The Housing Crisis

Inspired by Amity Shlaes seminal – and eminently readable work, The Forgotten Man, A New History of the Great Depression, I will attempt to briefly familiarize the reader with the economic and political causes of the housing crisis which led directly to the “Great Recession” of 2007-8 – blamed singularly, but erroneously, on Republican President George W. Bush.

“At first, the quota [mentioned above] was 30%; that is, of all the loans they bought, 30% had to be made to people at or below the median income in their communities. HUD, however, was given authority to administer these quotas, and between 1992 and 2007, the quotas were raised from 30% to 50% under Clinton in 2000 and to 55% under Bush in 2007 after the Democrats won control of both houses of Congress in 2006.

[Let’s savor that again. More than half of the housing loans issued were known to be bad loans as a matter of federal policy!]

In 1995, the Clinton Administration again changed the Community Reinvestment Act (CRA) mission in order to encourage even more lending in poor neighborhoods. Previously, the CRA directed government to monitor banks’ lending practices to make sure they did not violate fair lending rules in poor neighborhoods. With the 1995 change, the government published each bank’s lending activity and started giving bank ratings based primarily upon the amount of lending it performed in poor neighborhoods.

These changes empowered community-action organizations sponsored by the likes of Jesse Jackson and Al Sharpton – such as ACORN (Association of Community Organizations for Reform Now) – the socialist group that routinely engages in voter fraud – to pressure banks by pushing for risky loans to people with bad credit histories or little money for down payments in order to increase lending activities in poorer neighborhoods or face backlash from those organizations’ private and political associates. [Barrack Obama actually trained ACORN workers when he was a community organizer in Chicago!]

For instance, if Chase made 100 mortgages in a poor Chicago district, and Countrywide 150, the government would likely give Chase a lower CRA rating, and community organizers could pressure politicians to make it more difficult for Chase to get licensed to do full ranges of business in new areas of the country. Low CRA ratings could also disadvantage Chase with regard to government lending programs and make it more difficult for Chase to participate in mergers and acquisitions. [This is commonly called communism.]

“From 1993-99, the Clinton Administration replaced many of Fannie Mae’s key executives, including the CEO, the CEO’s number two, and nearly half the board of directiors. As a government sponsored enterprise (GSE), the President had the authority to make those appointments. The board, which increasingly consisted of Presidential appointments, then worked with the new CEO to change Fannie Mae executives’ salary structures in order to incentivize them to reach higher “affordable housing” mortgage targets.

More specifically, the board promised senior executives millions of dollars in bonuses each year as long as Fannie reported certain earnings figures. Just a quick reminder… Fannie’s ability to reach earnings targets is directly related to the number of mortgages it buys, as long as those mortgages do not default or as long as Fannie executives do not recognize negative changes in the payment flow.

Between 1994 and 2004, Fannie executives improperly reported $10.6 billion of earnings. Franklin Raines, the Clinton-appointed CEO, received over $90 million in bonuses. Jamie Gorelick – the top Clinton Administration lawyer whom he appointed in 1997 to be Fannie Mae vice-chairman despite having no formal financial experience – received over $26 million. Jim Johnson, eventually Barrack Obama’s vice president search committee chairman, hauled in millions from his work with Fannie Mae as CEO. Just by way of reference, in 2002, 21 senior Fannie Mae executives received over $1 million each.”

Just before Mr. Clinton curiously appointed Jamie Gorelick to the lucrative Fannie Mae post in 1997, she had authored a very significant and controversial legal directive that came into sharp focus on September 11, 2001. Her policy, which became known as the “Gorelick Wall” established barriers that prevented federal anti-terrorist criminal investigators from accessing various federal records and databases…one of the top causes for the 9-11 intelligence failure – thus making the Clinton administration complicit in the 9-11 disaster.

And, Jamie Gorelick’s curious appointments did not stop with Fannie Mae. Democrats selected her to serve on the 9-11 Commission; the official government investigation into what happened from an intelligence standpoint, and why. Thus, she was in the perfect spot to head off the “Gorelick Wall” from being a cause celeb in the 9-11 Commission’s obviously flawed final report. [With apologies to the legendary Paul Harvey, “now you know the rest of that story.”

“In 1999 the Congress enacted and President Clinton signed into law the Gramm-Leach-Briley Act, also known as the Financial Services Modernization Act. This law repealed the part of the Glass-Steagall Act that had prohibited a bank from offering a full range of investment, commercial banking and insurance services since its enactment in 1933. It was enacted as an emergency response to the failure of nearly 5,000 banks during the Great Depression [and was designed to prevent the same thing happening in the future].

Resistance to enacting the bill centered around the legislation’s language which would expand the types of banking institutions of the time into other areas of service but would not be subject to CRA compliance in order to do so. Opponents demanded full disclosure of any financial “deals” which community groups had with banks, accusing such groups of “extortion”. [Such warnings fell on deaf “professional politicians'” ears. They are now known as “establishment” politicians.]

In the fall of 1999, Senators Chris Dodd (D-CT) and Charles Schumer (D-NY) prevented an impass by securing a compromise between Republican senators and the Clinton Administration by agreeing to amend the Federal Deposit Insurance Act (12 U.S.C. ch. 16) to allow banks to merge or expand into other types of financial institutions. The FDIC related provisions of the new Gramm-Leach-Bliley Act directly to Title 12 and insured any bank- holding institution wishing to be re-designated as a financial holding institution by the Board of Governors of the Federal Reserve System would also have to follow the Community Reinvestment Act compliance guidelines before any merger or expansion could take effect.

At the same time the G-L-B Act’s changes to the Federal Deposit Insurance Act would now allow for bank expansions into new lines of business, and non-affiliated groups entering into agreements with these bank or financial institutions would also have to be reported as outlined under the newly added section to Title 12, para 1831y (CRA Sunshine Requirements, to satisfy Republican concerns. In conjunction with the Gramm-Leach-Bliley Act changes, smaller banks would be reviewed less frequently for CRA compliance.

These changes linked the Community Reinvestment Act to decreased lending standards that resulted in an increase of subprime (read risky) mortgages, as the law forced banks to set up quotas of lending to [mostly] minorities. As a result, “lenders had to resort to ‘innovative or flexible’ standards.” 

Senator Dodd (D-CT) was head of the powerful banking committee in the Senate. He and Representative Barney Frank (D-MA) consistently resisted attampts by the Bush Administration to closely regulate Fannie Mae and Freddie Mac. Senator Dodd also got preferential treatment from Countrywide on two personal mortgages. Countrywide was one of the biggest subprime providers. 

Democrat Representative Frank and Democrat Senator Dodd received thousands of dollars in contributions from [the quasi-governmental agencies] Fannie Mae and Freddie Mac over the years. Senator Dodd received $133,900 beginning in 1989; Congressman Frank received $40,100. (While in the Senate, Barack Obama received $105,849).

While Frank and Dodd’s tinkering with the CRA forced lending institutions to make a quota of bad loans that certainly contributed to the mortgage crisis, the primary cause of crisis was Frank and Dodd’s push to reduce mortgage buying standards at Fannie Mae and Freddie Mac, who, by law, provide liquidity to mortgagees [the lenders, like banks and credit unions] by buying the loans they (the mortgagees) make to the public.

Before Frank and Dodd were able to pass legislation weakening Fannie and Freddie’s buying standards, all mortgages purchased off the primary market [where bank loans are bundled for sale to investors] by these two Government Sponsored Enterprises adhered to Federal Housing Administration standards, i.e. they were “prime” loans. But Frank, Dodd, and their cohorts “rolled the dice” in regards to subprime lending, and, in effect, drowned Fannie and Freddie with junk [worthless] mortgage paper.

In turn, Fannie and Freddie sold the junk loans to institutional investors, who happily bought them with cheap capital provided (read “printed”) by the government – [after all, it was only] taxpayer money. Attaching trillions of dollars of derivatives [overly complex and risky financial inventions somehow tied to other market securities] to the junk they bought – in order to sell the junk to non-institutional investors, these investors (particularly the Big Banks) created a bona fide financial crisis [of risk].

A manual issued by the Federal Reserve Bank of Boston advised mortgage lenders to disregard financial common sense. [The Federal Reserve actually wrote the following instruction:] “Lack of credit history should not be seen as a negative factor.” Lenders were directed to accept welfare payments and unemployment benefits as “valid income sources” to qualify for a mortgage. Failure to comply could mean a lawsuit. [This guidance was obviously stupifyingly irresponsible! Apparently, no one in government – not establishment politicians, not lifetime bureaucrats – cared.]

The only way to change the structure put in place before 2000 would have been to forcibly replace the board of directors and senior management of Freddie Mac and Fannie Mae. But for that to happen, the President would need hard evidence that justified cause.  As far as Washington insiders publicly knew, all Fannie Mae was doing was helping poor people buy homes and, in the process, boosting economic activity. Who could argue with that? Certainly not any nationally-elected politician. 

That evidence finally came in 2004, despite fierce Democrat Party efforts to prevent it and their systematic attacks on people who tried to bring it to light. Even after the evidence was in clear public view, Democrats continued to resist any changes to the regulatory structure that would have slowed GSEs mortgage lending activity. [Incidently, Congressman Frank did finally admit that he eventually saw his error and corrected it when he got the power to do so when Democrats to control of Congress in 2007, but by then it was too late.]

As long ago as 2003, Republican President Bush was trying to get the House and Senate to carefully monitor the actions of Fannie Mae and Freddie Mac. His efforts were rejected by Democrats, preventing any action in the Senate. When the Bush administration proposed much tighter regulation of the two companies, Congressman 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, Congressman Frank [incoherently] complained that the administration was “… more concerned about financial safety than about housing” [as if the two were unrelated].

All this was justified as a means of increasing homeownership among minorities and the poor [- both powerful voting blocks for the Democrats]. In the end, affirmative-action policies trumped sound business practices – leading to [government mandated] reckless business practices. 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.

Many institutions actually welcomed the lowered credit standards to continue feeding the global demand for mortgage securities, generating huge profits which its investors shared. They also shared the risk. When the bubbles developed, household debt levels rose sharply after the year 2000. Households became dependent on being able to refinance their mortgages.

Further, U.S. households often had [riskier] adjustable rate mortgages, which had lower initial interest rates and payments that later rose. [Although disclosed, most lenders downplayed or dismissed the risk to home buyers during the housing boom.] When global credit markets [struggling from high mortgage default levels] essentially stopped funding mortgage-related investments in the 2007-2008 period, U.S. homeowners were no longer able to refinance and defaulted in record numbers not seen since the Great Depression, leading to the collapse of securities backed by these mortgages that now pervaded the system.”

Housing market value actually topped out in mid-2006. Then, the failure rates of subprime mortgages were the first symptom of a credit boom turned to bust and of a real estate market near-fatal shock. But large default rates on subprime mortgages alone cannot account for the severity of the crisis. Rather, low-quality mortgages acted as an accelerant to the fire that spread through the entire financial system.

The latter had become fragile as a result of several factors that are unique to this crisis: the transfer of assets from the balance sheets of banks to the markets in the form of securities; the creation of complex and opaque assets called derivitives; the failure of ratings agencies to properly assess the risk of such assets and the absence of the application of fair-value accounting. To these novel factors, one must add the now standard failure of regulators and supervisors in spotting and correcting the emerging weaknesses.

Summarizing: “The banking system had imprudently overleveraged itself by investing in “derivatives”, a fancy name for high-risk, poorly designed, misunderstood and incompetently managed and regulated investment vehicles that were widely traded, by and among, investment institutions in the first decade of the 21stCentury.

These derivatives were able to be created after the freeing up of world capital markets in the 1970s and the repeal of the Glass-Steagall in 1999. (Again, The term Glass–Steagall Act usually refers to four provisions of the U.S. Banking Act of 1933 that limited commercial bank securities activities and affiliations within commercial banks and securities firms.] 

Congressional efforts to “repeal the Glass–Steagall Act” referred to those four provisions (and then usually to only the two provisions that restricted affiliations between commercial banks and securities firms). Those efforts culminated in the 1999 Gramm-Leach-Briley Act (GLBA), which repealed the two provisions restricting affiliations between banks and securities firms.

Starting in the early 1960s federal banking regulators interpreted provisions of the Glass–Steagall Act to permit commercial banks and especially commercial bank affiliates to engage in an expanding list and volume of securities activities. By the time the affiliation restrictions in the Glass–Steagall Act were repealed through the GLBA, many commentators argued Glass–Steagall was already “dead.” 

Most notably,  Citibank’s 1998 affiliation with Salomon Smith Barney, one of the largest U.S. securities (stocks and bonds) firms, was permitted under the  Federal Reserve Board’s then existing interpretation of the Glass–Steagall Act. Democrat President Bill Clinton publicly declared “… the Glass–Steagall law is no longer appropriate.

The derivatives market allowed by the new banking practices, along with monitized (marketed to investors) subprime mortgages sold as “no-risk” investments [a colossal   oxymoron), reached a critical stage during September 2008, characterized by severely contracted liquidity [the ability to turn investments into cash] in the global credit markets and insolvency threats to investment banks and other financial institutions.

In response, the U.S. government announced a series of comprehensive steps to address the problems, following a series of “one-off” or “case-by-case” decisions to intervene or not, such as the $85 billion liquidity facility for American International Group (AIG) on September 16, 2007; the federal takeover of Fannie Mae and Freddie Mac, and the 2008 bankruptcy of Lehman Brothers

Subsequently, on Monday, October 6, 2008, the Dow Jones Industrial Average dropped more than 700 points and fell below 10,000 for the first time in four years. That was a 6% drop. For perspective, on October 29, 1929, the market lost 13% and another 12% the following day, precipitating the 10-year long Great Depression!

The same day, CNN reported these worldwide stock market events:

·                     Britain’s FTSE 100 Index was down 7.9%

·                     Germany’s DAX was down 7.1%

·                     France’s CAC 40 dropping 9%

·                     In Russia, trading in shares was suspended after the RTS stock index fell more                          than 20%.

·                     Iceland halted trading in six bank stocks while the government drafted a crisis                          plan.

U.S. Treasury Secretary Henry Paulson proposed a plan under which the U.S. Treasury would acquire up to $700 billion worth of mortgage-backed securities. The plan was immediately backed by President  George W. Bush and negotiations began with leaders in the U.S. Congress to draft appropriate legislation.

Consultations among Treasury Secretary Henry Paulson, Chairman of the Federal Reserve Ben Bernanke, U.S. Securities and Exchange Commision Chairman Christopher Cox, congressional leaders, and President Bush, moved forward with efforts to draft a proposal for a comprehensive solution to the problems created by illiquid assets. News of the coming plan resulted in some stock, bond, and currency markets’ stability by October 19, 2008.

The proposal called for the federal government to buy up to $700 billion of illiquid mortgage-backed securities with the intent to increase the liquidity of the secondary mortgage markets [described above] and reduce potential losses encountered by the financial institutions owning the securities.

The draft proposal was received favorably by investors in the stock market, but caused the U.S. dollar to fall against gold, the Euro, and petroleum. The plan was not immediately approved by Congress; debate and amendments were seen as likely before the plan was to receive legislative enactment. The “bank bailout bill” was finally approved by Congress and signed by President Bush on October 3, 2008, which virtually all responsible economists agree, aggressively, effectively and efficiently saved the world banking system.

Let’s say that again. The Republican President George W. Bush administration’s proposal known as the “bank bailout bill” literally saved the world’s banking system from collapse and prevented an economic “depression”!

H.R. 4173 modified Section 13(3) of the Federal Reserve Act, which says that “[i]n unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank” to lend money to “any individual, partnership, or corporation.” The Fed tapped this “rarely used legal authority,” in the words of the Wall Street Journal, in 2008 to lend money to AIG and Bear Stearns. It decided not to use the authority in the case of Lehman Brothers, but that’s a story for another time.

At the end of 2008, automobile industry giants General Motors and Chrysler were bleeding billions of dollars a month due to historically low car sales, and nobody in the private sector wanted to lend to them. Even the supposedly liberal Brookings Institution put out a report saying they should be allowed to go bust, with their factories and machinery being sold off to the highest bidder.

On December 19, 2008, a week after Republicans in the Senate had killed a bailout bill proposed by Democrats, saying it didn’t impose big enough wage cuts on the U.A.W., President Bush unilaterally agreed to lend $17.4 billion of taxpayers’ money to General Motors and Chrysler, of which $13.4 billion was to be extended immediately. He had to twist the law to get the money. Deprived of Congressional funding, he diverted cash from the loathed TARP program, which Congress had already passed, but which was supposed to be restricted to rescuing the banks.

The President, “… a man of steel in his spine … made the tough call… [he] was right, and they were dead wrong.”, President Obama’s Vice-President, Joe Biden said later. The “man with steel in his spine” he referred to was George W. Bush, not Barack Obama. Lest we forget, it was Bush, say it again, it was Bush, rather than Obama who initiated the government rescue of the auto companies. Today, things look very different. General Motors is profitable and has paid back all of the bailout money plus interest. Even Chrysler, which is now controlled by Fiat, is making money.

“I didn’t want there to be twenty-one-per-cent unemployment,” Bush said to a meeting of the National Automobile Dealers Association in Las Vegas, explaining why he acted as he did. “I didn’t want history to look back and say, ‘Bush could have done something but chose not to do it.’” As he left office, national unemployment was about 7.5%, compared to over 20% during the “Great Depression”.

President Barrack Obama who, in December 2008, was the President-elect, publicly supported Bush’s move, saying it was a “…necessary step to avoid a collapse in our auto industry that would have devastating consequences for our economy and our workers.”

After taking office six weeks later, Obama put together an auto task force that extended tens of billions of dollars more in emergency financing to Detroit over the ensuing months, and also did what appears to have been a pretty good job in restructuring G.M. and selling Chrysler to Fiat although, in the process, GM’s creditors (those who had risked their own money to keep GM afloat) were stiffed while the UAW got rich on the taxpayer’s money.

Obama stood with the auto workers, who were victims of extraordinary circumstances beyond their control. As the price of the bailout, he insisted on some changes at G.M., including the installation of new leadership and the elimination of several brands. On the downside; in the restructuring of the GM debt, the auto workers’ unions were put in first position to benefit from the bailout while private investors lost everything.

Then, President Obama went a step further with his American Recovery and Reinvestment Act of 2009 (ARRA) (Pub.Law 111-5), commonly referred to as the Stimulus or The Recovery Act, was an economic stimulus package enacted by the Democrat controlled 111th United States Congress in February 2009 and signed into law on February 17, 2009, by Democrat President Barack Obama.

Next time: The American Recovery and Reinvestment Act of 2009.

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