Monday, September 22, 2008

How the Democrats Created the Financial Crisis

Sept. 22 (Bloomberg) -- The financial crisis of the past year has provided a number of surprising twists and turns, and from Bear Stearns Cos. to American International Group Inc., ambiguity has been a big part of the story.

Why did Bear Stearns fail, and how does that relate to AIG? It all seems so complex.

But really, it isn't. Enough cards on this table have been turned over that the story is now clear. The economic history books will describe this episode in simple and understandable terms: Fannie Mae and Freddie Mac exploded, and many bystanders were injured in the blast, some fatally.

Fannie and Freddie did this by becoming a key enabler of the mortgage crisis. They fueled Wall Street's efforts to securitize subprime loans by becoming the primary customer of all AAA-rated subprime-mortgage pools. In addition, they held an enormous portfolio of mortgages themselves.

In the times that Fannie and Freddie couldn't make the market, they became the market. Over the years, it added up to an enormous obligation. As of last June, Fannie alone owned or guaranteed more than $388 billion in high-risk mortgage investments. Their large presence created an environment within which even mortgage-backed securities assembled by others could find a ready home.

The problem was that the trillions of dollars in play were only low-risk investments if real estate prices continued to rise. Once they began to fall, the entire house of cards came down with them.

Turning Point

Take away Fannie and Freddie, or regulate them more wisely, and it's hard to imagine how these highly liquid markets would ever have emerged. This whole mess would never have happened.

It is easy to identify the historical turning point that marked the beginning of the end.

Back in 2005, Fannie and Freddie were, after years of dominating Washington, on the ropes. They were enmeshed in accounting scandals that led to turnover at the top. At one telling moment in late 2004, captured in an article by my American Enterprise Institute colleague Peter Wallison, the Securities and Exchange Comiission's chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's position on the relevant accounting issue was not even ``on the page'' of allowable interpretations.

Then legislative momentum emerged for an attempt to create a ``world-class regulator'' that would oversee the pair more like banks, imposing strict requirements on their ability to take excessive risks. Politicians who previously had associated themselves proudly with the two accounting miscreants were less eager to be associated with them. The time was ripe.

Greenspan's Warning

The clear gravity of the situation pushed the legislation forward. Some might say the current mess couldn't be foreseen, yet in 2005 Alan Greenspan told Congress how urgent it was for it to act in the clearest possible terms: If Fannie and Freddie ``continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road,'' he said. ``We are placing the total financial system of the future at a substantial risk.''

What happened next was extraordinary. For the first time in history, a serious Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.

Different World

If that bill had become law, then the world today would be different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest and most venerable institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed.

But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.

That such a reckless political stand could have been taken by the Democrats was obscene even then. Wallison wrote at the time: ``It is a classic case of socializing the risk while privatizing the profit. The Democrats and the few Republicans who oppose portfolio limitations could not possibly do so if their constituents understood what they were doing.''

Mounds of Materials

Now that the collapse has occurred, the roadblock built by Senate Democrats in 2005 is unforgivable. Many who opposed the bill doubtlessly did so for honorable reasons. Fannie and Freddie provided mounds of materials defending their practices. Perhaps some found their propaganda convincing.

But we now know that many of the senators who protected Fannie and Freddie, including Barack Obama, Hillary Clinton and Christopher Dodd, have received mind-boggling levels of financial support from them over the years.

Throughout his political career, Obama has gotten more than $125,000 in campaign contributions from employees and political action committees of Fannie Mae and Freddie Mac, second only to Dodd, the Senate Banking Committee chairman, who received more than $165,000.

Clinton, the 12th-ranked recipient of Fannie and Freddie PAC and employee contributions, has received more than $75,000 from the two enterprises and their employees. The private profit found its way back to the senators who killed the fix.

There has been a lot of talk about who is to blame for this crisis. A look back at the story of 2005 makes the answer pretty clear.

Oh, and there is one little footnote to the story that's worth keeping in mind while Democrats point fingers between now and Nov. 4: Senator John McCain was one of the three cosponsors of S.190, the bill that would have averted this mess.

(Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist. He is an adviser to Republican Senator John McCain of Arizona in the 2008 presidential election. The opinions expressed are his own.)

To contact the writer of this column: Kevin Hassett at

Last Updated: September 22, 2008 00:04 EDT

In summary, the Democrats used the mortgage industry to buy votes by forcing/allowing the mortgage industry to lower the standards for home financing. It's that simple.


Mike West said...

You and I both know, we will never see this headline in the old press and this will not be the story most Americans will hear or see. Guess what? It's Bush's fault and Bush = McCain. This financial debacle will not help McCain's campaign.

twest said...

I saw Clinton (Bill) defending his administration today for their efforts to "promote" housing for those who were left out of the "American Dream of home ownership". Particularly Robt Rubin, Jane (or Jamie) Gorelick. She's infamous for setting up the firewall between FBI and CIA to protect Americans from domestic spying (sharing info). Hence - Sept 11. I"m convinced the Democrats in Congress have done everything they can to wreck the US economy just to put a Dem in White House, knowing Bush will get the blame. That's why they have a 7% approval rating - lowest in History

vwatt said...

Looks like it's back to work for us bloggers-the one week break is over! For starters, I see the author of this Bloomberg article is an unbiased former advisor to McCain. Neither party is blameless in this fiasco, but who controlled Congress and the committees in 2005? Yup. I give McCain lots of credit for being one of three senators who did get this bill out of the starting gate. However, I don't think the Dems can block a committee vote by themselves as they were the minority at this time. It must not have been much of a priority for the Republicans either as they had the votes to bring it to the floor but did not push it. The one thing I really have trouble understanding is how 700 billion is not a "handout" to Wall Street(resulting in a govt. takeover of a large chunk of our financial system) but 50 billion over a five year period for a childrens's health insurance bill is considered "the road to socialized medicine" by the compassionate conservatives. From "the Google":

"In the 109th Congress (2005-2006), the House overwhelmingly approved (331 to 90) HR 1461, The Federal Housing Finance Reform Act, designed "to create a stronger regulator for Fannie Mae and Freddie Mac." The Senate, still controlled by Republicans lagged the House in taking action. It is not clear if this was a lack of Republican leadership or blockage by Democratic leadership (filibuster threats). (Shout if you have links to illustrate this impasse.)

HR 1461 remained stalled in the Senate: last action, 31 October 2005, referred to the Committee on Banking, Housing, and Urban Affairs.

On 31 July 2007, after the Democrats obtained control of the Congress in the November 2006 election, House Speaker Nancy Pelosi introduced HR 3221, a "bill to provide needed housing reform and for other purposes." Among other things, the bill granted the newly formed Federal Housing Finance Agency "supervisory and regulatory authority over Fannie Mae, Freddie Mac, and the federal home loan banks (enterprises)" (per CRS analysis).

Pelosi's bill became Public Law 110-140 on 19 December 2007 110-289 on 30 July 2008.

vwatt said...

Here's one more perspective from a Republican(via our local Star Tribune newspaper) to shine a little more light on issues Faux News, Rush, and Hannity are not likely to visit for all their fans out there:

Inside Track

Last update: September 21, 2008 - 5:11 PM
Former U.S. Rep. Mike Oxley, a 25-year Republican who retired in 2006, blames the Bush administration and former Federal Reserve Chairman Alan Greenspan for failing to head off the current financial crisis.
They failed to act in 2005 when it became clear that the subprime mortgage boom was becoming a dangerous trend that would threaten government-sponsored buyers as well as homeowners, Oxley said at a Minneapolis speaking engagement last week.
"[The Federal Reserve] had the tools to police the ever-burgeoning number of 'no-documentation' and low-down-payment and other subprime mortgage products" that have flooded the market," said Oxley, a former chairman of the House Financial Services Committee.
"The number of mortgage brokers was exploding. There was cheap money and patchy state regulation. The brokers were dragging people in and they were targeting low-income and minority communities," he said. "We had old bankers saying: 'What planet are you on?'"
Oxley and other critics charge that the Bush White House and Greenspan's Federal Reserve ignored warning signs as Wall Street rushed to package and sell billions of dollars worth of suspect, mortgage-backed securities to other financial institutions and investors
Oxley's committee and the House passed a 2005 reform bill that would have put Fannie Mae and Freddie Mac, the huge mortgage buyers that are now in government receivership, on a much tighter leash. They wanted to require more capital reserves and accounting transparency. But the WHITE HOUSE failed to support the bill, and the Senate failed to take it up during the mortgage boom.
"I'm happy to be looking at this from the outside," said Oxley, one of the architects of the Sarbanes-Oxley boardroom-reform act of 2002. "The next administration and Congress will have to deal with this."
Oxley predicted that the next president will appoint a "gray beard" commission that will start with Treasury Secretary Henry Paulsen's proposed regulatory reforms.
Oxley was in town last week to receive an award from the Caux Round Table for his work to improve corporate governance and boardroom accountability.


vwatt said...

Desparate times call for desparate measures(from

Saving Sarah!

These guys are just digging into such depths of nonsense and desperation that pretty soon they're going to pop out in China, which will be helpful since they can ask the Chinese for the trillion dollars it'll take to bail out McCain's pals on Wall Street for the mess his economics advisor Phil Gramm made possible. Here's the latest attempt to exploit the financial market crisis for political ends (from CNN)...

McCain supporter Sen. Lindsey Graham tells CNN the McCain campaign is proposing to the Presidential Debate Commission and the Obama camp that if there's no bailout deal by Friday, the first presidential debate should take the place of the VP debate, currently scheduled for next Thursday, October 2 in St. Louis.

So we need to put the country first and cancel the vice presidential debate.

--Josh Marshall

Brodad Unkabuddy said...

It all seemed like a good idea at the time - get everyone in their own home. With the values of real estate rocketing, how could it go wrong? The mortgage companies figured they would get people signed up with cheap ARMs and no money down, then cash in later. Unfortunately the bubble burst sooner than later. It's hard to say whose fault it really is. Back during the dot.bomb boom was when the whole idea got its start, so maybe it's Clinton's fault. I personally think it's Congress' fault. Whichever party is not in power drags its feet to prevent the majority from accomplishing anything. Although the Republicans were in power in 2005 they were far from dominant. They Democrats freely used their 60 vote filibuster tool every chance they got. I fully expect the Democrats to drag this crisis out to the point of being chastised for delaying the solution so as to cause the most damage to the Bush administration and subsequently the McCain campaign. Here's to the United Socialist States of America and President Hussein Obama!

Mike West said...

I like the Andy Griffith Show.

Brodad Unkabuddy said...

Too much politics discussed at Floyd's Barber Shop.