How the Democrats Created the Financial Crisis: Commentary by Kevin Hassett
The financial crisis of the past year has provided a number of
surprising twists and turns, and from Bear Stearns Cos.
<http://www.bloomberg.com/apps/quote?ticker=JPM%3AUS> to American
International Group Inc.
<http://www.bloomberg.com/apps/quote?ticker=AIG%3AUS>, ambiguity has
been a big part of the story.
Why did Bear Stearns fail, and how does that relate to AIG? It all seems
so complex.
But really, it isn't. Enough cards on this table have been turned over
that the story is now clear. The economic history books will describe
this episode in simple and understandable terms: Fannie Mae
<http://www.bloomberg.com/apps/quote?ticker=FNM%3AUS> and Freddie Mac
<http://www.bloomberg.com/apps/quote?ticker=FRE%3AUS> exploded, and many
bystanders were injured in the blast, some fatally.
Fannie and Freddie did this by becoming a key enabler of the mortgage
crisis. They fueled Wall Street's efforts to securitize subprime loans
by becoming the primary customer of all AAA-rated subprime-mortgage
pools. In addition, they held an enormous portfolio of mortgages
themselves.
In the times that Fannie and Freddie couldn't make the market, they
became the market. Over the years, it added up to an enormous
obligation. As of last June, Fannie alone owned or guaranteed more than
$388 billion in high-risk mortgage investments. Their large presence
created an environment within which even mortgage-backed securities
assembled by others could find a ready home.
The problem was that the trillions of dollars in play were only low-risk
investments if real estate prices continued to rise. Once they began to
fall, the entire house of cards came down with them.
*Turning Point *
Take away Fannie and Freddie, or regulate them more wisely, and it's
hard to imagine how these highly liquid markets would ever have emerged.
This whole mess would never have happened.
It is easy to identify the historical turning point that marked the
beginning of the end.
*Back in 2005*, Fannie and Freddie were, after years of dominating
Washington, on the ropes. They were enmeshed in accounting scandals that
led to turnover at the top. At one telling moment in late 2004, captured
in an article by my American Enterprise Institute <http://www.aei.org/>
colleague Peter Wallison
<http://search.bloomberg.com/search?q=Peter+Wallison&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1>,
the Securities and Exchange Comiission's chief accountant told disgraced
Fannie Mae chief Franklin Raines
<http://search.bloomberg.com/search?q=Franklin+Raines&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1>
that Fannie's position on the relevant accounting issue was not even
``on the page'' of allowable interpretations.
Then legislative momentum emerged for an attempt to create a
``world-class regulator'' that would oversee the pair more like banks,
imposing strict requirements on their ability to take excessive risks.
Politicians who previously had associated themselves proudly with the
two accounting miscreants were less eager to be associated with them.
The time was ripe.
*Greenspan's Warning *
The clear gravity of the situation pushed the legislation forward. Some
might say the current mess couldn't be foreseen, *yet in 2005* Alan
Greenspan
<http://search.bloomberg.com/search?q=Alan+Greenspan&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1>
told Congress how urgent it was for it to act in the clearest possible
terms: If Fannie and Freddie ``continue to grow, continue to have the
low capital that they have, continue to engage in the dynamic hedging of
their portfolios, which they need to do for interest rate risk aversion,
they potentially create ever-growing potential systemic risk down the
road,'' he said. /``We are placing the total financial system of the
future at a substantial risk.'' /
*_What happened next was extraordinary_.* For the first time in history,
a serious Fannie and Freddie reform bill was passed by the Senate
Banking Committee <http://banking.senate.gov/public/>. The bill gave a
regulator power to crack down, and would have required the companies to
eliminate their investments in risky assets.
*Different World *
_If that bill had become law, then the world today would be different_.
In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered
out of the Fannie and Freddie clouds, burying many of our oldest and
most venerable institutions. Without their checkbooks keeping the market
liquid and buying up excess supply, the market would likely have not
existed.
/_*But the bill didn't become law, for a simple reason*_/: Democrats
opposed it on a party-line vote in the committee, signaling that this
would be a partisan issue. Republicans, tied in knots by the tight
Democratic opposition, couldn't even get the Senate to vote on the matter.
That such a reckless political stand could have been taken by the
Democrats was obscene even then. Wallison wrote
<http://www.aei.org/publications/pubID.22514/pub_detail.asp> at the
time: ``It is a classic case of socializing the risk while privatizing
the profit. The Democrats and the few Republicans who oppose portfolio
limitations could not possibly do so if their constituents understood
what they were doing.''
*Mounds of Materials *
Now that the collapse has occurred, the roadblock built by Senate
Democrats in 2005 is unforgivable. Many who opposed the bill doubtlessly
did so for honorable reasons. Fannie and Freddie provided mounds of
materials defending their practices. Perhaps some found their propaganda
convincing.
*But we now know that many of the senators who protected Fannie and
Freddie, including **Barack Obama*
<http://search.bloomberg.com/search?q=Barack+Obama&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1>*,
**Hillary Clinton*
<http://search.bloomberg.com/search?q=Hillary+Clinton&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1>*
and **Christopher Dodd*
<http://search.bloomberg.com/search?q=Christopher+Dodd&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1>*,*
have received mind-boggling levels of financial support from them over
the years.
Throughout his political career, Obama has gotten more than $125,000 in
campaign contributions from employees and political action committees of
Fannie Mae and Freddie Mac, second only to Dodd, the Senate Banking
Committee chairman, who received more than $165,000.
Clinton, the 12th-ranked recipient of Fannie and Freddie PAC and
employee contributions, has received more than $75,000 from the two
enterprises and their employees. The private profit found its way back
to the senators who killed the fix.
There has been a lot of talk about who is to blame for this crisis. /A
look back at the story of 2005 makes the answer pretty clear. /
Oh, and there is one little footnote to the story that's worth keeping
in mind while Democrats point fingers between now and Nov. 4: *Senator
**John McCain*
<http://search.bloomberg.com/search?q=John+McCain&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1>*
was one of the three cosponsors of **S.190*
<http://thomas.loc.gov/cgi-bin/bdquery/z?d109:SN00190:@@@P>*, the bill
that would have averted this mess. *
(Kevin Hassett
<http://search.bloomberg.com/search?q=Kevin+Hassett&site=wnews&client=wnews&proxystylesheet=wnews&output=xml_no_dtd&ie=UTF-8&oe=UTF-8&filter=p&getfields=wnnis&sort=date:D:S:d1>,
director of economic-policy studies at the American Enterprise
Institute, is a Bloomberg News columnist. He is an adviser to Republican
Senator John McCain of Arizona in the 2008 presidential election. The
opinions expressed are his own.)
To contact the writer of this column: Kevin Hassett at khassett@aei.org
<mailto:khassett@aei.org>
/Last Updated: September 22, 2008 00:04 EDT/
