Via Ace. Silence, and then a dodge. Says it all.

We're in the middle of nasty financial times, and as luck (or unluck) would have it, we're also in the middle of a presidential election. As I see it, that gives us a couple of responsibilities here: first of all, fixing the problem, but then, and perhaps more importantly, figuring out exactly what happened and ensuring that the mechanisms that were put in place to bring us to this point are disabled and that the people who built those mechanisms are not allowed to do it again. As for fixing the problems, well, I'll leave that to others. I have absolutely no confidence in Congress - frankly on either side of the aisle, although I'd prefer to have the Republicans in charge, because while they're politically stupid, at least they're not BATSHIT INSANE like Pelosi, Reid and their idiot minions.

So what happened?

Aah, sweet sweet Jimmy Carter. Will your legacy ever stop biting us in the ass? No. It never will. Back in 1977, Carter signed into law the Community Reinvestment Act, which required lenders to offer credit to borrowers who previously would have been considered less-than-creditworthy. It was a well-intentioned move, of course, with the goal of moving more low-income individuals into homes. But from this tiny acorn (heh) that was planted by the Carter Administration sprang the mighty poison oak that our government and financial markets are trying desperately to fell today.

Here's the problem with the CRA: it forced lenders to abandon free market principles. Under normal circumstances, a lender is not going to give money to a person who is unlikely to pay it back. This is, of course, an obvious problem for many minority groups who statistically tend to be poorer and a higher credit risk. It's an issue that should be addressed, although addressing it by using the government to force lenders to ignore creditworthiness in lending decisions is questionable at best. I'd argue that finding ways to encourage private wealth creating in poorer communities would be a better and more fruitful way of expanding homeownership, but then again, I'm not in Congress. (It should also be noted that CRE seems to be instrumental in spawning awful left-wing groups like ACORN, which unfortunately get funded with our tax dollars to advocate for lousy economic policy.) Nonetheless, my impression after some poking around is that throughout the 80s and early 90s, CRA chugged along below the radar as most federal legislation does - doing a little bit of good, probably causing more problems than it was worth, but certainly not causing any sort of major crisis. As evidenced by the fact that... there was no major crisis in the mortgage or credit markets.

Enter Bill Clinton. Among other changes to federal housing law, there was some serious attention paid to the operation of the CRA during the Clinton Administration, as explained by Thomas DiLorenzo, Professor of Economics at Loyola University:

...in 1995, the US Treasury Department created the multibillion-dollar "Community Development Financial Institutions" fund to "provide banks with access [i.e., taxpayers' dollars] to new opportunities to finance community economic development" as "encouraged" by the CRA, said the Fed chairman.

The government also "streamlined" the regulatory requirements for CRA loans in 1995, allowing — and indeed pressuring — banks to make such loans without the benefit of many traditional credit-worthiness criteria, such as the size of the mortgage payment relative to income, savings history, and even income verification! Instead, the Fed told banks that participation in a credit-counseling program, many of which are federally funded, could be used as "proof" of a low-income applicant's ability to make his mortgage payments. In other words, federal bank regulators required banks to make bad loans based on nonexistent credit standards.

Here's a bit more on the insanity that was going on in the early-to-mid 90's that sheds some light on where we are right now:

... the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: "discrimination may be observed when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants."

Some of these "outdated" criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification. Instead, the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant's ability to manage debt.

Sound crazy? You bet. Those "outdated" standards existed to limit defaults. But bank regulators required the loosened underwriting standards, with approval by politicians and the chattering class. A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities. It also let community activists intervene at yearly bank reviews, shaking the banks down for large pots of money.

Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department.

Flexible lending programs expanded even though they had higher default rates than loans with traditional standards. On the Web, you can still find CRA loans available via ACORN with "100 percent financing . . . no credit scores . . . undocumented income . . . even if you don't report it on your tax returns." Credit counseling is required, of course.

A note here, from personal experience: I recall being utterly shocked at how unbelievably easy it was for my wife and I to be pre-qualified for a mortgage back in October of 2001, especially considering that it was immediately after 9/11, the economy was in the tank, and I was unemployed. Frankly, we're probably among the class that would have been laughed out of any decent lender's office prior to the changes in the mid-90s. The good news is that we've actually been paying our mortgage, although who knows how many others in the mortgage class of '01 still are.

Back to the story: At this point, it seems wise to get some background on Fannie Mae and Freddie Mac. What are they? What do they do? What the heck happened to them? Here's the info:

Fannie and Freddie are government-chartered, shareholder-owned public companies. Because of their government charters and many government-provided privileges, they are known as government-sponsored enterprises, or GSEs. The companies carry on their business in two ways. In a process known as a securitization, they buy mortgages from mortgage originators, place them in trusts, and issue securities from these trusts that are backed by the payments of principal and interest on the pooled mortgages. These transactions create what are called mortgage-backed securities (MBS). Fannie and Freddie only guarantee to the holders of MBS that the principal and interest on the mortgages in the trusts will be paid in full and on time. In other words, Fannie and Freddie take only the credit risk on these mortgages; the interest-rate risk--that interest rates will rise and the mortgages will become less valuable, or that interest rates will fall and the mortgages will be prepaid and disappear--is taken by the holders of the MBS. For their guarantee, Fannie and Freddie receive an annual fee as long as the pools remain in existence. In this segment of their business, Fannie and Freddie have guaranteed about $2.2 trillion in mortgages.[1]

In the other part of their business, Fannie and Freddie buy mortgages from originators and hold them in portfolio; they also repurchase for their portfolios some of the MBS that they have already issued. Because they are then the owners of these mortgages and MBS, they have assumed the credit risk, and because they have to borrow the funds to buy the mortgages and MBS, they assume the associated interest-rate risk. Of the two, interest-rate risk is far more significant, and Fannie and Freddie have to enter into large hedging transactions to mitigate it. They assume these substantial risks, and contract for hedging, because their portfolios of mortgages produce by far the greater part of their profits. This is true because, as GSEs, they are accorded favorable rates in the capital markets, and thus can arbitrage between their borrowing costs and the rate they will receive on the mortgages and MBS they hold. Their mortgages and MBS assets are currently worth approximately $1.5 trillion, and this is also approximately the aggregate amount of their borrowings.

Please make sure you're paying attention to this next paragraph:

To place this in some perspective, all Treasury debt held by the public totals $4.4 trillion, and all corporate bonds outstanding total $2.9 trillion. Fannie's and Freddie's liabilities--including both their MBS guarantees and their borrowings--come in right in the middle, at $3.7 trillion. Thus, only two companies--both of which are GSEs and implicitly backed by the U.S. government--account for more default risk than all other U.S. corporations combined. The risks for the taxpayers are obvious, but as many commentators have also pointed out, risk of this size, if concentrated in only two companies, poses a danger to the U.S. economic system as a whole--a danger known as systemic risk.

Let's review: the Community Reinvestment Act - Carter era legislation - began the process of forcing lenders to extend credit to borrowers who would not qualify under traditional credit rules. Then in the mid 90's, the Clinton Administration Treasury Department worked hard to vastly increase the amount of credit available to low income borrowers. Freddie and Fannie jumped into this market with both feet, and built up a portfolio that held an amount of debt approaching the size of the U.S. national debt, helped along by the Fed, which was pursuing a policy of keeping interest rates low in order to keep the economy strong after the Tech bubble burst.

So now we've got a housing market awash in cheap money with a whole new class of potential homebuyers spurred on by CRA inspired regulatory changes. And naturally, since so many people are looking to buy, home values start to increase. Prior to the late 90's, home values had kept pretty close to the rate of inflation, but no longer. We now had a frenzy of buying and selling and flipping going on, driving prices up for no real reason other than as a response to an artificially propped-up demand. (This was the era when you couldn't go through a commercial break without seeing an ad for Countrywide Mortgage or some other lender promising great rates on home loans or "interest only" loans or some other such mortgage or equity related product.)

People with sense were already warning of problems within a few years of the genesis of this crisis. Going back to that New York Post article:

This damage was quite predictable: "After the warm and fuzzy glow of 'flexible underwriting standards' has worn off, we may discover that they are nothing more than standards that lead to bad loans . . . these policies will have done a disservice to their putative beneficiaries if . . . they are dispossessed from their homes." I wrote that, with Ted Day, in a 1998 academic article.

Sadly, we were spitting into the wind.

"I" in this case is Stan Liebowitz, the Ashbel Smith professor of Economics in the Business School at the University of Texas at Dallas. And it wasn't just a few academics saying this; there were politicians who were warning of the impending collapse of the Fannie Mae-driven subprime market, including the much-hated George W. Bush, whose administration had tried numerous times dating back to 2001 to reform Fannie and Freddie by attempting to restrict the size of their portfolios and create a more robust regulator for them. Here's a roundup of the Bush Administration's position on this issue through the past 8 years. For example:

** 2001

April: The Administration's FY02 budget declares that the size of Fannie Mae and Freddie Mac is "a potential problem," because "financial trouble of a large GSE could cause strong repercussions in financial markets, affecting Federally insured entities and economic activity."

** 2002

May: The President calls for the disclosure and corporate governance principles contained in his 10-point plan for corporate responsibility to apply to Fannie Mae and Freddie Mac. (OMB Prompt Letter to OFHEO, 5/29/02)

** 2003

January: Freddie Mac announces it has to restate financial results for the previous three years.

February: The Office of Federal Housing Enterprise Oversight (OFHEO) releases a report explaining that "although investors perceive an implicit Federal guarantee of [GSE] obligations," "the government has provided no explicit legal backing for them." As a consequence, unexpected problems at a GSE could immediately spread into financial sectors beyond the housing market. ("Systemic Risk: Fannie Mae, Freddie Mac and the Role of OFHEO," OFHEO Report, 2/4/03)

There's more, but I'll let you read the rest at that link, because I'd like to focus on that last item, involving the Office of Federal Housing Enterprise Oversight. Let's go back to that CEI analysis that I referenced earlier:

As part of the fallout from Enron and WorldCom, Freddie Mac decided to engage new auditors, replacing Arthur Andersen. The new auditors found discrepancies in the company's financial reports, and an independent counsel was engaged to do an investigation. The investigation showed that Freddie had manipulated its earnings in order to reduce reported volatility, and--perhaps more important--one of Freddie's senior managers seemed to have taken steps to obstruct the investigation. As a result, Freddie dismissed its three top officers, an action that apparently came as a complete surprise to the Office of Federal Housing Enterprise Oversight (OFHEO), the company's regulator. OFHEO was embarrassed by its failure to discover on its own the facts that led to the dismissal of Freddie's top officers--or even that there was an internal investigation that might lead to their dismissal--and its ability effectively to regulate the GSEs was publicly called into question.

This event seems to have precipitated major changes in the views and behavior of the three principal government groups that had the power to affect the future of Fannie and Freddie. The administration became engaged, seemingly for the first time, in considering the risks associated with both companies; OFHEO metamorphosed from a butterfly into a wasp; and members of Congress started to take Chairman Baker's legislation more seriously. The result was a compete change in the atmosphere surrounding the GSEs.

So finally OFHEO gets as tough on Fannie and Freddie as they should have been all along and presents a report to Congressional regulators on the shenanigans going on at the GSEs. How did the Congressional regulators respond? Judge for yourself:


Video via Everything I Know Is Wrong.

Also at that link is a reference to a 2005 bill - the Federal Housing Enterprise Regulatory Reform Act - which was yet another attempt to rein in Fannie and Freddie out of a concern over the systemic risk they posed to the US economy. Here's the bill summary:

1/26/2005--Introduced.

Federal Housing Enterprise Regulatory Reform Act of 2005 - Amends the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 to establish: (1) in lieu of the Office of Federal Housing Enterprise Oversight of the Department of Housing and Urban Development (HUD), an independent Federal Housing Enterprise Regulatory Agency which shall have authority over the Federal Home Loan Bank Finance Corporation, the Federal Home Loan Banks, the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac); and (2) the Federal Housing Enterprise Board.

Sets forth operating, administrative, and regulatory provisions of the Agency, including provisions respecting: (1) assessment authority; (2) authority to limit nonmission-related assets; (3) minimum and critical capital levels; (4) risk-based capital test; (5) capital classifications and undercapitalized enterprises; (6) enforcement actions and penalties; (7) golden parachutes; and (8) reporting.

Amends the Federal Home Loan Bank Act to establish the Federal Home Loan Bank Finance Corporation. Transfers the functions of the Office of Finance of the Federal Home Loan Banks to such Corporation.

Excludes the Federal Home Loan Banks from certain securities reporting requirements.

Abolishes the Federal Housing Finance Board.

One of the bill's primary backers? Senator John McCain. Here's his statement in support of the bill, back on May 25, 2006:

Mr. President, this week Fannie Mae's regulator reported that the company's quarterly reports of profit growth over the past few years were "illusions deliberately and systematically created" by the company's senior management, which resulted in a $10.6 billion accounting scandal.

The Office of Federal Housing Enterprise Oversight's report goes on to say that Fannie Mae employees deliberately and intentionally manipulated financial reports to hit earnings targets in order to trigger bonuses for senior executives. In the case of Franklin Raines, Fannie Mae's former chief executive officer, OFHEO's report shows that over half of Mr. Raines' compensation for the 6 years through 2003 was directly tied to meeting earnings targets. The report of financial misconduct at Fannie Mae echoes the deeply troubling $5 billion profit restatement at Freddie Mac.

The OFHEO report also states that Fannie Mae used its political power to lobby Congress in an effort to interfere with the regulator's examination of the company's accounting problems. This report comes some weeks after Freddie Mac paid a record $3.8 million fine in a settlement with the Federal Election Commission and restated lobbying disclosure reports from 2004 to 2005. These are entities that have demonstrated over and over again that they are deeply in need of reform.

For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac--known as Government-sponsored entities or GSEs--and the sheer magnitude of these companies and the role they play in the housing market. OFHEO's report this week does nothing to ease these concerns. In fact, the report does quite the contrary. OFHEO's report solidifies my view that the GSEs need to be reformed without delay.

I join as a cosponsor of the Federal Housing Enterprise Regulatory Reform Act of 2005, S. 190, to underscore my support for quick passage of GSE regulatory reform legislation. If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.

I urge my colleagues to support swift action on this GSE reform legislation.

The bill never made it out of committee. The Democrats in the Senate made it clear that they would not support the reforms, expressing attitudes similar to those of their colleagues in the House in the video above.

So - The Government required lenders to engage in risky behavior. Fannie and Freddie led the way in doing so. Republicans in both the Bush Administration and Congress recognized the danger as far back as 2000 (and frankly, probably earlier) and were urging action and submitting legislation in an attempt to ward off a collapse. Congressional Democrats insisted that there was no problem, fretted that taking any action might reduce the stock of affordable housing, and used all the means at their disposal to stop any reform.

When the first wave of loan defaults started hitting in 2007, banks started getting nervous and tightened up credit. Home values started to fall. Eventually, a couple of hedge funds at Bear Stearns that dealt with a lot of subprime mortgages collapsed. And now, just as predicted by Bush, McCain, and a ton of other folks of more conservative persuasion, Fannie and Freddie have imploded, Wall Street is in a panic, and everyone's talking about the return of the Great Depression.

And the Democrats say that this situation is the result of deregulation and is therefore a Republican scandal.

That takes some serious balls.

Heck, even a certain former President admits that the Democrats in Congress weren't exactly helpful in averting this crisis, as noted by the McCain campaign in this ad:



Allahpundit is even calling Billy Jeff "America’s favorite newly minted right-leaning independent." (Notice - Clinton also doesn't buy the left's argument that this is all the result of deregulation either.)

We're in the middle of a presidential campaign. Barack Obama claims that this election is about "judgement." Let's look at his judgement as relates to the people he's chosen to surround himself with as he tries to win the White House:

• Jim Johnson: former CEO of Fannie Mae ('91-'98 - the start of the subprime bubble), chosen by Obama to work on the selection committee that vetted potential VP picks. forced to quit as an advisor to the Obama Campaign after shady loans from Countrywide Mortgage came to light. Made millions at Fannie Mae, although the company hid a significant part of his compensation.
• Franklin Raines: CEO of Fannie Mae from 1998 to 2004, prime mover behind Fannie Mae's big push into a much riskier business model during that time period; forced to resign as CEO after investigations revealed Fannie's Enron-style accounting irregularities. Advised Obama's campaign on "mortgage and housing policy matters," according to the Washington Post.
• Penny Pritzker: Obama's national finance chair; former board member of failed Superior Bank S&L that pioneered subprime mortgage lending in the 90's. "Superior’s owners were to sub-prime lending, what Michael Milken was to junk bonds.”

These are the people that built the bomb that went off in the financial markets last week. They have played important roles in Obama's campaign. They likely would have played major roles in an Obama Administration, had the bomb not detonated. This is a real-world example of Obama's much-vaunted "judgement to lead."

Obama and his Democrat colleagues had opportunities to defuse the bomb through legislation and the exercise of proper oversight over GSAs. Not only did they fail to do so, they actually attacked those who raised the alarm about Fannie and Freddie for trying to create panic in the markets. They claimed the threat did not exist. They refused to defuse the bomb.

On the other hand, John McCain, George Bush and Congressional Republicans pushed for the reform and proper oversight the GSAs needed. That's the simple fact. I am by no means claiming that Republicans are always right - far from it. But on this one, they were, and for the Democrats and Obama to claim otherwise is a ridiculous lie.

By my count, this is at least two major issues on which we can compare McCain and Obama's "judgement to lead" - the surge in Iraq, and the subprime mess. Both issues are of vital national importance; failure on both entails serious consequences for our country. On both issues, John McCain was absolutely right, and Barack Obama was completely, dreadfully wrong.

Judgement to lead? Obama has a sterling public image and excellent PR, but a great facade does not equal good judgement. McCain has demonstrated excellent judgement on the two most important issues of our day.

A postscript: Nancy Pelosi has announced that she won't be allowing any "witch hunt" over Fannie and Freddie in the next congressional term:

...according to House Oversight Committee staff, Emanuel has received assurances from Pelosi that she will not allow what he termed a "witch hunt" to take place during the next Congressional session over the role Fannie Mae and Freddie Mac played in the economic crisis.

Emanuel apparently is concerned the roles former Clinton Administration members may have played in the mortgage industry collapse could be politically -- or worse, if the Department of Justice had its way, legally -- treacherous for many.

Translation: since there aren't any Republicans we can throw in jail for this, we're just going to let it slide.

Voting for Obama rewards and empowers this crowd. Judgement to lead? You be the judge.