This column by ACRU General Counsel and Senior Fellow for the Carleson Center for Public Policy (CCPP) Peter Ferrara was published November 10, 2011 on Forbes.com.
At the October 11 GOP Presidential primary debate on Bloomberg TV, Karen Tumulty of the Washington Post asked candidate Michelle Bachmann if Wall Street bankers had been adequately punished for “the damage they did to the economy.” In reply, Bachmann schooled the uninformed Tumulty, saying,
If you look at the problem with the economic meltdown, you can trace it right back to the federal government. It was the federal government that pushed the subprime loans. It was the federal government that pushed the Community Reinvestment Act….We had lending standards lowered for the first time in American history. The fault goes back to the federal government.
Newt Gingrich affirmed the same view.
The next day, the Washington Post struck back in a supposed “fact check.” The Post proclaimed: “The notion that the CRA – approved nearly 35 years ago in 1977–had anything to do with a lending crisis that flowered in 2007 and 2008 has been roundly discredited.”
Beware the supposed media fact check in this election cycle. So far, they are really “opinion checks” to enforce politically correct views. Step out of line with political correctness, and you will be labeled “factually incorrect.” What the Post has proclaimed is that the whole Republican/conservative interpretation of the financial crisis is “factually incorrect” and out of bounds.
Instead, the Post reports that “deregulation” was the cause of the financial crisis. Tumulty joined in the October 11 Presidential debate, piping up in rebuttal, “But the federal government has also deregulated them,” dutifully reflecting 2008 Obama campaign propaganda.
The Washington Post is so out of touch with mainstream America, it can no longer accurately report what is happening in the country, or even provide illuminating commentary on it.
One of the two primary causes of the financial crisis was overregulation, primarily forcing banks to trash traditional lending standards, and make ultimately trillions in subprime and other non-prime loans, for the social goal of promoting home ownership among the disadvantaged.
The full story is thoroughly explained in Paul Sperry, The Great American Bank Robbery: The Unauthorized Report About What Really Caused the Financial Crisis (Nashville: Thomas Nelson, Inc., 2011); Gretchen Morgenson, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon ((New York: Henry Holt, 2011); Stan Liebowitz, Anatomy of a Train Wreck: Causes of the Mortgage Meltdown, The Independent Institute, Independent Policy Report, October 3, 2008; and several articles by Peter Wallison, especially “The True Origins of the Financial Crisis,” The American Spectator, February, 2009.
Deregulation was responsible for exactly 0.00% of the crisis. That claim was Obama boob bait for the gullible, to draw attention from the real government causes, and blame free market economics instead. The oft-cited repeal of Glass-Steagall, for example, actually eased the crisis, by enabling the market rescue of failing investment banks and brokerage firms by commercial bank holding companies.
As Peter Wallison explained in his dissent to the Financial Crisis Inquiry Commission Report, the fundamental cause of the financial crisis was U.S. government affordable housing policy, enforced by federal regulation. In 1994, before this policy was strictly enforced, only 5 percent of all mortgage originations in the U.S. were subprime. By the time of the housing collapse, there were 27 million subprime and other risky loans, half of all mortgages in the United States.
These loans represented trillions poured into the housing market, pumping up housing demand and prices, and so greatly contributing to the housing bubble. Yet, these very same shaky loans were destined to default as soon as the bubble began to deflate. Wallison concludes, “If the U.S. government had not chosen this policy path–fostering the growth of a bubble of unprecedented size and an equally unprecedented number of weak and high risk residential mortgages–the great financial crisis of 2008 would never have occurred.”
That policy started with the CRA, which required banks to lend throughout the entire geographic area in which they operate, including the poorest neighborhoods where qualification for credit under traditional standards was quite limited. ACORN and other housing activists learned how to exploit that law more effectively in the late 1980s.
But still not much significant happened until 1995, when President Clinton announced his “National Home Ownership Strategy.” That new policy consisted of more than 100 specific regulatory actions to spread homeownership among lower income communities, and “close the ‘mortgage gap’ between blacks and whites.” In a splashy ceremony at the White House to announce his new policy, Clinton said, “Our homeownership strategy will not cost the taxpayers one extra cent. It will not require legislation.” That is because it only required regulation.
Clinton used Executive Orders to revise federal regulations regarding discriminatory housing lending (redlining) to mandate numerical targets for lending by mortgage institutions in predominantly poor, minority Census tracts, and to require banks to adopt “flexible underwriting standards” to meet those targets. He issued new CRA regulations requiring banks and savings and loan associations to meet quotas for mortgages to borrowers at or below 80% of median income in their service areas. Wallison explains,
In 1995, the regulators created new rules that sought to establish objective criteria for determining whether a bank was meeting CRA standards. Examiners no longer had the discretion they once had. For banks, simply proving that they were looking for qualified buyers wasn’t enough. Banks now had to show that they had actually made a requisite number of loans to low and moderate income (LMI) borrowers.
Also in 1995, HUD established regulatory quotas requiring Fannie and Freddie to devote 40% of their funds in 1996, and 42% in 1997, to low and moderate income housing. Former Texas Senator Phil Gramm notes in the Wall Street Journal that by the time the housing market collapsed, Fannie and Freddie faced three regulatory quota mandates. Those required 56% of their mortgages to individuals with below-average income, 27% of their mortgages to be granted to families with incomes at or below 60% of area median income, and 35% of their mortgages go to geographic areas deemed to be underserved.
Both HUD and the Justice Department also began bringing discrimination lawsuits against mortgage lenders that turned down a higher percentage of minority applicants than white applicants, regardless of whether that was justified under responsible lending standards. These lawsuits again involved regulatory enforcement.
The debasement of lending standards for the subprime market soon spread throughout the mortgage markets. As Wallison explains, “Once the standards were relaxed for low-income borrowers, it would seem impossible to deny these benefits to the prime market. Indeed, bank regulators, who were in charge of enforcing CRA standards, could hardly disapprove of similar loans made to better qualified borrowers.”
Through their securitization practices, Fannie and Freddie proceeded to spread the unrecognized high risks of these mortgages throughout the financial world, selling shares in pools of them to other financial institutions and investors, in America and around the globe. Because the capital markets believed, rightly as it turned out, that the bonds issued by Fannie and Freddie to raise money for their mortgage financing were effectively government guaranteed, the two organizations were able to raise huge sums at low interest rates to pump into these mortgages. That further pumped up the housing bubble, and exploded their pollution of U.S. and world financial markets to toxic levels. Fannie and Freddie alone eventually held a total of $1.6 trillion in subprime and Alt A loans.
The ratings agencies (Moody’s, Standard and Poor’s, Fitch) also let everyone down, because they were set up within a regulatory framework, protected from competition, to be the early warning system of trouble down the line. Government regulations mandated that certain financial institutions, such as insurance companies and money market funds, invest only in securities rated by these specific three agencies as AAA, to protect the institutions from excessive risk. Other institutions, such as commercial banks and investment banks, in the U.S. and around the world, based what they thought was an acceptable distribution of risk in their portfolios on the ratings these agencies gave various securities.
But this entire regulatory system broke down when the rating agencies were seduced into going along with the fashionable, subprime mortgage mania, failing to see through the fog of the housing bubble, which was their job. They consistently rated shares in securitized pools of mortgages, even subprime and Alt A mortgages, as AAA, causing the downfall of major financial institutions. Liebowitz emphasizes that because these ratings agencies were protected from free market competition, and so granted a government favored status by regulation, they naturally did not want to create controversial political waves by rocking the subprime mortgage boat, which would endanger their regulation protected profits.
When the housing bubble popped, and the resulting financial crisis spread, regulation further contributed to the problem. The SEC had just adopted an obscure accounting regulation known as mark to market in 2006 (also known as fair value accounting). This regulation required the balance sheets of financial institutions to list assets at their current market prices every day, rather than their historical costs or their expected values based on their probable future income streams.
This meant that when panic selling by some troubled institutions to raise capital drove the value of mortgage related securities to virtually zero, all institutions had to change their books to reflect this minimal market value of the securities. An institution could be receiving all of the payments due on its mortgage backed securities just fine, with nothing in default. But overnight they had to list these securities as worthless nevertheless because of the desperation, panic sales of others, under the mark to market regulatory requirements.
Consequently, balance sheets under mark to market accounting suddenly started to show insolvency, or near insolvency, for more and more institutions. All lending to these companies shut down, so they lost all liquidity needed to keep company operations going.
Stockholders realizing that they would be wiped out if the companies went into bankruptcy, or got taken over by the government, started panic selling, even when they knew the underlying business of the company was still viable. This is how with more than 90% of mortgages still paying on time, major companies like Merrill Lynch, Bear Stearns, AIG, and Lehman Brothers, found themselves suddenly bankrupt almost overnight.
The other major cause of the financial crisis was the cheap dollar monetary policy of the Federal Reserve, reflecting the benighted policies of President Bush and his Treasury Department. This is most authoritatively explained by Stanford Economics Professor John Taylor in his timely book, Getting Off Track:
“The classic explanation of financial crises, going back hundreds of years, is that they are caused by excesses – frequently monetary excesses – that lead to a boom and an inevitable bust. In the recent crisis we had a housing boom and bust, which in turn led to financial turmoil in the United States and other countries. I begin by showing that monetary excesses were the main cause of the boom and the resulting bust.”
The Fed pursued its wildly loose monetary policy from early 2001 to late 2006, with a negative real federal funds rate for 2 ½ years. Steve Forbes explained in his book, How Capitalism Will Save Us, “In 2004, the Federal Reserve made a fateful miscalculation. It thought the U.S. economy was much weaker than it was and therefore pumped out excess liquidity and kept interest rates artificially low.” This Fed policy further pumped up the housing bubble, as housing is a long lived asset especially favored by low interest rates.
The formerly mainstream media will hear this Republican/conservative explanation of the financial crisis throughout the election next year, all the while proclaiming it and many other Republican policies out of bounds. But if they are looking for people to punish for “the damage they did to the economy,” they need to turn to Washington not New York, and the names Dodd, Frank, Clinton, Bush, and Bernanke.