Saturday, September 20, 2008

The Real Reasons for the Financial Turmoil

There is no one explanation of what went wrong with the financial markets. Simply put, it is a case of many people deciding that age old rules need not be followed anymore – combined with breathtaking corruption. Both political parties share some blame in some stupid things that happened, although the Democrats seem to be well in the lead as far as corruption and stupidity goes. Let’s trace some history.

1. During the Great Depression of the 1930’s, one reform that came out of the crash of 1929 was the passage of the Glass-Steagall Act, that prohibited banks from both accepting deposits and underwriting securities which led to segregation of investment banks from commercial banks. Glass-Steagall was effectively repealed for many large financial institutions by the Gramm-Leach-Bliley Act in 1999. This repeal of a time-tested wall of separation was sponsored by Senator Gramm, passed by a Republican Congress and signed by a Democrat President (Clinton).

2. Fannie Mae and Freddie Mac, agencies now known as Government Sponsored Enterprises, were also creatures of the Great Depression, and were government agencies until the late 1960’s. President Johnson, wanting to get their debts off the budget, had them privatized. Then and now, they have access to funds at below market rates, and hold or guarantee most of the home mortgages in the country.

3. Under pressure and legislation from Congress to make home mortgages more accessible to people who were not qualifying for loans, Fannie Mae and Freddie Mac began to accept and insure questionable loans and to pressure banks to provide them. Since executives of both agencies got bonuses tied to the quantity of loans granted, this added to the snowball effect. Banks also began more and more to sell off their mortgages rather than keep them in house, obviously deciding that this was a way to reduce their own risk. This pattern actually started way back in the Carter Administration, but President Clinton put it in high gear.

4. Reform efforts were hijacked by politicians either benefiting personally with favored loans, or by political contributions numbering in the hundreds of thousands of dollars. The major recipients of these benefits were Democratic Senators Chris Dodd and Barack Obama. Senator McCain can show that he received much smaller contributions – and also that he recognized and tried to do something about the storm of problems that the multiplication of these risky loans was about to unfold. In fact, Senator McCain, in 2005, co-sponsored a reform bill that was killed by the ranking Senate Banking Committee member, Senator Dodd. Unfortunately, the Republican Congress allowed this to happen.

5. With this background of a mushrooming inventory of mortgage loans that should never have been issued, a rapidly rising level of home prices attracted millions of people to buy homes on speculation for profit and buy homes they could not afford – getting these loans at favorable interest rates. As usually happens when a speculative bubble takes off, the bubble burst, and home sales and home prices went into a steep and rapid decline. A huge number of these mortgages became unsustainable for the borrowers who stopped paying or walked away from their obligations.

The Real Culprits In This Meltdown

Big Government: Barack Obama and Democrats blame the historic financial turmoil on the market. But if it's dysfunctional, Democrats during the Clinton years are a prime reason for it.

Obama in a statement yesterday blamed the shocking new round of subprime-related bankruptcies on the free-market system, and specifically the "trickle-down" economics of the Bush administration, which he tried to gig opponent John McCain for wanting to extend.

But it was the Clinton administration, obsessed with multiculturalism, that dictated where mortgage lenders could lend, and originally helped create the market for the high-risk subprime loans now infecting like a retrovirus the balance sheets of many of Wall Street's most revered institutions.

Tough new regulations forced lenders into high-risk areas where they had no choice but to lower lending standards to make the loans that sound business practices had previously guarded against making. It was either that or face stiff government penalties.

The untold story in this whole national crisis is that President Clinton put on steroids the Community Redevelopment Act, a well-intended Carter-era law designed to encourage minority homeownership. And in so doing, he helped create the market for the risky subprime loans that he and Democrats now decry as not only greedy but "predatory."

Yes, the market was fueled by greed and overleveraging in the secondary market for subprimes, vis-a-vis mortgaged-backed securities traded on Wall Street. But the seed was planted in the '90s by Clinton and his social engineers. They were the political catalyst behind this slow-motion financial train wreck.

And it was the Clinton administration that mismanaged the quasi-governmental agencies that over the decades have come to manage the real estate market in America.

As soon as Clinton crony Franklin Delano Raines took the helm in 1999 at Fannie Mae, for example, he used it as his personal piggy bank, looting it for a total of almost $100 million in compensation by the time he left in early 2005 under an ethical cloud.

Other Clinton cronies, including Janet Reno aide Jamie Gorelick, padded their pockets to the tune of another $75 million.

Raines was accused of overstating earnings and shifting losses so he and other senior executives could earn big bonuses.

In the end, Fannie had to pay a record $400 million civil fine for SEC and other violations, while also agreeing as part of a settlement to make changes in its accounting procedures and ways of managing risk.

But it was too little, too late. Raines had reportedly steered Fannie Mae business to subprime giant Countrywide Financial, which was saved from bankruptcy by Bank of America.

At the same time, the Clinton administration was pushing Fannie and her brother Freddie Mac to buy more mortgages from low-income households.

The Clinton-era corruption, combined with unprecedented catering to affordable-housing lobbyists, resulted in today's nationalization of both Fannie and Freddie, a move that is expected to cost taxpayers tens of billions of dollars.

And the worst is far from over. By the time it is, we'll all be paying for Clinton's social experiment, one that Obama hopes to trump with a whole new round of meddling in the housing and jobs markets. In fact, the social experiment Obama has planned could dwarf both the Great Society and New Deal in size and scope.

There's a political root cause to this mess that we ignore at our peril. If we blame the wrong culprits, we'll learn the wrong lessons. And taxpayers will be on the hook for even larger bailouts down the road.

But the government-can-do-no-wrong crowd just doesn't get it. They won't acknowledge the law of unintended consequences from well-meaning, if misguided, acts.

Obama and Democrats on the Hill think even more regulation and more interference in the market will solve the problem their policies helped cause. For now, unarmed by the historic record, conventional wisdom is buying into their blame-business-first rhetoric and bigger-government solutions.

While government arguably has a role in helping low-income folks buy a home, Clinton went overboard by strong-arming lenders with tougher and tougher regulations, which only led to lenders taking on hundreds of billions in subprime bilge.

Market failure? Hardly. Once again, this crisis has government's fingerprints all over it.

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At 4:47 PM, Anonymous Kathy said...

An excellent, plain-spoken commentary on the some of the history of this problem!

Underlying all of this is another problem that really needs to be examined in the course of our American history: the disappearing understanding of the prudent use of credit on the part of all Americans.

At 7:11 PM, Anonymous Anonymous said...

Thank you for another great post. You really know how to cut through the bull and get to the point.

The actions that got us here were very unconservative.


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