Monday, September 22, 2008

This Just In, Democrats Behind Financial Crisis

How the Democrats caused the financial crisis

Not a word on the news the dumb masses get to see; but the financial industry trades don't have the luxury of hiding the truth to help Obama.

The mess wasn't created to create bad times in order to blame it on the Republicans, that was just an added benefit aided by the mainstream media.

Obama was the second largest recipient of Fannie and Freddie's thanks for keeping the regulations off their back. And McCain was one of three sponsors of the bill S.190 in 2005 that would have prevented all the pain and expense we will experience for the rest of our lives.


Anonymous said...

How Everybody Created the Financial Crisis

This responsive commentary is provided by an informed, independent voter, compiled from many sources with regard to ‘How the Democrats Created the Financial Crisis’ (09/22/08), by Kevin Hassett.

Original Text> (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.)

For background, Mr. Hassett is also co-author of the 1999 book Dow 36,000. In 2004 he argued that the housing bubble was nothing more than an illusion foisted upon the public by liberals, and that concerns about it were without foundation. Putting aside the fact that Hassett is a senior campaign advisor to McCain, when judging the strength of his opinion piece it is fair to bear in mind that his reasoning in his book and upon earlier stages of this very economic topic has already proven wrong.

Original Text> 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.

Original Text> 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.

Original Text> 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. [i.e., loan pools comprised mainly of Prime mortgages, with a smaller proportion of sub-prime mortgages in the mix – not enough to lower the pool’s overall rating]

Actually, other buyers formed 88% of that market. “Freddie’s purchases totaled 13 percent of all the securities created in 2006 and 2007, according to data from its regulator and Inside MBS & ABS, a Bethesda, Maryland-based newsletter used by Federal Reserve researchers. Fannie […] bought an additional 5 percent.”

(It should not be forgotten that this was very deliberately made an unregulated market, open to all comers. There was profit to be made with fully legal investment instruments, and nothing to bar participation by anyone – in keeping with free market principles. Numerous firms acted on the opportunities.)

Original Text> In addition, they held an enormous portfolio of mortgages themselves.

F&F do own a huge proportion of outstanding mortgages, but none were sub-prime; the statement is made to seem to lend weight, but is completely immaterial to the argument being made. It is important to recognize that federal law precluded Frannie & Freddie (F&F) from offering, buying or underwriting a single sub-prime mortgage. They could only buy mortgages issued to borrowers who made substantial down payments and who provided carefully documented proof of income. They were among the few lending institutions that precluded sub-prime lending. Because of regulation, their lending practices were considerably more conservative than those followed by others in the market. What is relevant is that F&F began engaging in the acquisition of AAA-rated loan pools that included within them some sub-prime mortgages.

Original Text> 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.

This is extremely overstated for effect; Hassett does not make a serious effort to show this assertion is true. Above, he identified the market he’s discussing as the market in subprime-mortgage loan pools … not individual loans. F&F together constituted only 18% of the marketplace of firms engaged in buying mortgage loan pools. As large as they were, and as big a position as they took there, they could not ‘become the market.” F&F can’t be blamed in isolation, or even primarily, for fueling the crisis.

Original Text> Their large presence created an environment within which even mortgage-backed securities assembled by others could find a ready home.

Neither Freddie Mac nor Fannie Mae created the housing bubble. Nor did they invent Collateral Debt Obligation instruments (CDOs), nor were they among the institutions that were betting it all on highly leveraged Credit Default Swaps (CDSs). Those extreme risks were taken by the investment banking firms, hedge funds, and other speculative investors.

Original Text> 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.

This is quite true. But as noted in Economist’s View, “There are two questions that are being confused in the debate over the source of the financial crisis:

1. What caused Fannie and Freddie to fail?
2. What caused the financial crisis?

Answering the first question does not necessarily answer the second.

Showing that some politician, some policy, some legislation, lack of effective regulation, whatever, caused Fannie and Freddie to fail is important, we need to know why they were vulnerable when the system got in trouble, but Fannie and Freddie did not cause the crisis, they were a consequence of it. “

Original Text> Turning Point

Original Text> 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.

With a large measure of hyperbole, this posits a convenient but highly questionable thesis. Regulation of F&F alone would have been insufficient - there were far too many players involved, and they were using far too many trading practices including but also going well beyond those employed by F&F.

The Downfall of Fannie & Freddie

Interestingly, because F&F were precluded from directly participating in the sub-prime boom their investment performance in the market was lower than others. (“Fannie dropped 17 percent from 2004 through 2006 and Freddie declined 7.9 percent. The Standard & Poor’s 500 Index, by contrast, gained 7.4 percent.”)

Therefore, Fannie and Freddie were under pressure from shareholders to generate profits to bolster their stock price. At the same time, in 2005, F&F were urged to increase purchases of sub-prime debt by the Bush administration (directly and via the Dept. of Housing), as part of its ‘Ownership Society’ initiative, begun in 2004.

Under pressure by its investors and the government alike, F&F eventually resorted to CDOs. But even then, F&F could not and did not want to buy or guarantee sub-prime loans, correctly perceiving them to be insanely risky. Instead, they limited themselves to purchasing only the supposedly very safest AAA-rated classes of mortgage-loan pools (as Chief Executive Officer Richard Syron noted in self-congratulatory manner in May 2007).

What finally got them into trouble, very late in the game, was that they were specially authorized and directed by the Fed (in an ill-fated attempt to stem the already-turning tide) to loan money to banks that already held too many sub-prime loans, and those which had engaged in a high degree of derivates trading. It is indeed clear, in retrospect, that the problem was larger than this measure could forestall, and that F&F were inadequately capitalizalized to take on that burden. It brought them down.

Original Text> 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 Commission’s chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie’s ------------- on the relevant accounting issue was not even ``on the page’’ of allowable interpretations.

Original Text> 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.

Original Text> Greenspan’s Warning

Original Text> 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.’’

It is important to be clearer about the nature of Alan Greenspan’s 2005 warning. In April, Alan Greenspan gave a speech praising sub-prime lending practices. He claimed that “Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately.”

Alan Greenspan’s actual concerns (and as reflected in the quotation above), were not with F&F’s lending practices, but instead that they were, simply put, too successful – he feared that if unrestricted they would continue growing until they constituted too large an influence in the market –that they might become so influential that if anything untoward were to happen, it would be disastrous. Because of F&F’s “creative accounting” abuses, and Greenspan’s warning, F&F’s regulators (the Office of Federal Housing Enterprise Oversight) placed limits on the amount of loans and securities the companies could own, and also created a regulatory requirement that they begin holding 30% more capital than required by law, to protect against housing market instability.

Going beyond F&F-related issues, he repeatedly expressed in many forums, even more strenuous objections to under-collateralized lending, excessive trading of overly complex CDOs, and under-collateralized CDSs (which is not to say that he himself did not also employ those vehicles, since they were available and legal). These warnings were not acted upon by Congress.

Original Text> 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.

Hassett’s claim that S.190 required F&F to get rid of risky assets appears made up out of whole cloth. The bill did NOT contain any requirement that F&F get rid of assets of any sort. Even if it had, the ‘risky assets’ Hassett cites would not include AAA-rated bonds, which were those at issue for F&F.

What the bill WOULD have done, in response to F&F’s “creative accounting” abuses, was give regulators more control over their accounting practices, the power to impose capital requirements, and the ability to restrict them from holding assets that weren’t “mission-related.” But it did NOT limit the amount of mortgage-backed securities that Fannie and Freddie could hold. This is the key point.

Original Text> Different World

Original Text> If that bill had become law, then the world today would be different.

The bill, limited as it was, would not have had remotely so large an effect. Even had it addressed mortgage-backed securities acquisitions by F&F, in its limitation to just those companies, it would not have covered enough institutions to have forestalled the current crisis.

Nonetheless, despite failure of the bill, regulators responded to the accounting scandals at F&F with restraints that curtailed their lending, limited the size of their allowed holdings, and increased capitalization requirements. The legislation became moot – what it had sought was instead enacted through regulation. (Indeed, the availability of that regulatory framework was the basis of some of the opposition to the bill; some deemed permanent legislation unnecessary to achieve the goal.)

Original Text> 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.

As noted above, the market for the purchase of loan pools was extremely large; F&F constituted only 18% of that market. To claim, as Hassett does, “Without [F&F’s] checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed” is to willfully ignore the sizable remainder of that market, the many other institutions filling the same role.

Original Text> 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.

This characterization is significantly incomplete. House Republican Mike Oxley (R-OH) -- now vice-chairman of NASDAQ – is the Republican who sponsored the House version of the Bill. In an article on September 9, Oxley colorfully and publicly expressed his frustration at the failure of that bill -- but he laid the responsibility for that failure on the Bush Administration:

“[Former Senator Oxley] fumes about the criticism of his House colleagues. “All the hand wringing and bedwetting is going on without remembering how the House stepped up on this,” he says. “What did we get from the White House? We got a one-finger salute.”

...Mr Oxley reached out to Barney Frank, then the ranking Democrat on the committee and now its chairman, to secure support on the other side of the aisle. After winning bipartisan support in the House, where the bill passed by 331 to 90 votes, the legislation lacked a champion in the Senate and faced hostility from the Bush administration.

Adamant that the only solution to the problems posed by Fannie and Freddie was their privatization, the White House attacked the bill. Mr Greenspan also weighed in, saying that the House legislation was worse than no bill at all.

“We missed a golden opportunity that would have avoided a lot of the problems we’re facing now, if we hadn’t had such a firm ideological position at the White House and the Treasury and the Fed,” Mr Oxley says.”

The preliminary bipartisanship evaporated under the hostility to the bill expressed by the Administration. Hassett’s claim that the Democrats are solely at fault because they blocked this bill is undermined by Senator Oxley’s account, though they certainly are not white-helmed knights, either.

Also, the argument weakens in light of the knowledge that the Republicans at that time controlled Congress and were unconstrained on other issues by any requirement for bipartisan support -- for example, without a single Democratic vote, the Republican-controlled Senate cut Medicaid funding by $10 billion and added $106 billion in corporate tax cuts in May of 2005. Had they been behind the bill, it would have been brought forward for a floor vote, even absent bipartisan support. That it was not, was due to White House opposition.

Original Text> 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.’’

For Hassett to cite Wallison in support of the idea that S.190 would have made a difference is dishonest, because Wallison said precisely the opposite, in the same document: “If Congress cannot take this essential step [to limit the amount of mortgage-backed securities that could be held by the firms], no amount of additional authority–given to a purported ‘world class regulator’–will significantly change the course of events.”

In keeping with that sentiment, and of much more import, given the limited scope of S.190, it is perhaps unfortunate that the bill took up narrow issues related to F&F, but Congress never addressed either the market-wide sub-prime lending practices, mortgage loan pool management, and derivatives trading problems.

Original Text> Mounds of Materials

Original Text> 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.

Original Text> 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.

Hassett’s intimations regarding potential influence upon Democratic senators who received financial support from F&F over the years is fair game, except that he excludes mention of equivalent or greater support that was granted to the Republican senators.

It should also be noted here that neither Obama nor Clinton were on the Banking, Housing, and Urban Affairs committee involved with the bill under discussion.

Original Text> 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.

Original Text> 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.

Here is the full source data table Hassett used (The ‘Total from Individuals’ category denotes political donations made by private individuals who are employees of F&F.):

Party – Name, Senate or House – State – Total – From PACs – From Individuals

D - Dodd, Christopher – CT - $165,4000 - $48,500 - $116.900

D – Obama, Barack – S – IL - $126,349 - $6,000 - $120,349

D – Kerry, John – S – MA - $111,000 - $2,000 - $109,000

R – Bennett, Robert – S – UT - $107,999 - $71,499 - $36,500

R – Bachus, Spencer – H – AL - $103,300 - $70,500 - $32,800

R – Blunt, Roy – H – MO - $96,950 - $78,500 - $18,450

D – Kanjorski, Paul – H – PA - $96,000 - $57,500 - $38,500

R – Bond, Christopher – S – MO - $95,400 - $64,000 - $31,400

R – Shelby, Richard – S – AL - $80,000 - $23,000 - $57,000

D – Reed, Jack – S – RI - $78,250 - $43,500 - $34,750

D – Reid, Harry – S – NV - $77,000 - $60,500 - $16,500

D – Clinton, Hillary – S – NY - $76,050 - $8,000 - $68,050

R – Davis, Tom – H – VA - $75,499 - $13,999 - $61,500

R – Boehner, John – H – OH - $67,750 - $60,500 - $7,250

D – Conrad, Kent – S – ND - $64,491 - $22,000 - $42,491

R – Reynolds, Tom – R – NY - $62,200 - $53,000 - $9,200

The PAC only gave Obama $6,000, Clinton $8,000, and Dodd $48,500 over a nineteen year period spanning the years 1989-2008.

These are far smaller amounts than were accepted by Republicans: $79,000 for Blunt, $71,000 for Bennett, $70,000 for Bachus, $64,000 for Bond, $61,000 for Boehner, and -- here we get our first Democrat- $61,000 for Reid.

If the topic is undue influence by F&F, then of equal import are the Republicans receiving donations. Also fairly falling under the topic of ‘currying influence’ is the information that John McCain’s campaign manager, Rick Davis, was paid over $2 million to lobby congress on behalf of F&F from 2000-2005 (the lobbying contract for his firm, Davis Manafort, was dropped in 2005).

Furthermore, Davis was yesterday revealed to still be on Freddie Mac’s payroll to the tune of $15,000 a month. These payments continued all the way up through last month. The disclosure undercuts a remark by Mr. McCain on Sunday night that the campaign manager, Rick Davis, had had no involvement with the company for the last several years. Sources within the firm indicate “…Mr. Davis’s firm was kept on the payroll because of Mr. Davis’s close ties to Mr. McCain, the Republican presidential nominee, who was widely expected by 2006 to run again for the White House.”

Another campaign staffer, Aquiles Suarez, was a director and later a lobbyist for Fannie Mae. Charlie Black, a top McCain aide, was also a lobbyist for Freddy Mac between 1999 and 2004.

In all, there are 19 people who are former lobbyists for Fannie or Freddie now working for the McCain campaign. Hassett disclosed none of this.

Original Text> 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.

Original Text> 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.

In actuality, John McCain was not involved either in formulating the bill or in bringing it forward … he only became a “retroactive cosponsor” of the bill long after the fact, about a year later, on 5/25/2006. (

In Sum

So, Hassett’s article makes three points, all of which have been shown to be either ill-founded or incomplete:

F&F are the cause of the sub-prime meltdown and our current economic crisis because they WERE the market for AAA-rated loan packages.

1) John McCain — a man who admits to knowing too little about economic issues —figured out in 2005 that this economic storm was coming and crafted a bill specifically designed to prevent it.

2) But because F&F and their lobbyists gave tons of money to Democrats in Congress, key Democratic senators were swayed to vote down McCain’s bill despite robust Republican support.

As stated by Richard Green, “Fannie and Freddie did bad things and followed the market down in lending standards--calling a mortgage "conforming" if it had a 5% down payment and a 15% mortgage-insurance policy purchased from a fly-by-night or AIG--but they did not lead the market down--it was Wall Street securitizers and their partners who did that.”

The crisis did not arise initially nor even primarily in these two institutions, though they certainly played a role along with many others.

The emerging consensus of economists, financiers, and politicians alike is that the root causes of the current crisis are broader –

(1) sub-prime lending practices throughout the market,

(2) inappropriate risk assessments on loan pools and CDOs,

(3) excessive complexity of derivative instruments (particularly, CDOs), which divorced potential gain from accurate risk of loss, and

(4) the lack of appropriate regulation on derivatives trading and regarding backing collateral on CDSs.

Where Now?

Hassett has simply responded in an oversimplistic, silly manner to Pelosi’s equally partisan, silly attempts to rewrite history. Any attempt to pin this mess on one political party or the other is mere political hackery … though that won’t stop people from trying.

Who was at fault? Both political parties, over the course of multiple administrations, multiple branches of government, investment firms, hedge managers, traders, economists, mortgage lenders, real estate agents, and credit rating companies, not to mention the innumerable individual borrowers.

Better now to admit that EVERYONE set up the conditions that allowed this crisis to arise. And EVERYONE will need to be open to reforming their own role in creating the mess, mitigating its effects, and precluding its repetition.

luxomni said...

Thank you, Anonymous. I especially like your last paragraph I have thought that for a long time.
I do have one concern. This response was obviously not written for me. Should this have attribution? There are a number of references to the author (Hassett) that is being responded to. But there is nothing about where the response was copied from.
So if you posted this, please add credits.
Thank you.