Just finished "Reckless Endangerment" by Gretchen Morgenson & Joshua Rosner. The secondary title is "How Outsize Ambition, Greed, and Corruption Led to Financial Armageddon" - whew!
Having watched a little news now and then, I was prepared to hate (hate, hate, hate) Barney Frank, Chris Dodd, and Franklin Raines, et.al., for their part in this. Ready to take umbrage with the banks, and be P.O.d at Wall Street. I came away with general disdain for them all. A pox on all their houses! 'Occupy Wall Street' has it wrong - trying to place all the blame on the tycoons. There is plenty of blame to go round.
The 2008 housing bubble started long before Bush was President (it's true, sorry.) Congress and the President (for several administrations, from the 1970s through 2008) had their fingerprints all over this disaster.
This problem starts back in 1977 (J. Carter (D.), President) signed a law that was conceived with good intentions - to prevent mortgage lenders 'redlining' (which prevented low income borrowers from buying homes.) Through the prism of race and civil rights, this was seen as a good thing. People who 'deserved' a home could now have one...
A timeline follows, gleaned from the book showing how we got to where we today. I have summarized, and in some case quoted from the book in the following summary.
1977 – “Community Reinvestment Act” – was passed to combat ‘redlining’, to especially help blacks and Hispanics to obtain mortgages.
1986 - Congress eliminated mortgage interest payments on tax deductibles. Seems innocuous, but further reduced the borrowers commitment to keep on paying the loan.
1991 – The racial background of the borrower was now required on every mortgage application. This was a response to a flawed report by the Boston Federal Reserve Bank.
1991 - Chris Dodd (D – Conn.) adds an amendment to a bill that provides government bailout for holders of risky and failed loans, turning out to be a much bigger deal than anyone realized at the time. Bankers were now able to use less caution because they knew bailout was inevitable – this is called a ‘moral hazard’.
1992 – “Financial Safety & Security Act” – which was supposed to protect tax payers from flame-out by FM, instead launched “affordable housing”. Note: this did not mean making the homes less expensive (i.e., affordable) but to lend money to those who couldn’t pay it back. Safety and soundness was replaced with political goals.
1992 - The Fed began reducing oversight of the Wall Street firms it worked with – ending a program used to audit these Wall Street firms – a tough regulatory approach ended. The collapse of AIG and Citibank followed.
1993 – ‘United Companies Financial’ (UCF - a lender) was the first to bundle sub-prime mortgages together and sell them to investors – usually mixed with good mortgages to lessen the risk. In ten years, this practice grew from $165M(illion) to $467M nationwide. Fannie Mae worked closely with UCF to buy these packages. UCF is not the only mortgage lender with shady practices with whom FM consorts – see also Countrywide, and others. This practice, bundling, grows each year but the problem deepens in that bad loans are no longer bundled with good, or other financial instruments. At its worst, bad loans are lumped together and fraudulently sold to investors.
1994 – The down payment was eliminated as a mortgage requirement. The result: the middle class had homes with huge loan payments, and were crushed when those heavy loan burdens crashed down on them. The unintended consequence: the borrowers have no ‘skin in the game’, it is easier to walk away, to default. What do you have to lose? Absolutely nothing.
1994 – Fannie Mae touted a $1T(rillion) plan to eliminate barriers to homeownership. Bribes (campaign contributions) flooded Congress to hold off criticism, most of it going to Democrats (e.g, Kennedy, Frank, Dodd, etc.); Republicans were also swept into the maelstrom. Gingrich praised Fannie Mae for its efforts, as did Bond of Missouri.
1994-97 – Sub-Prime mortgages exploded from $35B(illion) to $125B. As loans began to fail, the lenders could either go back to older practices by tightening standards, or expand, trying to outrun the problem. Guess which path they took!
1997 – Fannie Mae began “underwriting experiments” – loosening underwriting standards even more. This was based on the same flawed 1991 report by the Boston Federal Reserve Bank. Banks are forced to use new relaxed requirements, but now could off-load risky loans to GSEs (Government-Sponsored Enterprises, i.e, Fannie Mae, Freddie Mac), and thusly to the taxpayer.
1997 - Andrew Cuomo (HUD) – reduced the underwriting standards rules (again) for Fannie Mae and Freddie Mac.
1998 - The mortgage bubble burst – Savings & Loan Disaster. We should have learned our lessons – but, No!
1998 - Fannie Mae resorts to accounting fraud to report earnings, all to provide big bonuses to the Fannie Mae executives.
1998 - The Fed decides that increased oversight and discipline is not necessary for banks they work with. It was ‘clear’ the banks could be trusted, rather than be monitored closely. we see how that worked out. Obviously, not paying attention to the S&L disaster swirling around them!
1999 - “Financial Services Modernization Act” – let insurance companies act like banks. Greenspan, Rubin, and Larry Summers (all Democrats) were quite pleased with themselves – they also forgot the S&L disaster of 1998!
1999 - Glass-Steagal law rescinded. This act was sponsored by three Republicans, with the help of President Clinton and former Secretary of Treasury Robert Rubin. Glass-Steagal was passed in 1930s to prevent banks from mixing banking funds and investment funds – the two could now be pooled together. One U.S. Senator, Dorgan of N.D., warned us, and said we would regret this later. He was right!
2002 - Sarbanes-Oxley bill passes Congress and is signed by President Bush.
2002 - Moody’s (a rating agency) begins using a computer model to analyze risks for mortgagees and lenders – but it is seriously flawed. There are key pieces of information missing - like income! The other major agencies, Standard & Poor, Fitch, follow suit.
2003 - B. Frank, during a hearing, said that Fannie Mae presented no potential harm to taxpayers. Oops.
2006 - “Rating Reform Act” is passed by Congress and signed by President Bush. This act shone a light on the failure of the rating agencies, but it did nothing to reform Fannie Mae (see: Bribes, above).
2010 - Barney Frank cannot remember a thing about the 1992 legislation that helped launch this disaster.
As it worked out, I still hate Barney Frank and Chris Dodd, but I also have little sympathy for the G.S.E.s, banks and Wall Street. Executives from FM should be in jail, as should members of Congress that took the bribes. They wrote the laws that made some of these lending practices legal, but not moral. The lenders that fraudulently filled out mortgage applications should not get bonuses, but jail time.
A little background info:
Sub-Prime – less than prime borrowers. “A” rated borrowers were labeled prime, “B&C” rated borrowers came to be labeled sub-prime. Previously, sub-prime borrowers didn’t deal much with traditional banks – too many questions, too much hassle – from the banks’ point of view, the sub-prime borrowers were not reliable (e.g., defaults) and were shunned.
Fannie Mae (FM), Freddie Mac – Government Sponsored Enterprises (GSE). It turns out, these are not independent of the government, but basically are wholly owned subsidiaries. FM’s risk taking provided great wealth for its executives millions of dollars of salaries and bonuses, even while failing miserably. FM used aggressive lobbying to destroy regulators and critics. Jim Johnson, the architect of a disastrous home ownership strategy, became chief executive of FM in 1991, leaving in 1999 with over $100M! Franklin Raines (Barney Frank's lover) drove the failure bus even deeper into debt, but 'earned' millions. Between 1989-2009 huge campaign contributions (bribes), more than $100M, were sent to congressmen and senators. Huge subsidies (i.e., tax payer money) were siphoned off, some of it funneled to ACORN. Incentive pay for the FM executives grew by 400% between 1993-2000. FM poured money to ‘academic research’ – resulting nothing was studied or reported that would make FM look bad. The ‘independent scholarship’ did not want to lose the paycheck from FM.
FED - (Federal Reserve Bank) – I would suggest “Lords of Finance” by Liaquat Ahamed for a good primer of how the Fed came to be. It is supposed to be independent of the government – oh, well.
