen activists, want to bring an end to the bailouts, takeovers, and government manipulations of the markets, in Washington, the lunacy only grows.

Call it the Mad Tea Party.

Thanks to Congress, now the Federal Deposit Insurance Corporation (FDIC), Treasury and Federal Reserve will have the power to tax and spend, seize property and redistribute wealth, monitor individual finances and arbitrarily declare which firms pose “systemic risk,” all without any vote in Congress or the possibility of judicial review. Meanwhile, the legislation does not address one of the root, government causes of the financial crisis.

In short, Congress learned nothing from the housing bubble, which is owed mostly to the errant, misguided social policies to extend home ownership throughout the 1990’s and 2000’s.

This is not merely a talking point. From 1992 onward, the Department of Housing and Urban Development (HUD) loosened lending standards by imposing “affordable housing goals” on Fannie Mae and Freddie Mac, adopted “Fair Lending Best Practices” requiring low-income lending, and promulgated new Community Reinvestment Act “regulations applicable to all insured banks, in particular a change from a qualitative standard to a quantitative,” according to research by former Chief Credit Officer of Fannie Mae, Edward Pinto.

In 1995, according to Pinto’s research, the GSE’s were allowed to “get affordable-housing credit for buying subprime securities that included loans to low-income borrowers.” HUD proceeded to expand the GSE’s “affordable housing goals,” which rose from 30 percent in 1993 to 56 percent by 2008. Also, loans with down payments of 3 percent or less by the FHA and the GSE’s rose from 1991 of just $7 billion (exclusive to the FHA) to $14 billion for the FHA and $160 billion+ for the GSE’s in 2007.

Pinto writes that the “impact of highly leveraged lending on other market participants cannot be underestimated.” When the GSE’s adopted weaker lending requirements, the “market response was: if it’s okay with Fannie and Freddie (the de facto standards setters) it must be okay for us.” But, because of the GSE’s well-capitalized positions in the market, they received “the lower risk end of these high risk [loan] categories for themselves and to garner most of the industry’s profits.” Competitors got what was left over, which consisted of the riskier mortgages.

Nonetheless, the losses to the GSE’s because of this excessive risk-taking pushed them into bankruptcy. By June 2008, Fannie and Freddie had taken on some $1.835 trillion in higher-risk mortgages and mortgage-backed securities just before they were nationalized. This included high risk loans in whole loan form, most of which, $1.646 trillion, were GSE-issued mortgage-backed securities, and $189 billion of subprime and Alt-A private mortgage-backed securities.

Moreover, because of the implicit backing of taxpayers, Fannie and Freddie securities were automatically given AAA credit ratings, according to Pinto. Because of that shielding from scrutiny, Fannie and Freddie were able to misrepresent the quality of mortgages that underlined those securities.

And because of the implicit backing of taxpayers, Fannie and Freddie crafted a marketing plan that enabled them to sell some $4.7 trillion of mortgage-backed securities, $1.5 trillion of which were sold overseas to investors, as reported by the New York Times. By promising a higher rate of return than treasuries, but with the same risk associated with a taxpayer guarantee, the sales flooded the GSE’s throughout the housing bubble. As more securities were sold, Fannie and Freddie bought more mortgages and bundled them into securities. As a direct result, Fannie and Freddie were able to acquire about half of all mortgages as of July 2008.

All the while, the Federal Reserve kept interest rates too low for too long, providing the necessary capital for the housing bubble to explode. According to research by Stanford economist John Taylor who in a recent Wall Street Journal column wrote, “the Fed’s target for the federal-funds interest rate was well below what the Taylor rule would call for in 2002-2005. By this measure the interest rate was too low for too long, reducing borrowing costs and accelerating the housing boom. The deviation from the Taylor rule, which had characterized good monetary policy during the previous two decades, was the largest since the turbulent 1970s.”

The repercussions of these catastrophic policies are still being felt. The explosion of foreclosures is largely owed because of the government-mandated, irresponsible lending that took place as a direct result. It’s actually getting worse, when 2010 promises to be the worst year yet, with more foreclosures than ever, according RealtyTrac, Inc.

Alas, the bill, which will be the law of the land, addresses none of these root causes of the crisis, and provides no respite from the government distortions of the housing market. It does not bring an end to Fannie Mae and Freddie Mac, the taxpayer tab which is up to $145 billion. Nor does it audit the Fed. And it fails to rein in HUD’s “affordable housing goals” and does not repeal the Community Reinvestment Act.

So, the insanity will continue, all but guaranteeing that there will be another crisis. The only difference is that next time insolvent firms won’t have to go through the lengthy debates in Congress to get their bailouts. Instead, unelected bureaucrats will give them out as a matter of law, and tax the citizenry to pay for it — by decree.

The people will have no means to remove these dictators from power, who will act with limitless discretion, and the madness will never end. There will be no escape.

Bill Wilson is the President of Americans for Limited Government.

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