History and Cause of Financial Crisis

September 29th, 2008

Root Cause

Crisis of politically driven crony capitalism

The way it’s presented, Democrats have the media and public convinced they had nothing to do with it.

Over the past eight years, those who have tried to fix Fannie and Freddie (the epicenter of the current meltdown) were stymied repeatedly by Congressional Democrats. Some key Republicans deserve some blame as well, but the majority stake holders in this meltdown are Democrats.

Reason: Fannie and Freddie became massive providers of reliable votes from low-income homeowners and massive givers to the Democratic Party by investment bankers and Fannie and Freddie.

Where It Started

It started in 1977 during the Carter presidency. Carter and the Democrats brought us the Community Reinvestment Act (CRA). The main idea, eliminate the practice of redlining by lending institutions. The definition of redlining is banks setting up shop in low income areas, taking their deposits, then lending the funds to rich areas starving the poor and minorities communities of housing and capital.

The CRA came just years after other major civil rights acts that were passed. Blacks felt frozen out of home ownership. So, like most all good intentions without thought, we have bad results. This led to the housing boom, supported by shoddy loan practices, a subsequent bust, and the financial mess we have now.

Between 1977 and the early 1990s
The CRA forced banks and savings institutions to make loans to poor, often uncreditworthy minorities.

Banks were required to keep records of their minority lending practices. If they didn’t pass muster, they were refused to expand, merge with other banks, or boost lending in new markets.

There wasn’t much policing required then by government, they let radical community groups like ACORN (a communist organization) and NACA syphone billions of dollars from banks and let them lend money in poor communities.

These groups booked thousands in fees for every loan and required recipients to become active in radical causes – today’s community organizing or shakedown artists. Can you say Barry Obama.

If a group decided a bank wasn’t operating in good faith, the bank’s CRA rating would be affected. The scorecard for how well it lent to minorities.

Banks became targets, shakedown targets and so, not to be tagged as the enemy of the poor, they channeled billions to these groups who had meager results to show for it.

During the Clinton era, Fannie and Freddie got involved buying bad loans from banks, securitizing them for sale on the world markets, thus the seed of the subprime meltdown was planted.

How a Clinton-era Rule Rewrite Made the Subprime Crisis Inevitable

How did the government get so deeply involved in the housing market?

Answer: President Clinton wanted it that way.

Even though Carter signed the Community Reinvestment Act (CRA) which pushed Fannie and Freddie to aggressively lend to minority communities, IT WAS CLINTON WHO SUPERCHARGED THE PROCESS.

After entering office in 93, he extensively rewrote Fannie and Freddie’s rules.

As a result, he turned two quasi-private mortgage funding firms into a semi-nationalized monopoly that dispensed cash to markets, made loans to large Democratic voting blocs and handed favors, jobs, and money to political allies. This led to corruption and their ultimate current day collapse.

In October 1992, nearly 15 years before the housing meltdown and subprime crisis, Republican Rep. Jim Leach of Iowa was on the floor of the House, talking about something that no one at the time seemed to care about: the potential danger that Fannie Mae and Freddie Mac posed to the economy.

In remarks later reported by the Washington Post, Leach warned that Fannie and Freddie were changing “from being agencies of the public at large to money machines for the stockholding few.”

Leach’s prescient comments went unheeded — indeed, Congress spent the next decade and a half avoiding the alarms going off around Fannie and Freddie. Until, that is, it was too late.

Led by top Democrats, including Representative Barney Frank in the House and Senator Chris Dodd in the Senate, Congress not only did nothing about the growing risks at Fannie and Freddie, it in essence doubled down on their risks.

The Democrat-led Congress of the early 1990s eased capital limits on the two mortgage lending giants, letting them use enormous leverage — 2.5% of assets at Fannie and Freddie, vs. 10% for banks — to expand lending to low-income, minority communities.

What about regulation?

Regulator Reined In

Congress, with the passage of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, also created a regulator for Fannie and Freddie — but made sure that, from the very beginning, it would essentially be neutered.

That regulator, the Office of Federal Housing Enterprise Oversight, an arm of the Department of Housing and Urban Development, was unique among financial regulators in that it had to go back each year to Congress for its budget.

This assured its total dependence on Congress (how convenient) — a less-than-ideal situation for a regulator. Over the next decade or so, Fannie and Freddie made sure that OFHEO stayed off their backs, funneling $200 million to various political causes and community activists while donating to 354 political candidates of both parties.

Despite warnings of trouble at Fannie and Freddie, in 1994 Clinton unveiled his National Homeownership Strategy, which broadened the CRA in ways Congress never intended.

Congress Eases Lending Rules

In 1994, the Democratic Congress again moved, passing the Community Reinvestment Act — an update of the original 1977 law.

For the first time, homeowners that previously didn’t qualify — either because they couldn’t put any money down or had bad credit — were made eligible for government-backed loans.

The housing boom was on.

During the 1990s, according to one Fed study, Fannie and Freddie enjoyed a subsidy of as much as $182 billion, with most of that going to shareholders — not to poor borrowers, as supporters of the government-sponsored enterprises have often claimed.

Still, even after the GOP won control of Congress in 1995, Democrats in both houses worked with President Clinton as Fannie and Freddie’s enablers.

Though well-intended, the problem was that Congress was about to change hands, from the Democrats to the Republicans. Rather than submit legislation that the GOP-led Congress was almost sure to reject, Clinton ordered Robert Rubin’s Treasury Department to rewrite the rules in 1995.

Clinton, bypassing Republicans in Congress, had HUD rewrite the rules for Fannie and Freddie to let them get involved in the subprime market for the first time.

Robert Rubin’s Treasury got involved too, reworking its own rules to crack down on banks that didn’t make enough loans to distressed, minority neighborhoods.

That year, Fannie Mae bought an estimated $18.6 billion in subprime loans from banks. By 2004, that amount had exploded to $175 billion, or 44% of the total.

The rewrite, as City Journal noted back in 2000, “made getting a satisfactory CRA rating harder.” Banks were given strict new numerical quotas and measures for the level of “diversity” in their loan portfolios. Getting a good CRA rating was key for a bank that wanted to expand or merge with another.

Loans started being made on the basis of race, and often little else.

Clinton’s HUD secretary, Andrew Cuomo, “made a series of decisions between 1997 and 2001 that gave birth to the country’s current crisis,” the liberal Village Voice noted. Among those decisions were changes that let Fannie and Freddie get into subprime loan markets in a big way.

Other rule changes gave Fannie and Freddie extraordinary leverage, allowing them to hold just 2.5% of capital to back their investments, vs. 10% for banks.

Since they could borrow at lower rates than banks due to implicit government guarantees for their debt, the government-sponsored enterprises boomed.

With incentives in place, banks poured billions of dollars of loans into poor communities, often “no doc” and “no income” loans that required no money down and no verification of income.

By 2007, Fannie and Freddie owned or guaranteed nearly half of the $12 trillion U.S. mortgage market — a staggering exposure.

Worse still was the cronyism.

Fannie and Freddie became home to out-of-work politicians, mostly Clinton Democrats. An informal survey of their top officials shows a roughly 2-to-1 dominance of Democrats over Republicans.

Then there were the campaign donations. From 1989 to 2008, some 384 politicians got their tip jars filled by Fannie and Freddie.

Over that time, the two GSEs spent $200 million on lobbying and political activities. Their charitable foundations dropped millions more on think tanks and radical community groups.

Republicans controlled Congress from 1995 through 2006. But under Clinton their hold was precarious, and with the Internet boom on and several foreign financial crises to deal with, Fannie and Freddie got lost in the shuffle.

Too Little, Too Late

At the tail end of Clinton’s administration, Treasury officials under the new secretary, Lawrence Summers, became alarmed at Fannie and Freddie’s excesses.

Undersecretary Gary Gensler went to Congress in 2000 seeking an end to the companies’ special status — especially the “implicit” federal guarantee of their now-$5.4 trillion loan portfolio — and more power for regulators to boost the companies’ capital requirements.

Democrats raised a ruckus. So did Fannie and Freddie, which were both headed by politically well-connected CEOs who knew how to strategically reward — and punish — those who crossed them.

“We think that the statements evidence a contempt for the nation’s housing and mortgage markets,” Freddie Mac spokeswoman Sharon McHale said at the time, summing up the sentiment in Congress.

It was the last chance during the Clinton era for anything like real reform.

Could the crisis at Fannie Mae-Freddie Mac and the subprime meltdown have been avoided? The answer is yes.

As previously indicated, it was as early as 1992, alarm bells were going off on the threat Fannie and Freddie posed to our financial system and our economy. Intervention at any point could have staved off today’s crisis. But Democrats in Congress stood in the way.

As the president recently said, Democrats have been “resisting any efforts by Republicans in the Congress or by me . . . to put some standards and tighten up a little on Fannie Mae and Freddie Mac.”

No, it wasn’t President Bush who said that; it was President Clinton, Democrat, speaking just last week.

This is interesting, because it was his administration’s relentless focus on multiculturalism that led to looser lending standards and regulatory pressure on banks to make mortgage loans to shaky borrowers.

Freddie and Fannie, backed by an “implicit” taxpayer guarantee, bought hundreds of billions of dollars of those subprime loans.

The mortgage giants, whose executive suites were top-heavy with former Democratic officials (and some Republicans), worked with Wall Street to repackage the bad loans and sell them to investors.

As the housing market continued to fall in 2007, subprime loan portfolios suffered major losses. The crisis was on — though it was 15 years in the making.

Democrats Blocked Reform

Just as Republicans got blamed for Enron, WorldCom and other early-2000s scandals that were actually due to the anything-goes Clinton era, the media are now blaming them for the mortgage meltdown.

But Republicans tried repeatedly to bring fiscal sanity to Fannie and Freddie. Democrats opposed them, especially Senator Chris Dodd and Representative Barney Frank, who now run Congress’ key banking panels.

The Facts about this are crystal clear and history supports them.

After Treasury Secretary Lawrence Summers warned Congress in 1999 of the “systemic risk” posed by Fannie and Freddie, Congress held hearings the next year.

But nothing was done. Why? Fannie and Freddie had donated millions to key congressmen and radical groups, ensuring no meaningful changes would take place.

“We manage our political risk with the same intensity that we manage our credit and interest rate risks,” Fannie CEO Franklin Raines, a former Clinton official and current Barack Obama adviser, bragged to investors in 1999.

In November 2000, Clinton’s HUD hailed “new regulations to provide $2.4 trillion in mortgages for affordable housing for 28.1 million families.” It made Fannie and Freddie take part in the biggest federal expansion of housing aid ever.

Soon after taking office, Bush had his hands full with the Clinton recession and 9/11. But by 2003, he proposed what the New York Times called “the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.”

The plan included a new regulator for Fannie and Freddie, one that could boost capital mandates and look at how they managed risk.

Even after regulators in 2003 uncovered a scheme by Fannie and Freddie executives to overstate earnings by $10.6 billion to boost bonuses, the Democrats killed reform.

“Fannie Mae and Freddie Mac are not facing any kind of financial crisis,” said Rep. Frank, then-ranking Democrat on the Financial Services Committee.

North Carolina Democrat Melvin Watt accused the White House of “weakening the bargaining power of poorer families and their ability to get affordable housing.”

In 2005, then-Fed Chairman Alan Greenspan told Congress: “We are placing the total financial system of the future at substantial risk.”

McCain Urged Changes

That year, Sen. John McCain, one of three sponsors of a Fannie-Freddie reform bill, said: “If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system and the economy as a whole.”

Sen. Harry Reid — now Majority Leader — accused the GOP of trying to “cripple the ability of Fannie Mae and Freddie Mac to carry out their mission of expanding homeownership.” The bill went nowhere.

This year, the media have repeated Democrats’ talking points about this being a “Republican” disaster. Well, McCain has repeatedly called for reforming the mortgage giants. The White House has repeatedly warned Congress. This year alone, Bush urged reform 17 times.

Some GOP members are complicit. But Fannie and Freddie were created by Democrats, regulated by Democrats, largely run by Democrats and protected by Democrats.

That’s why taxpayers are now being asked for $700 billion.

While there are critics pointing to the repeal of the Glass-Steagall Act as the cause of this, there is some justification to do that, however, the first public securitization of CRA loans started in 1997 by Bear Stearns (first in, first out) two years before the repeal. While the repeal probably accelerated the overleveraging, it doesn’t serve as the beginning of mandatory neglect of fiduciary responsibility by lending institutions imposed by government (Democrats as the majority with some Republicans participating).

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