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Fannie, Freddie, and us

No shill for the McCain-Palin campaign, the WaPo’s Sebastian Mallaby shows how the Obama campaign’s deregulation narrative is either stupid or mendacious.

In so doing, he cites two papers written by Columbia University economist Charles Calormis. I’ve read the second one, not (yet) the first (which is 113 pp. long). Suffice it to say that the deregulation of the financial services industry by Republicans in the last eight years is obviously not the problem. On the other hand, a major contributor is Fannie Mae’s and Freddie Mac’s management of "political risk," which involved enormous lobbying expenditures and the adoption of a new mission--the aggressive promotion of affordable housing--that ensured Democratic opposition to Congressional efforts to rein these GSE’s in.

Here are two snippets from the second paper:

In June 2003, in the wake of the failures of Enron and WorldCom, Freddie’s board of directors suddenly dismissed its three top officers and announced that the company’s accountants had found serious problems in Freddie’s financial reports. In 2004, after a forensic audit by OFHEO, even more serious accounting manipulation was found at Fannie, and Raines, its chairman, and Timothy Howard, its chief financial officer, were compelled to resign.

It is eloquent testimony to the power of Fannie and Freddie in Congress that even after these extraordinary events there was no significant effort to improve or enhance the powers of their regulator. The House Financial Services Committee developed a bill that was so badly weakened by GSE lobbying that the Bush administration refused to support it. The Senate Banking Committee, then under Republican control, adopted much stronger legislation in 2005, but unanimous Democratic opposition to the bill in the committee doomed it when it reached the floor. Without any significant Democratic support, debate could not be ended in the Senate, and the bill was never brought up for a vote. This was a crucial missed opportunity. The bill prohibited the GSEs from holding portfolios of mortgages and mortgage-backed securities (MBS); that measure alone would have prevented the disastrous investment activities of the GSEs in the years that followed. GSE immunity to accounting scandal is especially remarkable when it is recalled that after accounting fraud was found at Enron (and later at WorldCom), Congress adopted the punitive Sarbanes-Oxley Act, which imposed substantial costs on every public company in the United States. The GSEs’ investment in controlling their political risk--at least among the Democrats--was apparently money well spent.


The events in 2003 and 2004 had undermined the legitimacy of the GSEs. They could no longer claim to be competently--or even honestly--managed. An important and respected figure, Alan Greenspan, was raising questions about whether they might be creating excessive risk for taxpayers and systemic risk for the economy as a whole. Greenspan had suggested that their most profitable activity--holding portfolios of mortgages and MBS--was the activity that created the greatest risk, and three Federal Reserve economists had concluded that the GSEs’ activities did not actually reduce mortgage interest rates. It was easy to see at this point that their political risk was rising quickly. The case for continuing their privileged status had been severely weakened. The only element of their activities that had not come under criticism was their affordable housing mission, and it appears that the GSEs determined at this point to play that card as a way of shoring up their political support in Congress.

From the perspective of their 2008 collapse, this may seem to have been unwise, but in the context of the time, it was a shrewd decision. It provided the GSEs with the potential for continuing their growth and delivered enormous short-term profits. Those profits were transferred to stockholders in huge dividend payments over the past three years (Fannie and Freddie paid a combined $4.1 billion in dividends last year alone) and to managers in lucrative salaries and bonuses. Indeed, if it had not been for the Democrats’ desire to adopt a housing relief bill before leaving for the 2008 August recess, no new regulatory regime for the GSEs would have been adopted at all. Only the Senate Republicans’ position--that there would be no housing bill without GSE reform--overcame the opposition of Senators Christopher Dodd (D-Conn.), the banking committee chairman, and Schumer.

The GSEs’ confidence in the affordable housing idea was bolstered by what appears to be a tacit understanding. Occasionally, this understanding found direct expression. For example, in his opening statement at a hearing in 2003, Representative Barney Frank (D-Mass.), now the chairman of the House Financial Services Committee, referred to an "arrangement" between Congress and the GSEs that tracks rather explicitly what actually happened: "Fannie and Freddie have played a very useful role in helping to make housing more affordable, both in general through leveraging the mortgage market, and in particular, they have a mission that this Congress has given them in return for some of the arrangements which are of some benefit to them to focus on affordable housing."[12] So here the arrangement is laid out: if the GSEs focus on affordable housing, their position is secure.

I suppose I can hope that a President Obama won’t do the what he’s promising, that he is simply saying what it takes to get elected. But I suspect that much of what he says (both awful and not-so-bad) falls into that category, which is to say, we’re not getting much guidance for what he’s going to do from what he says he’ll do. Reminds me of another eloquent and "empathetic" Democratic politician.

Discussions - 9 Comments

The Fannie Mae and Freddie Mac crap shoot is another failure of the Liberal/Democrats/Crazed Left’s desire to “social engineer” everything is this country. From public schools to population control (abortion), and health care to child rearing and now home ownership, the liberals/democrats/crazed left want government to either “Fix It’ or “Engineer It”. When are the liberals/democrats/crazed left going to come to the hard reality that social engineering doesn’t work at all. Period. Home ownership is not a right, it is a result of hard work and responsibility. You go to school, graduate with a degree or a vocation, buy an alarm clock and get up every day and go to work. Then you don’t blow your money on cars, ipods, electronics, booze or drugs. You don’t use every credit card that you receive in the mail and rack up $30,000 in debt for crap that you don’t need. You SAVE your money for your 20% down payment and you keep your credit record clean. You never, never believe that you are ENTITLED to anything except the rights granted to you by Constitution. These are not hard things to do. Our parents – the greatest generation – followed these steps and became very wealthy.

This is another very fair and balanced article from the POST. The issue: The current crisis will generate excessive animostity to deregulation. Conceivably, Obama--with his excellent experts--could see and manage that error. But with the highly Democratic Congress (and esp. Barney Frank etc., there would be no chance. And in fact, the most damage to the economy has come from the hyper-regulated Fannie Mae. So McCain should win just to moderate wrongheaded solutions. We need divided government to manage the angry finger pointing in the wrong directions.

Joe: If you and Peter (helped by Steve Hayward's soon-to-be-famous scissors?) could turn your analyses into educating 30-second sounds bites, then Sen. McCain would have a fighting chance to win the "economic judgement" battle. What's most dispiriting is that the reasons for our current financial turmoil (Barney Frank makes an excellent poster-boy, though he certain had/has co-perps.) are known....but I don't think it will matter. McCain is speaking in 2 1/2 hours at the student union at Univ./New Mexico...and a young, experienced team that eeked-out a victory for Bush here in '04 has just arrived in this battleground state. On espere.

I happen to be employed in the very office at HUD that was mandated by law to set affordable housing quotas for Fannie and Freddie.

Mallaby is absolutely on the mark when he writes: :"...Fannie and Freddie bought more than a third of the $3 trillion in junk mortgages created during the bubble and that they did so because heavy government oversight obliged them to push money toward marginal home purchasers. There's a vigorous argument about whether Calomiris's number is too high. But everyone concedes that Fannie and Freddie poured fuel on the fire to the tune of hundreds of billions of dollars."

The numbers he refers to are published at HUD's website, though they are not very exact. The scope is this: between 2005 and 2007 the GSEs wrote between 1 and 2 trillion dollars of mortgages that met the Affordable Housing quotas. It's critical to understand that this was required by Congress itself. Anyone who would have gone to Congress during that time to raise a red flag would have been hooted the very same Dodds and Franks who now sit pontificating about deregulation.

The Democratic Congress of 1992 is entirely responsible for originating this catastrophe. But the Clinton Administration ratcheted up these affordable housing quotas on mortgage lenders and the GSEs, and I must say that the Bush Administration continued the policy with only the most modest protests.

How can these institutions have given enough mortgages to low-income earners to meet their quotas? If you think about it, you will see that eventually the lenders would resort to subprime ARM mortgages with low teaser rates and high resets!

There is enough blame to go around, but the key is, who will end the madness of forcing mortgage lenders to lend to people -- whether minority or not -- who simply don't have the income or credit scores to pay them off? This policy has made the US govt. the enabler of massive predatory lending that has hurt minorities, immigrants, and poor people more than it will ever hurt Wall St. bankers. The policy is shameful and must be reversed by the next administration.

Well, I take politicians who take ill-informed, malign, or stupid positions at their word. So I have no hope for us when Obama is our Maximum Leader.

Might the GOP run a commercial in Congressman Frank's district, playing the "roll the dice" quote over and over?

Thanks for this Joe. And thank you anonymous.

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On Wednesday, October 14, 2008, the eyes of the world were fixed on Hempstead, New York and the third and final U.S. Presidential Debate. Sen. Barack Obama of Illinois entered the arena with an eight-point lead according to an average of national polls as compiled by CNN, and it appeared that he was content to sit on that lead. Sen. John McCain of Arizona took advantage of Obama’s laurel resting and brought the fight to him regarding the younger candidate’s policies, judgment and qualities of character. When Obama did adopt a more critical stance regarding the economic policies of the past eight years, McCain was quick to point out that he is “not President Bush.” He stated that he would enact an “across the board spending freeze,” take a hatchet to some programs and use a scalpel on the remainder once the dust settled. Obama’s stance sounded more conservative; he would “go through the federal budget page by page, line by line” in order to close programs that aren’t working as they should. Both candidates claim their economic plans will bring needed change to a broken America, but will it leave consumers with the ability to choose where and when they’ll have access to payday loans? That remains to be seen. Just because Americans see themselves as living in “the land of the free” doesn’t mean that interest groups (i.e. banks and credit unions) want them to have the freedom to choose.
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