Wednesday, December 31, 2008


The Real Problem With Fannie and Freddie
...For decades Countrywide Financial was a largely unsuccessful firm that was only re-listed on the New York Stock Exchange in 1985. But between 1985 and 2003 Countrywide delivered investors a 23,000% return, exceeding the returns of Washington Mutual, Wal-Mart, and Warren Buffett’s Berkshire Hathaway. How did they do it? This 2000 report by the Fannie Mae Foundation provides a clue:

Countrywide tends to follow the most flexible underwriting criteria permitted under GSE and FHA guidelines. Because Fannie Mae and Freddie Mac tend to give their best lenders access to the most flexible underwriting criteria, Countrywide benefits from its status as one of the largest originators of mortgage loans and one of the largest participants in the GSE programs. …

When necessary—in cases where applicants have no established credit history, for example—Countrywide uses nontraditional credit, a practice now accepted by the GSEs....

Choosing Our Economic Future Wisely
...For example, Countrywide Bank, now criticized as one of the perpetrators of the financial crisis, in 2000 was lauded by the Fannie Mae Foundation for its leadership in providing flexible lending standards. The report stated: “Countrywide tends to follow the most flexible underwriting criteria permitted under GSE and FHA guidelines…When necessary – in cases where applicants have no established credit history, for example – Countrywide uses nontraditional credit, a practice now accepted by the GSEs.”...

... Rather than accept at least some of the responsibility for the crisis, they shamelessly shift the blame to “free” markets that had been, in fact, doing their bidding.

• Corruption? Both Freddie and Fannie were found to have committed accounting fraud, making their profits higher, and their CEO bonuses richer.

• Executive compensation: Fannie’s CEO, Franklin Raines, made $90 million between 1998 and 2004.

• Buying influence: Fannie and Freddie were two of the biggest campaign contributors to congressmen and senators....

Stop Covering Up And Kill The CRA
...Myth: The CRA could not have led to financial Armageddon, because the overwhelming share of subprime mortgages came from lenders that were not banks and not regulated by the CRA.

Fact: Nearly 4 in 10 subprime loans between 2004 and 2007 were made by CRA-covered banks such as Washington Mutual and IndyMac. And that doesn't include loans made by subprime lenders owned by banks, which were in effect covered by the CRA.

Last year, when the bubble burst, bank subprime loans totaled $142 billion, dwarfing those made by lenders.

What's more, the biggest subprime lender, Countrywide, while not subject to the law, still came under federal pressure to make risky loans in minority communities.

Clinton created a separate department at HUD to police "fair lending" at Fannie and Freddie and also at lenders like Countrywide, which became Fannie's biggest client. In 1994, Countrywide became the nation's first mortgage lender to sign with HUD a "Declaration of Fair Lending Principles and Practices."...

Analysis: Reckless Mortgages Brought Financial Market to Its Knees
...One lender singled out by Fannie Mae for special praise for following these new criteria was Countrywide:

Countrywide tends to follow the most flexible underwriting criteria permitted under [Government Sponsored Enterprises] and FHA guidelines. Because Fannie Mae and Freddie Mac tend to give their best lenders access to the most flexible underwriting criteria, Countrywide benefits from its status as one of the largest originators of mortgage loans and one of the largest participants in the [Government Sponsored Enterprises] programs. When necessary — in cases where applicants have no established credit history, for example — Countrywide uses nontraditional credit, a practice now accepted by the [Government Sponsored Enterprises].

Or take a 1998 sales pitch from Bear Stearns, which also followed the Boston Fed manual:

Credit scores. While credit scores can be an analytical tool with conforming loans, their effectiveness is limited with [Community Reinvestment Act] loans. Unfortunately, [Community Reinvestment Act] loans do not fit neatly into the standard credit score framework… Do we automatically exclude or severely discount … loans [with poor credit scores]? Absolutely not.

Given these lending practices mandated by the Fed and encouraged by Fannie Mae and Freddie Mac, the resulting financial problems for financial institutions such as Countrywide and Bear Stearns are not too surprising.

Anatomy of a Train Wreck (PDF)
...What was the impact of this attack on traditional
underwriting standards? As you might guess, when
government regulators bark, banks jump. Banks
began to loosen lending standards. And loosen and
loosen and loosen, to the cheers of the politicians,
regulators, and GSEs.

One of the banks that jumped most completely
on to this bandwagon was Countrywide, which used
its efforts to lower underwriting standards “on behalf”
of minorities (and everyone else) to catapult
itself to become the leading mortgage lender in the
nation. Countrywide not only made more loans
to minorities than any other lender, it also had the
highest consumer satisfaction among large mortgage
lenders, according to J.D. Power and Associates.5
Testimonials to Countrywide’s virtue abound....

Housing Goals We Can’t Afford
THE national wave of home foreclosures, many concentrated in lower-income and minority neighborhoods, has created a strong temptation to find the villains responsible. Among the nominees are the major credit rating agencies like Moody’s and Fitch, which certified that the securities backed by subprime loans were a good investment.

There’s little doubt that the rating agencies helped inflate the housing bubble. But when we round up all the culprits, we shouldn’t ignore the regulators and affordable-housing advocates who pushed lenders to make loans in low-income neighborhoods for reasons other than the only one that makes sense: likely repayment. ...

Frank's fingerprints are all over the financial fiasco
...As long as housing prices kept rising, the illusion that all this was good public policy could be sustained. But it didn't take a financial whiz to recognize that a day of reckoning would come. "What does it mean when Boston banks start making many more loans to minorities?" I asked in this space in 1995. "Most likely, that they are knowingly approving risky loans in order to get the feds and the activists off their backs . . . When the coming wave of foreclosures rolls through the inner city, which of today's self-congratulating bankers, politicians, and regulators plans to take the credit?"

Frank doesn't. But his fingerprints are all over this fiasco. Time and time again, Frank insisted that Fannie Mae and Freddie Mac were in good shape. Five years ago, for example, when the Bush administration proposed much tighter regulation of the two companies, Frank was adamant that "these two entities, Fannie Mae and Freddie Mac, are not facing any kind of financial crisis." When the White House warned of "systemic risk for our financial system" unless the mortgage giants were curbed, Frank complained that the administration was more concerned about financial safety than about housing....

Global warming: Reasons why it might not actually exist
......Temperatures are falling, not rising

As Christopher Booker says in his review of 2008, temperatures have been dropping in a wholly unpredicted way over the past year. Last winter, the northern hemisphere saw its greatest snow cover since 1966, which in the northern US states and Canada was dubbed the "winter from hell". This winter looks set to be even worse.

The earth was hotter 1,000 years ago

Evidence from all over the world indicates that the earth was hotter 1,000 years ago than it is today. Research shows that temperatures were higher in what is known as the Mediaeval Warming period than they were in the 1990s.

The earth's surface temperature is not at record levels

According to Nasa's Goddard Institute for Space Studies analysis of surface air temperature measurements, the meteorological December 2007 to November 2008 was the coolest year since 2000. Their data has also shown that the hottest decade of the 20th century was not the 1990s but the 1930s.

Ice is not disappearing

Arctic website Crysophere Today reported that Arctic ice volume was 500,000 sq km greater than this time last year. ...

HOW FEDS INVITED THE MORTGAGE MESS
... From the current hand-wringing, you'd think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job. In fact, it was the regulators who relaxed these standards - at the behest of community groups and "progressive" political forces.

In the 1980s, groups such as the activists at ACORN began pushing charges of "redlining" - claims that banks discriminated against minorities in mortgage lending. In 1989, sympathetic members of Congress got the Home Mortgage Disclosure Act amended to force banks to collect racial data on mortgage applicants; this allowed various studies to be ginned up that seemed to validate the original accusation.

In fact, minority mortgage applications were rejected more frequently than other applications - but the overwhelming reason wasn't racial discrimination, but simply that minorities tend to have weaker finances.

Yet a "landmark" 1992 study from the Boston Fed concluded that mortgage-lending discrimination was systemic.

That study was tremendously flawed - a colleague and I later showed that the data it had used contained thousands of egregious typos, such as loans with negative interest rates. Our study found no evidence of discrimination.

Yet the political agenda triumphed - with the president of the Boston Fed saying no new studies were needed, and the US comptroller of the currency seconding the motion.

No sooner had the ink dried on its discrimination study than the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: "discrimination may be observed when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants."

Some of these "outdated" criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification. Instead, the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant's ability to manage debt.

Sound crazy? You bet. Those "outdated" standards existed to limit defaults. But bank regulators required the loosened underwriting standards, with approval by politicians and the chattering class. A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities. It also let community activists intervene at yearly bank reviews, shaking the banks down for large pots of money.

Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department. ...

Monday, December 29, 2008


Whose Ponzi Scheme Is Worse: Madoff’s or the Government’s?
Pardon my humbug this Christmas Day, but how many people have considered that the trillion-or-so dollars the Bush and Obama administrations might spend on bailout and stimulus efforts could turn out to be a worse Ponzi scheme than Bernard Madoff’s fleecing of investors, estimated at up to $50 billion?

Before we rush headlong and panicked into throwing even more good taxpayer money into believing that, yes Virginia, government programs like this actually work, have we looked at the model for all this — similar government “rescue” spending during the Great Depression?

That “New Deal” turned out to be a bad deal. Research by historians including Amity Shlaes, Jim Powell and others has found that President Roosevelt’s expensive Depression-era make-work projects actually coincided with an increase in unemployment and that the projects took years to complete, producing at best minimal benefits to the economy....

Wednesday, December 24, 2008


Washington Is Killing Silicon Valley
...For more than 30 years the entrepreneurship-venture capital-IPO cycle centered in Silicon Valley has generated new wealth, commercialized innovation, and created new companies and industries. It's also spun off millions of new jobs. The great companies created by this process -- Intel, Apple, Google, eBay, Microsoft, Cisco, to name just a few -- have propelled most of the growth in the U.S. economy in the last two decades. And what began as a process almost exclusively available to scientists and engineering Ph.D.s became open to just about anyone with a good business plan and a healthy dose of entrepreneurial drive....

...From the beginning of this decade, the process of new company creation has been under assault by legislators and regulators. They treat it as if it is a natural phenomenon that can be manipulated and exploited, rather than the fragile creation of several generations of hard work, risk-taking and inventiveness. In the name of "fairness," preventing future Enrons, and increased oversight, Congress, the SEC and the Financial Accounting Standards Board (FASB) have piled burdens onto the economy that put entrepreneurship at risk.

The new laws and regulations have neither prevented frauds nor instituted fairness. But they have managed to kill the creation of new public companies in the U.S., cripple the venture capital business, and damage entrepreneurship. According to the National Venture Capital Association, in all of 2008 there have been just six companies that have gone public. Compare that with 269 IPOs in 1999, 272 in 1996, and 365 in 1986....

...For all of this, we can first thank Sarbanes-Oxley. Cooked up in the wake of accounting scandals earlier this decade, it has essentially killed the creation of new public companies in America, hamstrung the NYSE and Nasdaq (while making the London Stock Exchange rich), and cost U.S. industry more than $200 billion by some estimates.

Meanwhile, FASB has fiddled with the accounting rules so much that, as one of America's most dynamic business executives, T.J. Rodgers of Cypress Semiconductor, recently blogged: "My financial statements are a mystery, even to me." FASB's "mark-to-market" accounting rules helped drive AIG and Bear Stearns into bankruptcy, even though they were cash-positive.

But FASB's biggest crime against the economy and the American people came when it decided to measure the impossible: options expensing. Given that most stock options in new start-up companies are never worth anything, this would seem a fool's errand. But FASB went ahead -- thereby drying up options as an incentive for people to take the risk of joining a young company and guaranteeing that the legendary millionaire secretaries would never be seen again.

Not to be outdone, the SEC has, through the minefield of "full disclosure" requirements and other regulations, made sure that corporate directors would never again have financial privacy and would be personally culpable for malfeasance anywhere in the company. This has led to a mass exodus of talented people from boards of directors in places like Silicon Valley. Full disclosure was supposed to make boards more responsible. Instead, it has made them less competent....

Crunch time for capitalism? I don't think so
...Since then, however, I have heard it everywhere, this notion of my old foe. The idea is that the financial crisis vindicates the left-wing critique of capitalism. We are, apparently, at one of the most significant points in the ideological debate since the early years of Thatcher or since the fall of the Berlin Wall or something. The years of free-market triumphalism are over. The State is back.

I've heard it so often, in fact, that I can't let it go any more. The problem is - I am really not sure what all these people mean, what all this talk of vindication and new eras, and resurgence of the Left is really all about. And it's hard to mount a fierce rebuttal of an argument that never really takes shape. ...

...In 1983 Labour wanted to set up a national investment bank “to put new resources from private institutions and from the Government - including North Sea oil revenues - on a large scale into our industrial priorities”. It also wanted to force banks to grant mortgages to lower-income groups and favoured Labour causes.

These policies were accompanied by a threat both vague and menacing: “We expect the major clearing banks to co-operate with us fully on these reforms, in the national interest. However, should they fail to do so, we shall stand ready to take one or more of them into public ownership.”

In other words, what the banks did imprudently during the recent housing boom - lend to those to whom it was not sensible to lend - Labour in 1983 insisted they do as a conscious policy of the State. To describe the recent financial woes of the banks as a vindication of this programme is perverse. And maybe Mr Livingstone meant it to be so. ...

...Let's try a vaguer formulation of the “new era” argument, one that doesn't involve banks or intervention. Gordon Brown and Lord Mandelson both argue that the case for “active government” has now been made. In a lecture earlier this year, Mr (as he was then) Mandelson stated boldly that “government is making a comeback”.

Really? Has it been away? I hadn't noticed. I'd have bought it a welcome-home card.

Throughout the period of free-market triumphalism that is now supposed to be passing, the State spent 40 per cent or so of GDP, provided welfare to those down on their luck and participated in national and international schemes to prevent an economic crisis. This seems like quite active government to me.

In so far as the recent events have changed the argument, they have made it hard to see how government spending can keep on growing at such a pace and they have made a strong case for the State to be reorganised to be sure that it can afford its commitments. The borrowing mess suggests that government has been too active, rather than not active enough.

So Lord Mandelson has made a comeback. But government? I think not.

Tuesday, December 23, 2008


Church to out ex-member's 'sexually immoral relationship'
She quit after members confronted her; she needs to be disciplined, pastor says.

Grace Community Church in Mandarin plans to tell it on the mountain - or at least preach it from the pulpit - on Sunday, Jan. 4. And it's not something former church member Rebecca Hancock wants her children or anyone else to hear.

The Jacksonville church informed Hancock, 49, this month it will make her "sexually immoral relationship" with her boyfriend public at that service.

Hancock, who is divorced, said she left the church in October because members confronted her over it. On Wednesday, she also sent the church a letter officially resigning - hoping to stop the action so her children, who attend services there, would not have to face her embarrassment....

...Just before the divorce was finalized a few months ago, she began dating a man and confided to a woman at church who she went to for "guidance, assistance and counsel." But that woman told church officials, Hancock said.

One Sunday in October, her confidant hugged her and led her to a meeting with some of the church's female members.

"They all went after me," Hancock said. "One of the ladies said, 'I know you haven't come home at night because I was at your house and I saw you not come home.'

"It was so devastating. ... I thought the people who cared for me were in this room."

Her boyfriend sent an e-mail asking for her removal from church membership, and she moved to a Southside church, thinking it was all over - until her son brought home the church letter....


Church shields itself from buzz over news story

The Mandarin church that plans to publicly discipline a former member for what senior officials call a "sexually immoral relationship" went private itself Thursday.

After news reports of the situation created a stir this week, Grace Community Church's Web site was inaccessible, the pastor's home phone was disconnected, the church's office doors were locked by 4 p.m. and the church issued only a short, new statement....

Sunday, December 21, 2008


The Subprime Lending Bias
...Just how did Americans come to lose $10 trillion in real estate and stock wealth? And why are our children and grandchildren on the hook for as much as $8 trillion in federal bailout money? These are some of the most important questions of our time. Yet the mainstream media, plagued by monopartisan bias, are not providing the public honest answers.

Take, for instance, a recent front-page article in the Washington Post, under the headline, "How HUD Mortgage Policy Fed the Crisis." The piece correctly fingers HUD for helping fuel risky lending at Fannie Mae and Freddie Mac. But the newspaper starts its analysis in 2004 (in fact, the first sentence begins, "In 2004 . . . "), making it seem as if the Bush administration crafted "affordable housing" policy and created the subprime market.

The Post knows better. The Bush HUD merely continued a politically correct policy launched by the Clinton administration. For the first time, President Clinton ordered HUD to set quotas for Fannie and Freddie to buy huge portions of Community Reinvestment Act loans and other low-income mortgages made to borrowers with poor credit. The Post failed to mention this key fact.

By 2000, fully half of the mortgage giants' portfolios consisted of these risky loans, most of them subprime mortgages. In effect, the Clinton HUD set a time bomb that would explode years later with the collapse of home prices, which happened to occur on Bush's watch.

At the same time, HUD pressured the federally subsidized giants to lower their loan-to-value ratios and other underwriting requirements to accommodate minority borrowers. HUD Secretary Andrew Cuomo even admitted that the administration was mandating a policy of "affirmative action" lending (his words, not ours).

And it was Clinton who initially spread the subprime rot to Wall Street. To help Fannie and Freddie reach their "affirmative action" lending quotas, HUD in 1995 let them get affordable-housing credit for buying subprime securities that included loans to low-income borrowers...

Saturday, December 20, 2008


Now Playing at Reason.tv: Peter Wallison on the Roots of the Financial Crisis


What Got Us Here?


Cause and Effect: Government Policies and the Financial Crisis
...Instead of a direct government subsidy, say, for down-payment assistance for low-income families, the government has used regulatory and political pressure to force banks and other government-controlled or regulated private entities to make loans they would not otherwise make and to reduce lending standards so more applicants would have access to mortgage financing.

The two key examples of this policy are the CRA, adopted in 1977, and the affordable housing "mission" of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. As detailed below, beginning in the late 1980s--but particularly during the Clinton administration--the CRA was used to pressure banks into making loans they would not otherwise have made and to adopt looser lending standards that would make mortgage loans possible for individuals who could not meet the down payment and other standards that had previously been applied routinely by banks and other housing lenders. The same pressures were brought to bear on the GSEs, which adapted their underwriting standards so they could accept the loans made under the CRA and other loans that did not conform to what had previously been considered sound lending practices. Loans to members of underserved groups did not come with labels, and once Fannie and Freddie began accepting loans with low down payments and other liberalized terms, the same unsound practices were extended to borrowers who could have qualified under the traditional underwriting standards. It should not be surprising that borrowers took advantage of these opportunities. It was entirely rational to negotiate for a low-down-payment loan when that permitted the purchase of a larger house in a better neighborhood. ...

...As originally enacted in 1977, the CRA was a vague mandate for regulators to "consider" whether an insured bank was serving the needs of the whole community it was supposed to serve. The "community" itself was not defined, and the act stated only that it was intended to "encourage" banks to meet community needs. It was enforced through the denial of applications for such things as mergers and acquisitions. The act also stated that serving community needs had to be done within the context of safe and sound lending practices, language that Congress probably inserted to ensure that the law would not be seen as a form of credit allocation. Although the act was adopted to prevent "redlining"--the practice of refusing loans to otherwise qualified borrowers in low-income areas--it also contained language that included small business, agriculture, and similar groups among the interests that had to be served. With the vague compliance standard that required banks only to be "encouraged" and their performance to be "considered," the act was invoked relatively infrequently when banks applied for permission to merge or another regulatory approval, until the Clinton administration.[1]


The decisive turn in the act's enforcement occurred in 1993 and was probably induced by the substantial amount of media and political attention that had been paid to the Boston Federal Reserve Bank's 1992 study of discrimination in home mortgage lending.[2] The study concluded that while there was no overt discrimination in the allocation of mortgage funds, more subtle forms of discrimination existed in which whites received better treatment by loan officers than members of minorities. The methodology of the study has since been questioned,[3] but it seems to have been highly influential with regulators and members of the incoming Clinton administration at the time of its publication. In 1993, bank regulators initiated a major effort to reform the CRA regulations. Some of the context in which this was occurring can be gleaned from the following statement by Attorney General Janet Reno in January 1994: "[W]e will tackle lending discrimination wherever and in whatever form it appears. No loan is exempt, no bank is immune. For those who thumb their nose at us, I promise vigorous enforcement."[4]

The regulators' effort culminated in new rules adopted in May 1995 that would be phased in fully by July 1997. The new rules attempted to establish objective criteria for determining whether a bank was meeting the standards of the CRA, taking much of the discretion out of the hands of the examiners. "The emphasis on performance-based evaluation," A. K. M. Rezaul Hossain, an economist at Mount Saint Mary College, writes, "can be thought of as a shift of emphasis from procedural equity to equity in outcome. In that, it is not sufficient for lenders to prove elaborate community lending efforts directed towards borrowers in the community, but an evenhanded distribution of loans across LMI [low and moderate income] and non-LMI areas and borrowers."[5] In other words, it was now necessary for banks to show that they had actually made the requisite loans, not just that they were trying to find qualified borrowers. In this connection, one of the standards in the new regulations required the use of "innovative or flexible" lending practices to address credit needs of LMI borrowers and neighborhoods.[6] Thus, a law that was originally intended to encourage banks to use safe and sound practices in lending now required them to be innovative and flexible--a clear requirement for the relaxation of lending standards. ...

...The important question, however, is not the default rates on the mortgages made under the CRA. Whatever those rates might be, they were not sufficient to cause a worldwide financial crisis. The most important fact associated with the CRA is the effort to reduce underwriting standards so that more low-income people could purchase homes. Once these standards were relaxed--particularly allowing loan-to-value ratios higher than the 80 percent that had previously been the norm--they spread rapidly to the prime market and to subprime markets where loans were made by lenders other than insured banks. The effort to reduce mortgage underwriting standards was led by the Department of Housing and Urban Development (HUD) through the National Homeownership Strategy published in 1994 in response to a request by President Clinton. Among other things, it called for "financing strategies, fueled by the creativity and resources of the private and public sectors to help homeowners that lack cash to buy a home or to make the payments."[9] Many subsequent studies have documented the rise in loan-to-value ratios and other indicators of loosened lending standards.[10]...

...The problem is summed up succinctly by Stan Liebowitz of the University of Texas at Dallas: "From the current handwringing, you'd think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job. In fact, it was the regulators who relaxed these standards--at the behest of community groups and ‘progressive' political forces...

...By 2005, it had become clear that Fannie and Freddie were not materially assisting middle-class homebuyers by lowering interest rates.[15] Given the political basis for the existence of the GSEs, this is a significant fact. Both Fannie and Freddie had suffered major accounting scandals in 2003 and 2004, and their political support in a Republican Congress was shaky. Alan Greenspan, then at the height of his reputation for financial sagacity, had begun to campaign against them--particularly against their authority to hold the portfolios of mortgages and MBS that constituted their most profitable activity.

When the history of this era is written, students will want to understand the political economy that allowed Fannie and Freddie to grow without restrictions while producing large profits for shareholders and management but no apparent value for the American people. The answer is the affordable housing mission that was added to their charters in 1992, which--like the CRA--permitted Congress to subsidize LMI housing without appropriating any funds. As long as Fannie and Freddie could credibly contend that they were advancing the interests of LMI homebuyers, they could avoid new regulation by Congress--especially restrictions on the accumulation of mortgage portfolios, totaling approximately $1.5 trillion by 2008, that accounted for most of their profits....

...By 1997, Fannie was offering a 97 percent loan-to-value mortgage, and by 2001, it was offering mortgages with no down payment at all. By 2007, Fannie and Freddie were required to show that 55 percent of their mortgage purchases were LMI loans and, within this goal, that
38 percent of all purchases were from underserved areas (usually inner cities) and 25 percent were purchases of loans to low-income and very-low-income borrowers.[19] Meeting these goals almost certainly required Fannie and Freddie to purchase loans with low down payments and other deficiencies that would mark them as subprime or Alt-A....

...The decline in underwriting standards is clear in the financial disclosures of Fannie and Freddie. From 2005 to 2007, Fannie and Freddie bought approximately $1 trillion in subprime and Alt-A loans, amounting to about 40 percent of their mortgage purchases during that period. Freddie's data show that it acquired 6 percent of its Alt-A loans in 2004; this jumped to 17 percent in 2005, 29 percent in 2006, and 32 percent in 2007. Fannie purchased 73 percent of its Alt-A loans during these three years. Similarly, in 2004, Freddie purchased 10 percent of the loans in its portfolio that had FICO scores of less than 620; it increased these purchases to 14 percent in 2005, 17 percent in 2006, and 30 percent in 2007, while Fannie purchased 57.5 percent of the loans in this category during the same period.[20] For compliance with HUD's affordable-housing regulations, these loans tended to be "goal-rich." However, because they are now defaulting at unprecedented rates, the costs associated with these loans will be borne by U.S. taxpayers...

...Under a 1988 international protocol known as Basel I, the bank regulators in most of the world's developed countries adopted a uniform system of assigning bank assets to different risk categories. ...

...The 50 percent risk weight placed on mortgages under the Basel rules provides an incentive for banks to hold mortgages in preference to commercial loans. Even more important, by purchasing a portfolio of AAA-rated MBS, or converting their portfolios of whole mortgages into an MBS portfolio rated AAA, banks could reduce their capital requirement to 1.6 percent. This amount might have been sufficient if the mortgages were of high quality or if the AAA rating correctly predicted the risk of default, but the gradual decline in underwriting standards meant that the mortgages in any pool of prime mortgages--and this was certainly true of subprime and Alt-A mortgages--often had high loan-to-value ratios, low FICO scores, or other indicators of low quality. In other words, the effect of the Basel bank capital standards, applicable throughout the world's developed economies, has been to encourage commercial banks to hold only a small amount of capital against the risks associated with residential mortgages. As these risks increased because of the decline in lending standards and the ballooning of home prices, the Basel capital requirements became increasingly inadequate for the risks banks were assuming in holding both mortgages and MBS portfolios. Even if it is correct to believe that residential mortgages are less risky than commercial loans--an idea that can certainly be challenged in today's economy--the lack of bank capital behind mortgage assets became blazingly clear when the housing bubble deflated....

Friday, December 19, 2008


Global cooling is here
...According to the National Climatic Data Center, 2008 will be America's coldest year since 1997, thanks to La NiƱa and precipitation in the central and eastern states. Solar quietude also may underlie global cooling. This year's sunspots and solar radiation approach the minimum in the Sun's cycle, corresponding with lower Earth temperatures. This echoes Harvard-Smithsonian astrophysicist Dr. Sallie Baliunas' belief that solar variability, much more than CO2, sways global temperatures.

Meanwhile, the National Weather Service reports that last summer was Anchorage's third coldest on record. "Not since 1980 has there been a summer less reflective of global warming," Craig Medred wrote in the Anchorage Daily News. Consequently, Alaska's glaciers are thickening in the middle. "It's been a long time on most glaciers where they've actually had positive mass balance," U.S. Geological Survey glaciologist Bruce Molnia told Medred Oct. 13. Similarly, the National Snow and Ice Data Center found that Arctic sea ice expanded 13.2 percent this year, or a Texas-sized 270,000 square miles.

Across the equator, Brazil endured an especially cold September. Snow graced its southern provinces that month.

"Global Warming is over, and Global Warming Theory has failed. There is no evidence that CO2 drives world temperatures or any consequent climate change," Imperial College London astrophysicist and long-range forecaster Piers Corbyn wrote British Members of Parliament on Oct. 28. "According to official data in every year since 1998, world temperatures have been colder than that year, yet CO2 has been rising rapidly." That evening, as the House of Commons debated legislation on so-called "global-warming," October snow fell in London for the first time since 1922.

These observations parallel those of five German researchers led by Professor Noel Keenlyside of the Leibniz Institute of Marine Sciences. "Our results suggest that global surface temperature may not increase over the next decade," they concluded in last May's "Nature," "as natural climate variations in the North Atlantic and tropical Pacific temporarily offset the projected anthropogenic (man-made) warming."...

Wednesday, December 17, 2008


Orangutans, Resistance and the Zoo
While bread and circuses might work on the human species, orangutans require a different combination of incentives. Their control lies in bananas and sex. Orangutans are almost helpless to such things. It’s instinct, don’t you know. Surely, if San Diego Zoo officials could just discover the correct instinctual cocktail, they could solve their orangutan problem before it got any worse. All they needed was a lot of bananas, some willing female participants, and time.

Efforts on this project began in earnest in the summer of 1985. The new Heart of the Zoo exhibit had opened three years earlier, and day to day operations could not have been going better. But then that darn Ken Allen started acting up. Ken was born in February of 1971 to San Diego’s Maggie and Bob. He was, officially speaking, a Bornean orangutan - although he never stepped foot on the island nor knew anything about arboreal culture. It might be more correct to classify him as a zoo orangutan. Institutional life was the only one that Ken ever experienced. The zoo is where he was born, and the zoo is where he died of lymphoma in 2000. In between, Ken had to deal with captivity on a daily basis. Interestingly, the San Diego Zoo understood from the very beginning that he was going to be more difficult to handle than the facility’s previous orangutans.

In his nursery, Ken would unscrew every nut that he could find and remove the bolts. Keepers would no sooner put them back when he would be at it again. Nor could he ever be kept in his room. One of his favorite schemes, a trainer described, was to “grab someone’s hand who was waving at him, and swing himself up.” Good luck trying to catch the little red ape after that. Yet, for the zoo, his later life would represent a much greater challenge. In fact, when Ken was first moved into the Heart of the Zoo exhibit, he was caught throwing rocks at a television crew that was filming the neighboring gorillas. When he ran out of rocks, Ken threw his own shit. The crew scattered. In an ironic twist, there would be a similar problem at the zoo several years down the road. Large glass windows had been installed in the exhibit, and the orangutans took to pitching rocks at them. San Diego officials, thinking quickly, instituted an exchange program. One non-thrown stone would get you a banana. But the orangutans were not interested and kept trying to break the windows. The park finally had to bring in a contractor to dig up the entire ground floor of the exhibit in order to remove all of the rocks, as each shattered window cost the zoo $900 to replace. What happened next? The orangutans began to tear the ceramic insulators off of the wall and threw them instead. Evidently, these animals really wanted out....

Why The Mortgage Crisis Happened
...In subcommittee testimony, Democrats vehemently reject regulation of Fannie Mae in the face of dire warning of a Fannie Mae oversight report.

A few of them — Black Caucus members in particular — are angry at the OFHEO director as they attempt to defend Fannie Mae and CRA.

Committee Chairman Baker called the report "very troubling" and "of extraordinary importance not only to those who wish to own a home, but as to the taxpayers of this country who would pay the cost of the cleanup of an enterprise failure. . . . The analysis makes clear that more resources must be brought to bear to ensure the highest standards of conduct are not only required, but more importantly, they are actually met."

In reply, Rep. Waters said: "Through nearly a dozen hearings . . . we were trying to fix something that wasn't broke. . . . We do not have a crisis at Freddie Mac, and particularly at Fannie Mae, under the outstanding leadership of Mr. Frank Raines."

Added Rep. Gregory Meeks, D-N.Y.: "I'm just pissed off at OFHEO. Because if it wasn't for you, I don't think that we'd be here in the first place. And now the problem . . . we're faced with is maybe some individuals who wanted to do away with GSEs in the first place, you've given them an excuse to try to have this forum so that we can talk about it and maybe change the the direction and the mission of what the GSEs had, which they've done a tremendous job.

"There's been nothing that was indicated that's wrong with Fannie Mae. Freddie Mac has come up on its own. And the question that then presents is the competence that your agency has with reference to deciding and regulating these GSEs . . . I am very upset, because you . . . may be giving any reason to give someone heart surgery when they really don't need it."

But Rep. Ed Royce, R-Calif., said he hoped the committee would "move swiftly to create a new regulatory structure for Fannie Mae, for Freddie Mac, and the Federal Home Loan Banks."

Replied Rep. Lacy Clay, D-Mo.: "This hearing is about the political lynching of Franklin Raines."

Royce: "There is a very simple solution. Congress must create a new regulator with powers at least equal to those of other financial regulators, such as the OCC or Federal Reserve."

Rep. Gregory Meeks, D-N.Y.: "Why should I have confidence, why should anyone have confidence, in you as a regulator at this point?"

Armando Falcon, OFHEO director: "Sir, OFHEO did not improperly apply accounting rules; Freddie Mac did. OFHEO did not fail to manage earnings properly; Freddie Mac did. So this isn't about the agency engaging in improper conduct. It's about Freddie Mac."

Rep. Christopher Shays, R-Conn., noted: "We passed Sarbanes-Oxley, which was a very tough response to that, and then I realized that Fannie Mae and Freddie Mac wouldn't even come under it. They weren't under the '34 act, they weren't under the '33 act, they play by their own rules, and I'm tempted to ask how many people in this room are on the payroll of Fannie Mae, because what they do is basically hire every lobbyist they can possibly hire. They hire some people to lobby, and they hire some people not to lobby so that the opposition can't hire them."

Rep. Arthur Davis, D-Ala.: "You're making very broad and categorical judgments about the management of this institution, about the willfulness of practices that may or may not be in controversy. You've imputed various motives to the people running the organization. You went to the board and put a 48-hour ultimatum on them without having any specific regulatory authority to put that kind of ultimatum on them. That sounds like some kind of an invisible line has been crossed."

Rep. Shays: "Fannie Mae has manipulated OFHEO for years. And for OFHEO to finally come out with a report as strong as it is, tells me that's got to be the minimum not the maximum."

Rep. Frank: "You seem to me saying, 'Well, these are in areas which could raise safety and soundness problems.' I don't see anything in your report that raises safety and soundness problems."

Rep. Waters: "Under the outstanding leadership of Mr. Frank Raines, everything in the 1992 Act has worked just fine. In fact, the GSEs have exceeded their housing goals. What we need to do today is to focus on the regulator, and this must be done in a manner so as not to impede their affordable housing mission, a mission that has seen innovation flourish from desktop underwriting to 100% loans."

Rep. Lacy Clay, D-Mo.: "I find this to be inconsistent and and a rush to judgment. I get the feeling that the markets are not worried about the safety and soundness of Fannie Mae as OFHEO says that it is, but of course the markets are not political."

Rep. Frank: "But I have seen nothing in here that suggests that the safety and soundness are at issue, and I think it serves us badly to raise safety and soundness as kind of a general shibboleth when it does not seem to me to be an issue."

Rep. Don Manzullo, R-Ill.: "Mr. Raines' $1.1 million bonus and a $526,000 salary. Jamie Gorelick, $779,000 bonus on a salary of $567,000. This is . . . nothing less than staggering....


Barney Frank's Bankrupt Ideas
...In 1995, as Howard Husock pointed out eight years ago in City Journal, "the Clinton Treasury Department's 1995 regulations made getting a satisfactory CRA rating much harder. The new regulations de-emphasized subjective assessment measures in favor of strictly numerical ones. Bank examiners would use federal home-loan data, broken down by neighborhood, income group, and race, to rate banks on performance."

Creditworthiness and due diligence no longer mattered. As a 1999 New York Times editorial observed: "Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Bill Clinton administration to expand mortgage loans among low- and moderate-income people and felt pressure to maintain its phenomenal growth in profits."

On Frank's and Clinton's watch, the Community Reinvestment Act was changed to force the issuance of bad loans. Banks would be rated on the number of loans, not on their soundness. Fannie Mae and Freddie Mac were then encouraged to buy them up. It was all about affordable housing, even if the housing was unaffordable.

"From the perspective of many people, including me, this is another thrift industry growing up around us," Peter Wallison, a resident fellow at the American Enterprise Institute, said back in 1999. "If they fail, the government will have to step in and bail them out the way it stepped up and bailed out the thrift industry." ...

...Democrats believe in affordable housing even if it's at the expense of the vast majority who watch their credit, work hard and pay their mortgages on time. But for the deadbeats, particularly Democratic constituencies, they have ways to make affordable the housing you couldn't afford. So first, they forced them into housing they couldn't afford, and now they give them a financial mulligan....


How Mortgage Crisis Happened: Good Intentions Paved Dire Path
...The New York Times wrote that the "democratization of credit" is "turning the American dream of homeownership into a nightmare for many borrowers." The "newfangled mortgage loans" — called affordability loans — "represent 60% of foreclosures."...

...Rep. Arthur Davis, D-Ala., now admits Democrats were in error: "Like a lot of my Democratic colleagues, I was too slow to appreciate the recklessness of Fannie and Freddie. I defended their efforts to encourage affordable homeownership when in retrospect I should have heeded the concerns raised by their regulator in 2004. Frankly, I wish my Democratic colleagues would admit when it comes to Fannie and Freddie: We were wrong."...

Cooling on Global Warming
...The wrangle over the EU's controversial climate package at a separate summit in Brussels wrong-footed the world's green bureaucracy. The EU climate deal was diluted beyond recognition. Instead of standing by plans to cut CO2 emissions by 20% below 1990 levels by 2020, the actual reductions might be as trivial as 4% if all exemptions are factored in.

The Brussels summit symbolizes a turning point. The watered-down climate deal epitomizes the onset of a cooling period in Europe's hitherto overheated climate debate. It may lead eventually to the complete abandonment of the unilateral climate agenda that has shaped Europe's green philosophy for nearly 20 years.

The reasons for the changing political atmosphere in Europe are manifold. First, the global economic crisis has demoted green policies nearer to the bottom of the political agenda. Saving the economy and creating jobs take priority now.

Second, disillusionment with the failed Kyoto Protocol has turned utopian thinking into sobriety. After all, most of the Kyoto signatories failed to reduce their CO2 emissions during the last 10 years. There are also growing doubts about the long-term viability of the EU's Emissions Trading Scheme. The price of carbon credits has collapsed as a result of the financial crisis. The drop in demand and the recession are likely to depress carbon prices for years to come. As a result, the effectiveness of the extremely volatile scheme is increasingly questioned.

Third, a number of countries have experienced a political backlash over their renewable energy schemes. Tens of billions of euros of taxpayers' money have been pumped into projects that depend on endless government handouts. Each of the 35,000 solar jobs in Germany, for instance, is subsidized to the tune of €130,000. According to estimates by the Rhine-Westphalia Institute for Economic Research, green subsidies will cost German electricity consumers nearly €27 billion in the next two years.

Perhaps even more important is the growing realization that the warming trend of the late 20th century has, for the last 10 years or so, essentially come to a temporary halt. The data collected by international meteorological offices confirm this. This most peculiar fact is rarely mentioned in policy debates, but it certainly provides decision makers with a vital respite to reconsider their climate policy options....

Obama and the "Second Bill of Rights"
...In a 2001 interview on Chicago public radio, Obama lamented that “the Supreme Court never ventured into the issue of the redistribution of wealth.” The problem, he said, was that the court “didn’t break free from the essential constraints that were placed by the Founding Fathers in the Constitution… that generally the Constitution is a charter of negative liberty.”...

Tuesday, December 16, 2008


The Fed's Binge
...This means that the total bailout is not the $700 billion that Congress appropriated, but at least $1.2 trillion. And that figure doesn’t include the Fed’s mid-October promise of $540 billion to bail out money market funds, which if not covered by the Fed’s sale of other assets, will require either further monetary increases or further Treasury borrowing. Thus we now have the worst of both worlds: a massive bailout financed both by Treasury borrowing (in order to avoid inflation) and a Federal Reserve increase of the monetary base (which heralds future inflation anyway).

Of the $1.2 trillion increase in federal government borrowing, at least half took place within the space of a month. This sudden 25 percent increase in the outstanding national debt qualifies as the most dramatic peacetime experiment in fiscal stimulus the U.S. government has ever implemented. If Keynesian theory were correct, the economy should have been well beyond the reach of any potential recession by the end of October. But how many economists are going to acknowledge this striking empirical refutation of the fiscal policy they hold dear?

This enormous increase in government debt may at least partly explain the sudden stock market collapse after the bailout passed. Government borrowing represents a future tax liability, and expected future taxes affect the value of equities. Some argue that this new borrowing may not increase taxes at all because it merely finances the purchase of earning assets that the government can later resell. While that’s certainly possible in the long run, no one knows the true value of those assets in the short run. After all, the market’s anxiety about their worth was the justification for the bailout in the first place. So now the government is transferring that uncertainty from private financial institutions to the taxpayers....

Saturday, December 13, 2008


Smaller Banks Resist Federal Cash Infusions
Community banking executives around the country responded with anger yesterday to the Bush administration's strategy of investing $250 billion in financial firms, saying they don't need the money, resent the intrusion and feel it's unfair to rescue companies from their own mistakes. ...

...The opposition suggested that the government may have to continue to press banks to participate in the plan. The first $125 billion will be divided among nine of the largest U.S. banks, which were forced to accept the investment to help destigmatize the program in the eyes of other institutions. ...

...In return for its investments, Treasury will receive preferred shares of bank stock that pay 5 percent interest for up to five years. After that, if the companies haven't repaid the government's initial investment, the interest rate goes up to 9 percent. ...

Bush's Regulatory Kiss-Off
...Since Bush took office in 2001, there has been a 13 percent decrease in the annual number of new rules. But the new regulations' cost to the economy will be much higher than it was before 2001. Of the new rules, 159 are "economically significant," meaning they will cost at least $100 million a year. That's a 10 percent increase in the number of high-cost rules since 2006, and a 70 percent increase since 2001. And at the end of 2007, another 3,882 rules were already at different stages of implementation, 757 of them targeting small businesses.

Overall, the final outcome of this Republican regulation has been a significant increase in regulatory activity and cost since 2001. The number of pages added to the Federal Register, which lists all new regulations, reached an all-time high of 78,090 in 2007, up from 64,438 in 2001....

...President Bush deserves most of the blame for this regulatory expansion. While the president does not have to sign new rules before they're implemented, he does implicitly approve them. In addition, he signed hundreds of laws commanding federal agencies to produce new regulations. One is the Sarbanes-Oxley Act of 2002, which established new or enhanced standards for all publicly held companies and accounting firms in the United States....

...The Bush team has spent more taxpayer money on issuing and enforcing regulations than any previous administration in U.S. history. Between fiscal year 2001 and fiscal year 2009, outlays on regulatory activities, adjusted for inflation, increased from $26.4 billion to an estimated $42.7 billion, or 62 percent. By contrast, President Clinton increased real spending on regulatory activities by 31 percent, from $20.1 billion in 1993 to $26.4 billion in 2001....

...The data also show that, adjusted for inflation, expenditures for the category of finance and banking were cut by 3 percent during the Clinton years and rose 29 percent from 2001 to 2009, making it hard to argue that Bush deregulated the financial sector....


Is Deregulation to Blame?
...The Glass-Steagall Act of 1933 prohibited investment banks from acting as commercial banks, and vice versa. Signed by Bill Clinton (who continues to defend the legislation), the Gramm-Leach-Bliley Act of 1999 repealed those aspects of the law. Many on the left blame at least part of our current woes on that move. With the repeal, Barack Obama said in a March economic address, “we have deregulated the financial services sector, and we face another crisis.”

In fact, multiple exemptions to Glass-Steagall had been granted for years before Gramm-Leach-Bliley was signed into law. Most European financial markets, not normally known as more “deregulated” than the U.S., never separated commercial and investment banks in the first place. And there is no correspondence between institutions that benefited from the repeal and those that recently collapsed. Institutions that didn’t take advantage of the Glass-Steagall repeal, such as Lehman Brothers and Bear Stearns, were the ones that failed most spectacularly, in part because they lacked the stability provided by commercial banking deposits.

If anything, Gramm-Leach-Bliley may have softened the blow. The George Mason economist Tyler Cowen argues that Gramm-Leach-Bliley made way for more diversity in the financial sector, and “so far in the crisis times the diversification has done considerably more good than harm.” Under the Glass-Steagall rules, Bank of America and J.P. Morgan Chase would not have been able to acquire Merrill Lynch and Bear Stearns. Nor would Goldman Sachs and Citibank have their current unified form, which may have helped them survive.

There is a significant body of academic work supporting this idea. The Rutgers economist Eugene Nelson White, for example, has found that national banks with security affiliates—the sort of institutions Glass-Steagall was designed to prevent—were much less likely to fail than banks without affiliates....

...Unlike the banks and other market institutions that went down in the crisis, the government-sponsored enterprises Fannie and Freddie were always creatures of the federal government. As such, they were regulated less than their fully private counterparts when it came to such crisis-impacting phenomena as derivatives trading and capital requirements. Because of their size and politicized culture, they were able to fend off periodic attempts at reform. And because of the government’s implicit (and eventually explicit) guarantees of their multi-trillion-dollar portfolios, they lacked the discipline of worrying about failure.

Letting Freddie and Fannie get away with murder wasn’t deregulation. It was bad governance. And letting deregulation take the primary blame for a credit-fueled housing bubble and its aftermath isn’t an argument. It’s misdirection.

Sunday, December 07, 2008


Anatomy of a Breakdown
It was not an absence of federal intervention that produced the Great Financial Panic of 2008. Contrary to the assertions of those clamoring for new regulations (see "Is Deregulation to Blame?," page 36), the liquidity shortage and credit freeze that triggered Washington's biggest intrusion into the economy since Richard Nixon's wage and price controls were caused by bad government policy and worse crisis management....

...Other, more recent developments played a bigger role in the financial crisis. In 1993 the Federal Reserve Bank of Boston published "Closing the Gap: A Guide to Equal Opportunity Lending." The report recommended a series of measures to better serve low-income and minority households. Most of the recommendations were routine and mundane: better staff training, improved outreach and communication, and the like. But the report also urged banks to loosen their income thresholds for receiving a mortgage. In the years after the report was published, activists and officials—especially in the Department of Housing and Urban Development, under both Bill Clinton and George W. Bush—used its findings to pressure banks to increase their lending to low-income households. By the turn of the century, other changes in federal policy made those demands more achievable.

You can't lend money if you don't have it. And beginning in 2001, the Federal Reserve made sure lots of people had it. In January 2001, when President Bush took office, the federal funds rate, the key benchmark for all interest rates in this country, was 6.5 percent. Then, in response to the meltdown in the technology sector, the Fed began cutting the rate. By August 2001, it was at 3.75 percent. And after the terrorist attacks of September 11, the Fed opened the spigot. By the summer of 2002, the federal funds rate was 1 percent....

...In June 2003, Freddie Mac surprised Washington and Wall Street with a management shakeup. The top executives were sent packing, and a new auditor, PricewaterhouseCoopers, identified several accounting irregularities on the company's books, especially related to its portfolio of derivatives. The company would have to restate earnings for the previous several years.

Just days before, the agency responsible for regulating Freddie, the Office of Federal Housing Enterprise Oversight, had reported to Congress that the company's management "effectively conveys an appropriate message of integrity and ethical values." Just how wrong this assessment was would soon become abundantly clear.

As the extent of the accounting irregularities emerged, federal regulators descended on the company and quickly determined that the accounting troubles extended to Fannie Mae as well. With concerns about the companies growing, the Bush administration unveiled proposals to rein them in. Then-Treasury Secretary John Snow proposed putting Fannie and Freddie under his department's oversight and subjecting them to the kind of controls over risk and capital reserves that apply to commercial banks. (Fannie's debt-to-capital ratio was 30 to 1, whereas conventional banks have debt-to-capital ratios of around 11 to 1.)

But Fannie and Freddie by this point were political powerhouses. When the accounting scandal first emerged, Fannie's chairman was Franklin Raines, former director of the Office of Management and Budget under President Bill Clinton. Its vice chairman was Jamie Gorelick, a former Justice Department official who had served on the 9/11 commission. The two companies provided tens of millions of dollars in annual campaign contributions and spent more than $10 million a year combined on outside lobbyists.

Fannie and Freddie rallied their friends on Capitol Hill, who immediately pushed back against the Bush proposals. Rep. Barney Frank (D-Mass.), the ranking Democrat on the House Financial Services Committee, said, "These two entities-Fannie Mae and Freddie Mac-are not facing any kind of financial crisis. The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing." The reform effort fizzled....

...In the end, Fannie and Freddie had to restate more than $15 billion in earnings. The Office of Federal Housing Enterprise Oversight and the Securities and Exchange Commission fined Fannie $400 million and Freddie $125 million. There was a new push for tighter oversight on the Hill, but this too withered as Fannie and Freddie rallied support through increased lending to low-income borrowers.

Then Fannie and Freddie went on a subprime bender. The companies made it clear they wanted to buy up all the subprime mortgages—and Alt-A mortgages, whose risk is somewhere between prime and subprime—that they could find. They eventually acquired around $1 trillion of the paper. The market responded. In 2003 less than 8 percent of all mortgages were subprime. By 2006 the number was more than 20 percent. Banks knew they could sell subprime products to Fannie and Freddie. Investments banks realized that if they laced ever-increasing amounts of subprime mortgages into mortgage-backed securities, they could add slightly higher levels of risk and, as a result, boost the returns and earn bigger fees. The ratings agencies, thinking they were simply dealing with traditionally appreciating mortgages, didn't look under the hood....

...The original plan crafted by the Treasury Department would have authorized the government to spend up to $700 billion on mortgage-backed securities and other "toxic" debt, thereby removing them from banks' balance sheets. With the "bad loans" off the books, the banks would become sound. Because it was assumed that the mortgage-backed security market was "illiquid," the government would become the buyer of last resort for these products. There was a certain simple elegance to the plan. To paraphrase H.L. Mencken, the solution was neat, plausible, and wrong.

No market is truly illiquid. Last summer, Merrill Lynch unloaded a bunch of bad debt at 22 cents on the dollar. There are likely plenty of buyers for the banks' toxic debt, just not at the price the banks would prefer. Enter the government, which clearly intended to purchase mortgage-backed securities at some premium above the market price....

British Balance Benefit vs. Cost of Latest Drugs
RUISLIP, England — When Bruce Hardy’s kidney cancer spread to his lung, his doctor recommended an expensive new pill from Pfizer. But Mr. Hardy is British, and the British health authorities refused to buy the medicine. His wife has been distraught.

“Everybody should be allowed to have as much life as they can,” Joy Hardy said in the couple’s modest home outside London.

If the Hardys lived in the United States or just about any European country other than Britain, Mr. Hardy would most likely get the drug, although he might have to pay part of the cost. A clinical trial showed that the pill, called Sutent, delays cancer progression for six months at an estimated treatment cost of $54,000.

But at that price, Mr. Hardy’s life is not worth prolonging, according to a British government agency, the National Institute for Health and Clinical Excellence....

How Government Stoked the Mania
...Congress designed Fannie and Freddie to serve both their investors and the political class. Demanding that Fannie and Freddie do more to increase home ownership among poor people allowed Congress and the White House to subsidize low-income housing outside of the budget, at least in the short run. It was a political free lunch.

The Community Reinvestment Act (CRA) did the same thing with traditional banks. It encouraged banks to serve two masters -- their bottom line and the so-called common good. First passed in 1977, the CRA was "strengthened" in 1995, causing an increase of 80% in the number of bank loans going to low- and moderate-income families.

Fannie and Freddie were part of the CRA story, too. In 1997, Bear Stearns did the first securitization of CRA loans, a $384 million offering guaranteed by Freddie Mac. Over the next 10 months, Bear Stearns issued $1.9 billion of CRA mortgages backed by Fannie or Freddie. Between 2000 and 2002 Fannie Mae securitized $394 billion in CRA loans with $20 billion going to securitized mortgages.

By pressuring banks to serve poor borrowers and poor regions of the country, politicians could push for increases in home ownership and urban development without having to commit budgetary dollars. Another political free lunch.

Fannie and Freddie and the banks opposed these policy changes at first through both lobbying and intransigence. But when they found out that following these policies could be profitable -- which they were as long as rising housing prices kept default rates unusually low -- their complaints disappeared. Maybe they could serve two masters. They turned out to be wrong. And when Fannie and Freddie went into conservatorship, politicians found out that budgetary dollars were on the line after all.

While Fannie and Freddie and the CRA were pushing up the demand for relatively low-priced property, the Taxpayer Relief Act of 1997 increased the demand for higher valued property by expanding the availability and size of the capital-gains exclusion to $500,000 from $125,000. It also made it easier to exclude capital gains from rental property, further pushing up the demand for housing.

The Fed did its part, too. In 2003, the federal-funds rate hit 40-year lows of 1.25%. That pushed the rates on adjustable loans to historic lows as well, helping to fuel the housing boom....

Delinquencies and Foreclosures Increase in Latest MBA National Delinquency Survey
...From the previous quarter, prime fixed rate loan foreclosure starts increased 4 basis points to 0.22 percent, prime ARM foreclosure starts increased 40 basis points to 1.02 percent, subprime fixed foreclosure starts increased 3 basis points to 1.38 percent, subprime ARM foreclosure starts increased 88 basis points to 4.72 percent, and FHA foreclosure starts increased 16 basis points to 0.95 percent.

Since the third quarter of 2006, the foreclosure start rates for prime ARMs increased from 0.30 percent to 1.02 percent and the rate for subprime ARMs increased from 2.19 percent to 4.72 percent. The foreclosure starts rate for prime fixed loans increased from 0.13 percent to 0.22 percent and the rate for subprime fixed loans have increased from 0.97 percent to 1.38 percent. ...

1999: Fannie Mae Eases Credit To Aid Mortgage Lending
In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits. ...

...In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.'' ...

...Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings....

Fannie Mae's Patron Saint
...By early 2007, Mr. Frank was in charge of the House Financial Services Committee, arguing that he had long favored some kind of reform. "What blocked it [reform] last year," Mr. Frank said then, "was the insistence of some economic conservative fundamentalists in the Bush Administration who, to be honest, don't think there should be a Fannie Mae or a Freddie Mac." What really blocked it was Mr. Frank's insistence that any reform be watered down and not include any reduction in their MBS holdings.

In January of last year, Mr. Frank also noted one reason he liked Fannie and Freddie so much: They were subject to his political direction. Contrasting Fan and Fred with private-sector mortgage financers, he noted, "I can ask Fannie Mae and Freddie Mac to show forbearance" in a housing crisis. That is to say, because Fannie and Freddie are political creatures, Mr. Frank believed they would do his bidding.

And this is exactly what Mr. Frank attempted to prove when the housing market started to go south. He encouraged the companies to guarantee more "affordable" mortgages, thus abetting their disastrous plunge into subprime and Alt-A loans. He also pushed for, and got, an increase in the conforming-loan limits to allow Fan and Fred to securitize and guarantee larger mortgages. And he pressured regulators to ease up on their capital requirements -- which now means taxpayers will have to make up that capital shortfall.

But the biggest payoff for Mr. Frank is the "affordable housing" trust fund he managed to push through as one political price for the recent Fannie reform bill. This fund siphons off a portion of Fannie and Freddie profits -- as much as $500 million a year each -- to a fund that politicians can then disburse to their favorite special interests.

This is also why Mr. Frank won't tolerate cutting the companies' MBS portfolios. He knows those portfolios (bought with debt borrowed at taxpayer-subsidized rates) were a main source of Fannie's profits before the housing crash, and he figures that once this crisis passes they can do it again. And this time, his fund will get part of the loot....

Government Policies and the Financial Crisis
The current financial crisis is not--as some have said--a crisis of capitalism. It is in fact the opposite, a shattering demonstration that ill-considered government intervention in the private economy can have devastating consequences. The crisis has its roots in the U.S. government's efforts to increase homeownership, especially among minority and other underserved or low-income groups, and to do so through hidden financial subsidies rather than direct government expenditures. The story is an example, enlarged to an American scale, of the adverse results that flow from the misuse and manipu-lation of banking and credit by government. When this occurs in authoritarian regimes, we deride the outcome as a system of "policy loans" and note with an air of superiority that banks in these countries are weak, credit is limited, and financial crises are frequent. When the same thing happens in the United States, however, we blame "greedy" people, or poor regulation (or none), or credit default swaps, or anything else we can think of--except the government policies that got us into the disaster. ...

...The two key examples of this policy are the CRA, adopted in 1977, and the affordable housing "mission" of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. As detailed below, beginning in the late 1980s--but particularly during the Clinton administration--the CRA was used to pressure banks into making loans they would not otherwise have made and to adopt looser lending standards that would make mortgage loans possible for individuals who could not meet the down payment and other standards that had previously been applied routinely by banks and other housing lenders. The same pressures were brought to bear on the GSEs, which adapted their underwriting standards so they could accept the loans made under the CRA and other loans that did not conform to what had previously been considered sound lending practices. Loans to members of underserved groups did not come with labels, and once Fannie and Freddie began accepting loans with low down payments and other liberalized terms, the same unsound practices were extended to borrowers who could have qualified under the traditional underwriting standards. It should not be surprising that borrowers took advantage of these opportunities. It was entirely rational to negotiate for a low-down-payment loan when that permitted the purchase of a larger house in a better neighborhood. ...

...There is very little data available on the performance of loans made under the CRA. The subject has become so politicized in light of the housing meltdown and its effect on the general economy that most reports--favorable or unfavorable--should probably be discounted. Before the increases in housing prices that began in 2001, reviews of the CRA were generally unfavorable. The act increased costs for banks, and there was an inverse relationship between their CRA lending and their regulatory ratings.[7] One of the few studies of CRA lending in comparison to normal lending was done by the Federal Reserve Bank of Cleveland, which reported in 2000 that "respondents who did report differences [between regular and CRA housing loans] most often said they had lower prices or higher costs or credit losses for CRA-related home purchase and refinance loans than for others."[8] Much CRA lending after 2000 occurred during a period of enormous growth in housing values, which tended to suppress the number of defaults and reduce loss rates.

The important question, however, is not the default rates on the mortgages made under the CRA. Whatever those rates might be, they were not sufficient to cause a worldwide financial crisis. The most important fact associated with the CRA is the effort to reduce underwriting standards so that more low-income people could purchase homes. Once these standards were relaxed--particularly allowing loan-to-value ratios higher than the 20 percent that had previously been the norm--they spread rapidly to the prime market and to subprime markets where loans were made by lenders other than insured banks. The effort to reduce mortgage underwriting standards was led by the Department of Housing and Urban Development (HUD) through the National Homeownership Strategy published in 1994 in response to a request by President Clinton. Among other things, it called for "financing strategies, fueled by the creativity and resources of the private and public sectors to help homeowners that lack cash to buy a home or to make the payments."[9] Many subsequent studies have documented the rise in loan-to-value ratios and other indicators of loosened lending standards.[10]...

...When the history of this era is written, students will want to understand the political economy that allowed Fannie and Freddie to grow without restrictions while producing large profits for shareholders and management but no apparent value for the American people. The answer is the affordable housing mission that was added to their charters in 1992, which--like the CRA--permitted Congress to subsidize LMI housing without appropriating any funds. As long as Fannie and Freddie could credibly contend that they were advancing the interests of LMI homebuyers, they could avoid new regulation by Congress--especially restrictions on the accumulation of mortgage portfolios, totaling approximately $1.5 trillion by 2008, that accounted for most of their profits. They could argue to Congress that if the mortgage portfolios were constrained by regulation, they could not afford to subsidize affordable housing.[16] In addition, the political sophistication of Fannie Mae's management enabled the company to serve the interests of key lawmakers who could and did stand in the way of the tougher regulation that might have made the current crisis far less likely.[17]...

...By 1997, Fannie was offering a 97 percent loan-to-value mortgage, and by 2001, it was offering mortgages with no down payment at all. By 2007, Fannie and Freddie were required to show that 55 percent of their mortgage purchases were LMI loans and, within this goal, that
38 percent of all purchases were from underserved areas (usually inner cities) and 25 percent were purchases of loans to low-income and very-low-income borrowers.[19] Meeting these goals almost certainly required Fannie and Freddie to purchase loans with low down payments and other deficiencies that would mark them as subprime or Alt-A....

What Really Happened?
...The housing-finance boom and bust are not the results of a laissez-faire monetary and financial system. We didn’t have one. The boom and bust happened in a system with an unanchored government fiat money and extensive legal restrictions on financial intermediation. Nor have we had banking and financial deregulation since the bipartisan Financial Services Modernization Act (the Gramm-Leach-Bliley Act), signed by President Clinton in 1999. Far from contributing to the recent turmoil, moreover, that act has clearly been a blessing in containing it by allowing acquisitions, such as the acquisition of Bear Stearns by JPMorgan Chase or of Merrill Lynch by Bank of America, that have shielded bondholders from losses....

...In the recession of 2001, the Federal Reserve System under Chairman Alan Greenspan began aggressively expanding the U.S. money supply. Year-over-year growth in the M2 monetary aggregate rose briefly above 10 percent, and remained above 8 percent entering the second half of 2003. The expansion was accompanied by the Fed’s repeatedly lowering its target for the “federal funds” (interbank short-term) interest rate. The fed funds rate began 2001 at 6.25 percent and ended the year at 1.75 percent. It was reduced further in 2002 and 2003, reaching in mid-2003 a record low of one percent, where it stayed for a year. The real Fed funds rate was negative—meaning that nominal rates were lower than the contemporary rate of inflation—for two and a half years....

...The excess credit thus created went heavily into real estate. From mid-2003 to mid-2007, while the dollar volume of final sales of goods and services was growing at a compounded rate of 5.9 percent per annum, real-estate loans at commercial banks were (as already noted) growing at 12.26 percent...

...The federal government fostered the expansion in risky mortgages to under-qualified borrowers in several ways. It is hard to judge how much each of these contributed, but all worked to loosen lending standards.

First, the Federal Housing Administration over the years progressively loosened its down payment requirements on FHA mortgages. By 2004 the down payment requirement on the FHA’s most popular program had fallen to only 3 percent. [7] Private lenders felt compelled to offer lower down payments on non-FHA loans. Mortgages with very low down payments have had very high default rates.

Second, Congress strengthened the Community Reinvestment Act. The CRA had initially, from its passage in 1977, merely imposed reporting requirements on commercial banks. Amendments in 1995 empowered regulators to deny a bank with a low CRA rating permission to merge with another bank—at a time when the arrival of interstate banking made such approvals especially valuable—or even to open new branches. In response to the new CRA rules, some banks joined into partnerships with community groups to distribute millions in mortgage money to low-income borrowers previously considered non-creditworthy. Other banks took advantage of the newly authorized option to boost their CRA rating by purchasing special “CRA mortgage-backed securities,” that is, packages of disproportionately nonprime loans certified as meeting CRA criteria and securitized by Freddie Mac. Federal Reserve Chairman Ben Bernanke aptly commented in a 2007 speech that “recent problems in mortgage markets illustrate that an underlying assumption of the CRA—that more lending equals better outcomes for local communities may not always hold.”[8]

Third, the Department of Housing and Urban Development pressured lenders for “affordable housing” loans. Beginning in 1993, HUD officials began bringing legal actions against mortgage bankers that declined a higher percentage of minority applicants than white ones. To avoid legal trouble, lenders began relaxing their down-payment and income qualifications.[9]

Fourth and likely most important, implicit taxpayer guarantees allowed the dramatic expansion of the government-sponsored mortgage buyers Fannie Mae and Freddie Mac, at a time when Congress and HUD were pushing Fannie and Freddie to promote “affordable housing” through ever-expanding purchases of non-prime loans to low-income applicants. The two mortage giants grew to hold or guarantee around $5 trillion in mortgages, about half of the entire U.S. market. Institutional investors were willing to lend to the government-sponsored mortgage companies cheaply, despite the risk of default that would normally attach to private firms holding such highly leveraged and poorly diversified portfolios, because they were sure that the Treasury would repay them should Fannie or Freddie be unable. (It turns out that they were right.) Congress pointedly refused to moderate the moral hazard problem of implicit guarantees or otherwise to rein in the hyper-expansion of Fannie and Freddie. Warnings about Fannie and Freddie, and efforts to rein them in, came to naught because the two giants had cultivated powerful friends on Capitol Hill.

A 1992 law, as described by Bernanke, “required the government-sponsored enterprises, Fannie Mae and Freddie Mac, to devote a large percentage of their activities to meeting affordable housing goals.”[10] HUD set numerical goals for Fannie and Freddie: for the year 2000, 50 percent of their financing was to go to below-median-income borrowers; for 2005 the target rose to 52 percent. Additional goals required that increasing shares of lending go to borrowers with income under 60 percent of the median for their areas. [11]...