Faith-based economic theory

January 25, 2012

The Republican candidates for president have some major differences in their policies and their personal lives. But they have one striking thing in common—they all say the federal government is responsible for the financial crisis. Even Newt Gingrich (pilloried for having been a Freddie Mac lobbyist) says: “The fix was put in by the federal government.”

The notion that the federal government, via the Community Reinvestment Act (CRA) and by pushing housing finance giants Fannie Mae and Freddie Mac to meet affordable housing goals, was responsible for the financial crisis has become Republican orthodoxy. This contention got a boost from a recent lawsuit the Securities and Exchange Commission (SEC) filed against six former executives at Fannie and Freddie, including two former CEOs. “Today’s announcement by the SEC proves what I have been saying all along—Fannie Mae and Freddie Mac played a leading role in the 2008 financial collapse that wreaked havoc on the U.S. economy,” said Congressman Scott Garrett, the New Jersey Republican who is chairman of the financial services subcommittee on capital markets and government-sponsored enterprises (GSEs).

But the SEC’s case doesn’t prove anything of the sort, and in fact, the theory that the GSEs are to blame for the crisis has been thoroughly discredited, again and again. The roots of this canard lie in an opposition—one that festered over decades—to the growing power of Fannie Mae, in particular, and its smaller sibling, Freddie Mac. This stance was both right and brave, and was mostly taken by a few Republicans and free-market economists—although even President Clinton’s Treasury Department took on Fannie and Freddie in the late 1990s. The funny thing, though, is that the complaint back then wasn’t that Fannie and Freddie were making housing too affordable. It was that their government-subsidized profits were accruing to private shareholders (correct), that they had far too much leverage (correct), that they posed a risk to taxpayers (correct), and what they did to make housing affordable didn’t justify the massive benefits they got from the government (also correct!). Indeed, in a 2004 book that recommended privatizing Fannie and Freddie, one of its authors, Peter Wallison, wrote, “Study after study has shown that Fannie Mae and Freddie Mac, despite full-throated claims about trillion-dollar commitments and the like, have failed to lead the private market in assisting the development and financing of affordable housing.”

When the bubble burst in the fall of 2008, Republicans immediately pinned the blame on Fannie and Freddie. John McCain, then running for president, called the companies “the match that started this forest fire.” This narrative picked up momentum when Wallison joined forces with Ed Pinto, Fannie’s chief credit officer until the late 1980s. According to Pinto’s research, at the time the market cratered, 27 million loans—half of all U.S. mortgages—were subprime. Of these, Pinto calculated that over 70 percent were touched by Fannie and Freddie—which took on that risk in order to satisfy their government-imposed affordable housing goals—or by some other government agency, or had been made by a large bank that was subject to the CRA. “Thus it is clear where the demand for these deficient mortgages came from,” Wallison wrote in a recent op-ed in The Wall Street Journal, which has enthusiastically pushed this point of view in its editorial section since the crisis erupted.

But Pinto’s numbers don’t hold up. The Financial Crisis Inquiry Commission (FCIC)—Wallison was one of its 10 commissioners— met with Pinto and analyzed his numbers, and concluded that while Fannie and Freddie played a role in the crisis and were deeply problematic institutions, they “were not a primary cause.” (Wallison issued a dissent.) The FCIC argued that Pinto overstated the number of risky loans, and as David Min, the associate director for financial markets policy at the Center for American Progress, has noted, Pinto’s number is far bigger than that of others—the nonpartisan Government Accountability Office estimated that from 2000 to 2007, there were only 14.5 million total nonprime loans originated; by the end of 2009, there were just 4.59 million such loans outstanding.

The disparity stems from the fact that Pinto defines risky loans far more broadly than most experts do. Min points out that the delinquency rates on what Pinto calls subprime are actually closer to prime loans than to real subprime loans. For instance, Pinto assumes that all loans made to people with credit scores below 660 were risky. But Fannie- and Freddie-backed loans in this category performed far better than the loans securitized by Wall Street. Data compiled by the FCIC for a subset of borrowers with scores below 660 shows that by the end of 2008, 6.2 percent of those GSE mortgages were seriously delinquent, versus 28.3 percent of non-GSE securitized mortgages.

To recap: If private-sector loans performed far worse than loans touched by the government, how could the GSEs have led the race to the bottom?

Another problematic aspect to Pinto’s research is that he assumes the GSEs guaranteed risky loans solely to satisfy affordable housing goals. But many of the guaranteed loans didn’t qualify for affordable housing credits. The GSEs did all this business because they were losing market share to Wall Street—their share went from 57 percent in 2003 to 37 percent by 2006. As the housing bubble grew larger, they wanted to recapture their share and boost their profits.

Indeed, the SEC lawsuit specifically says Fannie and Freddie began to do more risky business not to meet their goals, but rather to recapture market share—and they began to do so aggressively in 2006, when the market was already peaking. So while the GSEs played a huge role in blowing the bubble bigger than it otherwise would have been—and the numbers in the SEC complaint are huge—they followed, rather than led, the private market.

It’s also very hard to look at what happened in the crisis and conclude that nothing went wrong in the private sector. Note that the other Republican members of the FCIC refused to sign on to Wallison’s dissent. Instead, they issued their own dissent. “Single-source explanations,” they said, were “too simplistic.”

Yet despite all that, the one-note Republican refrain hasn’t changed. The explanation is obvious: The “government sucks” rant polls well with conservatives. Mix in an urge to counter the equally simplistic story from the left—that the crisis was entirely the fault of greedy, unscrupulous bankers—and you get a strong resistance to the facts. Maybe there’s a deeper reason, too. For many, belief in the all-knowing market was (and is) almost a religion. This financial crisis challenged that faith by showing the market would indeed allow loans to be made that could never be paid back, and by showing that highly paid financial services executives aren’t gods, and that many of them are stupid and venal and all too human.

So maybe the Republican orthodoxy is understandable, but that doesn’t mean it isn’t scary. Of course, there’s the great line from Edmund Burke: “Those who do not know history are destined to repeat it.” Our housing market is a mess that threatens to drag down the entire economy, and whoever is president in 2013 needs to have a plan. Denying the facts is not a good start.

PHOTO: Republican presidential candidates (L-R) former U.S. Senator Rick Santorum (R-PA), former Massachusetts Governor Mitt Romney, former Speaker of the House Newt Gingrich and U.S Representative Ron Paul (R-TX) arrive on stage before the Republican presidential candidates debate in Tampa, Florida January 23, 2012.  REUTERS/Brian Snyder


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There certainly was a time when the market would not “allow loans to be made that could never be paid back” – until the government distorted the market by regulation requiring that those loans be made.

Posted by SayHey | Report as abusive

Saywhat? Gov absolutely did not require those loans to be made. Complete BS.

Posted by gordo365 | Report as abusive

Where was the SEC when wall street was pushing for more mortgages to bundle and sell as class bonds??? SEC during the Bush administration was a joke at best and negligent at worse.

Posted by colt1210 | Report as abusive

The most invalidating fact is that the whole rationale of securitization is flawed, and it explains things like robo-signing. And no voodoo economics is necessary, only mainstream economics.

When a lender, say a bank, has to keep the mortgage it is in its best interest to ensure that it will recover the principal and the interest. That mortgage is an asset backing up its liabilities (for a bank, people’s deposits)

Any attempt from the government to force the lender to make more risky mortgages would come with a behavioral change in the lender – charging more interest, undervaluing the asset as to make a smaller loan, or simply “drag its feet” and slow down the process. moreover, if the lender foresees that there would be more defaulting loans, it will make sure the liquidation of that loan happens fast so it will keep all its backing documentation tidy and neat.

When a lender sells that mortgage to someone else, none of those things apply any more. Selling the mortgage means recovering the principal and getting ready to make other loans. Importantly, the loan is NO LONGER in the books. That destroys any incentive to be cautious when assessing a loan, or keeping records. All the stories about faking income in loan applications, the “robo-signing” scandal showing lenders’ horrendous practices at record keeping stand as evidence. What government regulation would have told banks to forget about paperwork? And as I pointed out, if private lenders were unwilling to lend they could have used the paperwork process as an efficient way to slow down granting mortgages they did not want.

But the secondary mortgage market was not limited to the fannies and freddies. With the deregulation in finance, a whole new cadre of financial intermediaries have every single incentive to buy mortgages, repackage them, and sell the corresponding securities ALL OVER THE WORLD.

That alone is an interesting illustration of Say’s law that supply produces its own demand, but also of what happens when money is being “printed” – inflation. Instead of greenbacks, the private sector could expand the supply of “mortgage money” at will as long as they were investors willing to buy the “AAA” securities. Is there any surprise of how housing prices went through the roof and beyond during that time with money flowing from all over the world to buy the coveted securities?

Did the fannies and freddies buy those loans? Sure! The same point that was made in the article – that involvement with the subprime came from push to regain market share was uncovered by an article published long ago by the New York Times. More interesting, the article reveaded that those with knowledge inside those organizations warned the top brass that they did not know what they were buying. But corporations being autocracies – you do what the top brass says, or you are shown the door – those claims were ignored.

There is little evidence that the story is how the GOP pretends it to be, but that is of little use. They do not care about facts or evidence; they only care about keeping their voting base with them and their sponsors happy… and deregulated.

Posted by ecogabriel1 | Report as abusive

I should have probably added a note: I worked for banks for several years before going into academia.

A good deal of our mastery – and profits – came from how to avoid and circumvent government regulation. There was no way for government to force us to do something we did not want; we would find a way to limit our exposure to the unwanted risk in that market or somewhere else.

Posted by ecogabriel1 | Report as abusive


You have no idea how a bank works. Let me share another tidbit.

Long ago I was sent to an overseas branch, where the government had recently banned taking short-term money as CODs. When I got there, the legal people were drawing a scheme – together with the people from corporate finance and those that worked on the day-to-day operations – on how to get those deposits under a new name. It turned out that the idea had been floated before in a meeting of the banking association in that country. Two months later, we were all taking the “ex-cod” deposits using the savings accounts. A few months after that, the government had to lift the ban.

Stop talking nonsense and drinking fauxnews coolaid

Posted by ecogabriel1 | Report as abusive

There were certainly federal government people who were involved, but rating mortgage-backed securities as low risk when they were clearly predominantly comprised of
high-risk mortgages is quite simply fraud.

That fraud was enabled by government when it removed financial regulations, but it was perpetrated by Wall Street and the rating agencies. I firmly oppose any effort to deflect that horrendous blame.

The perpetrators of the fraud should have been prosecuted under RICO, stripped of all their ill-gotten assets and unceremoniously imprisoned for the rest of their lives.

Posted by breezinthru | Report as abusive

RICO… it’s not too late.

I don’t know why it took so long but President Obama mentioned in last night’s State of the Union speech that he was finally instructing Attorney General Eric Holder to investigate and prosecute the perpetrators of the biggest fraud the world has ever seen.

It’s about time.

Posted by breezinthru | Report as abusive

just read “the big short” by michael lewis to find the truth about the financial collapse. if after reading that you still believe by faith that the gop is right then we are headed for a cliff no matter who is in charge.

Posted by jcfl | Report as abusive

This is reporting that rarely occurs in the US. Since these presidential candidates are basically corporate agents representing a corrupt oligarchy, of course they would blame the government which has been raped and pillaged by financial elites. These same agents have deliberately prevented government agencies from applying regulations and enforcement through legal maneuvers, preventing funding, and creating legislative restrictions to protect corrupt business practices. The crisis was caused by corrupt private sectors which “legitimized” fraud and have turned America into a corporate, fascist state by virtue of its government takeover. You can bet that the majority of voting Americans will swallow the lies hook, line, and sinker, but then it is always easier to blame the government than to analyze facts or consider one’s own culpability.

Posted by Greenspan2 | Report as abusive

Feb 20th 2003, G W Bush pushed for the ownership society. The mantra was used to cut taxes, extend home ownership even if subprime. It was the Koolaid that distracted from the mistake that was the Iraq War. Never did any good. The White House under Bush played its role in this housing crisis.

Posted by ishamon | Report as abusive

Is it not very, very convenient that the Republicans forget that they supported spending over $1 trillion per year for a decade so that Muslims would not be given the vote in Israel? Then they point fingers at everyone else. But they certainly do not advocate anything other than getting that trillion per year out of the pockets of the poor, disabled and elderly. They are the party of more of the same.

The solution is to ban deployment of more than 10,000 combat troops, whether uniformed or “contract” (mercenary), outside of the USA. No declaration of war, no pay, no bullets, no benefits.

Posted by txgadfly | Report as abusive

Just to be clear – this article is trying to debunk the notion that the government was not at fault or totally responsible for the mortgage crisis. This is nit-picking. When government agencies or political parties influencing government agencies commandeer a market – it will wind up in the tank because there is no accountability, cockeyed incentives, and the rules are changed to accelerate the pay to those in high positions. So sure the private market beat Fannie and Freddie at its own game – and brought on the eventual collapse of the market. This is crony capitalism – get back to smart regulations and stop trying to social engineer the housing market. How many government failures does it take to realize that government is mostly comprised of the friends of the latest elected party. It takes real management and know how to make things work and this is not what government engenders. I’ve done quite a few projects with government agencies and there are very few that work well. The most accountable government you will get is the one you can see – your local government.
Keep your eyes open….wide.

Posted by xit007 | Report as abusive

Wall Street blaming its woes on the Federal Government is like a teenager blaming his parents because he can’t afford gas to get to the prom….. after he spent all his money on weed for the prom. “See what you made me do!”

Posted by AlkalineState | Report as abusive

@Ocala123456789 Romney was not a banker…

Posted by Snake.Plissken | Report as abusive

The credibility of the Dismal Seven or so is so low in the minds of rational people that it cannot be said that none of these Bobbleheaded Fizzlewhizzes have any semblance of being elected president. These people and their party machine are without merit and they know it. Thats why the Big Lie continues in MSM and Faux news. Shame on them all.

Posted by ClaudeM | Report as abusive

Sounds like ecogabriel is on to something. Securitization definitely played a major role in all this. I buy that it facilitates capital flows, and that under ‘normal’ circumstances this may be beneficial, but in an environment of excessive credit (we are still in this although it no longer extends to all of us) and a financial system filled with distorted incentives (both Federal Reserve and government policies have a lot to do with this) it mostly accelerates the malinvestment. The problem seems to be structural and as far as I can tell the remedy is unclear. You may disagree with some of his libertarian positions, but at least Ron Paul recognizes the severity of the debt crisis in which we find ourselves and rightfully points blame in the direction of our (government sponsored) financial system. Also, his genuine preference towards decentralization seems well placed as a basic principle with which to address the problems related to our financial system. So please don’t lump him with the other three marionettes.

Posted by sid25 | Report as abusive

colt1210…the head of the SEC was busy attending Bernie Madoff’s son’s wedding. They aren’t negligent…they’re in cahoots with the likes of Goldman Sachs and Citibank. They failed to act on evidence they got for 10 years that Bernie was running a ponzie scheme. Bernie finally turned himself in sans any SEC involvement. The SEC is currently fighting tooth and nail against a federal judge that is blocking their settlement with Citibank over hawking a subprime package to investors while Citibank shorted it. Obama should start at home and clean up the SEC. Best group of regulators that money can buy!

Posted by xyz2055 | Report as abusive

Not Edmund Burke. It was George Santayana who wrote “Those who cannot remember the past are condemned to repeat it”.

Posted by NewConstitution | Report as abusive

This was a good article that I enjoyed reading. It seems like jobs that solve real problems or reduce costs for future generations are a good thing. Jobs that are about selling financial instruments that do not work as pitched are a bad thing. Hopefully, the electorate will push for solutions to the current economic quagmire.

Posted by M.C.McBride | Report as abusive

AIG, which had a back door connection to Goldman Sachs was front and center when all those financial weapons of mass destruction detonated triggering the bailout of not only themselves but every major bank in America. AIG’s Financial Products unit based in London has been identified as the epicenter of the crisis. It’s nothing more than crony capitalism for the Republicans to blame this mess on Freddie and Fannie. Sure they played a role. But they were merely complicit and not the primary cause of this mess. For the Republican Party to acknowledge that AIG and the bankers were the true culprit would be to give Dodd-Frank (and Obama) an air of legitimacy. That ain’t gonna happen.

Posted by xyz2055 | Report as abusive

The author all too self-assuredly dismisses the theory that the government bears a large portion of the blame for the recent financial crisis. Interestingly, she wrote a book on the topic, which means she should actually be familiar with all the various criticisms lobbed at the federal government’s role in the situation – a number greater (even on the Republican stage) than what she represents here. She should also be well aware of the continuing debate among intellectuals over government versus private responsibility. Instead she picks the least important line of argument on the government responsibility side, totally dropping concerns that utilizing GSEs at all can lead to over-investment in housing or that interest rates were kept too low for too long. I would expect a Reuters opinion column to do better – or rather, I would have expected it, except that the current opinion editors seem bent on signing up token ridiculous conservatives and filling most of its space with uninformative drivel. The author’s arrogant tone has actually made me reconsider my own conviction that the private sector caused the crisis.

Posted by Jayhay | Report as abusive

Jayhay…your post is the epitome of “missing the forest for the trees”.

Posted by xyz2055 | Report as abusive

Hey, I thought the mighty “invisible hand of the marketplace” was supposed to prevent things like this. Where was it? I didn’t see it.

Posted by borisjimbo | Report as abusive

To those who have been saying the RICO statutes should have been invoked, the Supreme Court (guess which wing?) narrowed their reach considerably in a case handed down not so many years ago.

Posted by borisjimbo | Report as abusive

yes the govt did have something to do with the crisis, but not what the right believes by faith. one only has to look at the demise of glass-steagel, where the gop pledged that the banks and investment companies would “police” themselves and didn’t need all that ancient & unecessary regulation holding them back from reaching their potential. that went pretty well i think! and what’s the gop answer? remove more regulation so they can work things out – if that happens look for another round of trillion dollar gop welfare, only who are you going to get it from this time?

Posted by jcfl | Report as abusive

The truth is that the government did play a role and so did private industry and many other parties.

1)The affordable housing initiatives began to distort the housing market – prices going up, people want to participate in it.

2)Parts of Glass-Steagall were repealed by Gramm Leach Bliley, effectively allowing banks to take greater risk with their capital to achieve greater returns. (We should never mix investment banks with depository institutions)

3)In reaching for greater yield, Banks started securitizing and buying up MBS because they had a nice yield, solid credit rating and were backed by ever increasing property prices.

4)Most everyone missed the ball, ratings agencies, banks, derivative “insurance” (CDS), AIG, Federal government, investors, and individual borrowers alike.

5)Bubble bursts, economy crashes, jobs lost, mortgages default, bank capital quickly erodes and the largest American banks (who participated most heavily) needed to be bailed out – otherwise it could have been a true apocalypse. The only person big enough to backstop the banks, AIG, etc. was the Federal governemnt.

It’s pretty simple really. There is no single root cause, rather a succession of events.

So, yes, the Federal government did play a role and yes so did the bankers on Wall street and just about everyone in between. What frustrates me is tht while everyone plays the blame game, nobody is looking forward into the long term to address these issues going forward. the far left and the far right are both wrong. Yes, we need to let free markets work (government distorted housing market was absolutely a precursor and catalyst) and yes we need regulation, but not regulation in mass quantity, but in quality – and we need honest people who truly understand the issues to impose effective regulation that does not impede free market dynamics.

I think the author paints a very biased picture, to say the least.

Posted by jaham | Report as abusive

@ecogabriel…considering you worked at a bank I thought you would realize that banks cannot hold all loans on their books. If they did, the 30 yr mortgage simply wouldn’t exist.

Look at rates right now – what do you think would happen to a bank that made long term fixed loans in this rate environment (and held them for investment)? They’d be belly up in about 3 years. Banks fund with short term money and therefore can’t lend very long, you have to match durations/maturities in any business or you’re asking for trouble

That is why banks typically hold commercial loans for investment and underwrite and sell home mortgages. Commercial loans typically have about a 5 yr balloon and then the rate adjusts. If every homeowner had an adjustable rate in a rising rate environemtn, things would get ugly as well.

I see your point that banks have no “skin in the game” in making long term fixed mortgages and that is true, but there is a reason for that. I would hope that a former banker and now an academic would understand that.

Posted by jaham | Report as abusive

May I also point out that in my previous post, points 1 and 2 were both directly influenced by the Federal government. Without those two, the rest would not have followed. So, while everyone played a role, in my opinion, government laid the groundwork and private industry was greedy and took the bait.

Posted by jaham | Report as abusive

Your article discusses the selling of the GOP falsehood that the crisis was due to big government, Freddie Mac, and Fannie Mae and “faith” in unregulated markets. However, there is no mention of the dirty tactic used by the GOP of intentionally pushing “bigot buttons” to get folks (many of whom do not really think that they are bigots) to believe this tale. Witness the ubiquitous claim in right wing circles, that Barney Frank (openly gay congressman) personally forced banks to make bad loans to poor people (implying black and brown folks, of course). They really don’t explain how a single Democratic congressman could override Republican majorities in both houses and a Republican presidency to make this happen. However many, many folks, because of conscious or unconscious prejudices, will immediately buy into any argument that pushes their bigot buttons. All part of the GOP “Southern Strategy.” Needless to say such people really get really indignant if you point out this out.

Posted by QuietThinker | Report as abusive

No one in the GOP / tea party is ever able to articulate how a single Congressman (Barney Frank) was able to ‘force’ Fannie and Freddie into millions of risky home loans that those banks did not want to make. How does a single Congressman do that? Where is the documentation of this, and if this really happened…. why didn’t Bush stop it? Bush was in charge of the Office of Federal Housing Enterprise Oversight, the Federal Housing Finance Board, and HUD before and during the collapse.

This whole Barney Frank conspiracy theory appears to be one of the goofiest deflections cooked up on AM radio in recent years. There are apparently still some people in Kentucky who believe in it.

Posted by AlkalineState | Report as abusive

The profitability of repackaged mortgage securities distorted the supply side. Demand for more mortgages to feed the beast could only be met by lax lending standards. Authorities and rating agencies were blind to the bubble. No one dared kill the golden goose, and anyone who tried was shouted down. Responsibility should be shared by all participants, but the ultimate safety mechanism for this kind of blow out failed. Now, who wants to ‘fess up to criminal intent or negligence?

Posted by vh070 | Report as abusive

Any time someone is ‘selling’ debt, be very skeptical of how that ends. It’s poison-shuffling nonsense. Debt is not a product or a service. It is a liability in its simplest form. Anyone who thinks debt is something you should buy…. I’ve got some new doctor bills I can send you (Broken collar bone and arm at Whistler – the cost of adventure). Just Send me a thousand dollars and I’ll send you all of my bills. We’ll do us a ‘debt sale.’

Posted by AlkalineState | Report as abusive

jaham…Mortgages have been packaged and sold to investors for decades. What changed during the subprime days was how the CDO’s and CDS’s were rated. Both Goldman Sachs and Citibank sold mortgage packages to investors that had triple AAA ratings that were in fact piles of dog do-do. That’s why they shorted them unbeknown to the buyers of those securities. That’s fraud plain and simple. Part of the problem is the regulators and the rating system. MF Global, as you might remember, got a clean bill of health only months before they filled for bankruptcy.

Posted by xyz2055 | Report as abusive

Yep. It was easy access to capital and then the repackaging of the loans. Everyone is at fault.

Posted by Matt-Chicago | Report as abusive

Private ‘ratings firms’ don’t work. We don’t have ratings firms grading eggs and meat instead of USDA. Come up with a single, consistent set of criteria and have the government rate banks and securities. The only way ‘rating’ can be profitable as a private firm is if you’re on the take.

Posted by AlkalineState | Report as abusive

Seriously? The bad paper was generated by private bankers, who shoveled it through the federally chartered mortgage conduits. The crime came as the last administration bailed the perpetrators, and asumed the tab for the bills and responsibility for trillions in crappy loans (Goldman speak)

Posted by SanPa | Report as abusive

Raghuram G. Rajan book “Fault Lines” should be required reading for every person. This article takes a selective view of Republican opinion and creates a a sort of caricature of the party. It appears that the author can make little distinction between “playing politics” and the really more detailed views that many of these candidates no doubt hold. Why are people always so naive?

Rajan’s response to Paul Krugmans review of his theory is very illuminating and can be found with a little determination. I highly recommend it.

The author would be advised to study “the housing boom and bust” by Thomas Sowell, to avoid writing such a terribly polarised article.

Posted by MrRipley | Report as abusive

Finance based on faith?

Professionals get paid for due diligence, and a lack of faith (a poor substitute for trust but verify).

The only role “faith” ought have in finance can be found in the Bible (and most religious teachings):

For instance – thou shalt not steal, nor tamper with weights and measures, and more recently, nor turn my father’s house into a market.

Regulation cannot cure a financial system based on dishonesty.

Posted by JonParks | Report as abusive

The failure is larger than a partisan finger-pointing exercise. It is historical. The government did fail, because it did not fulfill its legal mandate under the securities laws of the 1930s to regulate all securities. It failed to enforce the basic rules. These securitizations were simply treated as traditionally exempt from securities scrutiny and oversight. The issue was obvious, but the relevant regulators regarded it as off their turf and out of their purview. The GSEs were a government program run as a monopoly. They had no rules, other than those they made themselves. The government is treated as if it needs no rules, because nothing the government does has to be economically rational. Government is simply assumed to be well motivated and benign—and often, it is. Whatever mistakes the government makes are by definition simply absorbed by the American people.

Originally, the GSEs had been run with integrity. To securitize home mortgage debt after the Great Depression was a good government program, particularly under conditions of the 1930s: diverse small local banks with limited portfolios of home and local commercial loans which, if combined, could be made overall safer, courtesy of government pooling. Government-backed finance for the little guy, structured to be safer by nationalizing it. FDR invented, by the way, the 30 year mortgage. The usual home mortgage at that time was 5 years to pay off, 50% down. (This datum comes from Raghuram Rajan’s Fault Lines.) Thus, there is nothing economically “natural” about the 30 year mortgage. FDR rationalized what was at that time an industry subject to local ups and downs, with a monopoly insurance plan. When the GSEs were later privatized (which happened not in the 80s “decade of greed,” but in 1968, in the effort to lay GSE liabilities off onto the private sector, due to the budget pressures of Vietnam and the Great Society), the need to inspect the integrity of the securities packaging process was just spaced out by Congress and all the rest of Washington.

As sole securitizer, the GSEs would never have lent to deadbeats. But there was no such restraint on private market securitizers. The government’s debt securities packaging technique — which amounted to cranking paper out of word processing — was now normalized and blindly handed off to financial firms to simply emulate. Banks themselves were now also no longer local small lenders eking out a small profit on lending to well scrutinized debtors, but highly aggregated volume sales fee generators, soon to be on digital steroids, and also, by that time, all rolled up over a long series of mergers and acquisitions into a vast cartel. Banking itself emulated government, in size and aggregation structure. There was no antitrust scrutiny in the 80s. For other reasons antitrust was under a cloud. This too had the effect of extending the originally limited government guarantee to the little guy against his home, to all of finance. The original limitation had been based on the early segregated nature of banks’ very function and structure, an industry structure originally enforced by Glass Steagall. The fact of Glass Steagall itself should have suggested to Congress that it held significance to the overall structure of the law. But Congress isn’t capable of that kind of deep thinking. They respond to the immediacies of campaign self-promotion, and lobbying.

Even government officials using Other People’s Money have the “skin in the game” of a sense of responsibility to the public, and whatever native smarts they may have. But privatizing the GSEs eliminated even this pillar of restraint and accountability. Meanwhile the private sector could also con its new buyers by pointing to debt securitizations’ long, apparently safe track record in the hands of the government. The world simply assumes the integrity of our markets. By long habit, the SEC didn’t notice the lack of arms’ length market scrutiny in the debt securities packaging process. Though, it should have. When entrepreneurs form a company, and do business, then seek capital to expand, entering into debt agreements or seeking to sell equity securities to people, in its nature this is scrutinized by lenders and VCs. The government’s word processing technique of taking debt off banks’ hands and bundling it into securities to resell, has no such nature. But securities law certainly requires some such rigorous process of transparency, scrutiny, and arms’ length negotiation.

Wall Street lawyers did not miss this, by the way. They knew, but weren’t telling. They served their clients, the banks, whose interest was to land all this business, and devil take the hindmost. The lawyers got to look the other way, collect big fees for themselves, and whistle Dixie. They also knew the government would in effect be on the hook. By the 80s all of elite law was full of this type of speculative thinking. The government itself was also specifically advised of its duty to subject all such securities to the full monte of regulatory oversight. It ignored it out of the bureaucrat’s instinct to ignore anything that seems to fall between stools. That is why Republicans are right to blame government, even if they get most of the details wrong. By long habit, Washington “trusts” Wall Street to guide it. But here, government was conned by Wall Street. Too much money was at stake. Government should not have been so stupid, but it was.

The American people rely on the government to do the basics. The basics are to enforce the antitrust and the securities laws. Instead, the government indulges in convoluted bread and circuses: massive self promotions, clamorous issuance of “new” laws that do nothing but confuse and trip up all the existing law. In this, government ignored all the basics. We have much to fear because if they cannot get the basics right, none of the rest matters. In a meta-sense Republicans are very right to warn against the piling on of feckless government promises.

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