National Journal’s Michael Hirsh (formerly of Newsweek, Harper’s, and Washington Monthly, among others) says that Republicans are perpetrating “a myth” when they argue that Fannie and Freddie Mac were major causes of the financial crisis. The real cause? “Reckless” de-regulation:
Unfortunately for the blame-the-government crowd, the facts don’t bear out their conclusions. Yes, Fannie and Freddie are government sponsored, but they’re run by shareholders looking for a substantial return. And the prime force that was driving them and just about everyone else in the world to take risks was Wall Street, which kept looking for higher returns. Indeed, Fannie and Freddie didn’t go nearly as far out on a limb as other lenders, and they hadn’t actually created derivative products themselves.
[…]
Mini-blowups began happening in the the’90s, but the warning signs were ignored. Tempted by the high yields, state, county, and local investment funds that were supposed to be playing it safe began indulging in highly risky derivatives trades under cover. The temptation of showing great returns to one’s board of directors, looking like a market whiz, was just too great. And one by one, they began going up in smoke. At one point, 18 Ohio towns lost $14 million. City Colleges of Chicago lost almost its entire investment portfolio — $96 million. In 1995, the Wisconsin Investment Board abruptly announced a $95 million loss, $60 million of which was linked to investments in the Mexican peso. These state and local funds had no business investing their citizens’ money in high-risk currency trades; in fact, most were banned by law from indulging in such speculation. But somehow they felt they could do it if they were packaged as derivatives.
Some of these scandals were so astonishing in scope and criminality that they should have raised at least a few warning flags back in Washington. Orange County, California, under its treasurer, Robert Citron — a college dropout who consulted psychics and astrologers about interest rates — had lost a billion dollars and filed for bankruptcy in 1994. Again, it was a case of a Wall Street firm, Merrill Lynch, knowingly selling Citron investments that were so complex he simply could not comprehend them. But no one did anything. As the speculative collapses continued, there were no rules in place to stop them — no requirement as there was on exchanges for mark to market or paying margin on a daily or intra-daily basis.
As the years went by, the only change that occurred despite the regular blowups was even more deregulation.
Let me just stop here to note that I find it ironic that someone would be railing against “investments that were so complex” that no mere man could possibly understand them — even as the government is consistently shoving 2000-3000 page bills down our throats and telling us we’ll know what’s in them once they pass.
— The difference being that in the case of Merrill Lynch pushing certain investments to willing speculators, the force of government isn’t there to compel participation — a point that appears lost on Mr Hirsh.
[…]
In his public comments, Fed Chairman Alan Greenspan kept saying again and again that derivatives were just diffusing risk through the system, parceling it out in little pieces, making everyone individually safer. That was true, but this process was also infecting the entire system with risk, and thereby making the total risk greater. Trade by trade, instrument by instrument, through CDOs and credit default swaps and the rest, every major market player was becoming systemically linked up with everyone else.
After 20 years of free-market fervor, the world of the mid-’00s had become one of overleveraged banks too big to regulate and trillions of dollars worth of derivatives bets that no one had track of — which in turn were helping to accelerate huge flows of capital coming in from abroad — and a Fed and government regulators who weren’t aware or weren’t watching.
And that was the real cause of the crisis, whose aftereffects continue to drag on the economy today. Fannie and Freddie were, like almost every other big player, both culprits and victims, but just two of many.
So there you have it. Deregulation and “free-market fervor” were the real causes of the financial crisis.
Meaning that any sane and caring government will perforce need to step in, clamp down, oversee, micromanage, and essential take control of the “free-market” in order to make it safe for simple folk who need them some protecting.
For the greater good, you see.
That this will almost assuredly lead to corruption and a culture of crony capitalism that will become institutionalized and protected by the very government who has shown a canny ability to avoid ever investigating itself — well, that’s just nitpicking, now, isn’t it…?
I got a hint somwheres this week that “they” might try to use “mortgage buybacks” to make Fannie and Freddie look like the victims.
It’s a busy week so I couldn’t spend a lot of time on it, but I think it’s out there.
*somewheres*
Let’s see, Mr. Hirsh, I’m a banker. I can either deny loans to those who don’t qualify and have ACORN lawyered by Barak Obama camped in my lobby while government regulators go through my files — or I can say the hell with it and loan to anyone with a pulse, then sell the paper to Fannie and Freddie. I wonder which one I should choose……
And the Congressional Record shows attempts by Republicans to rein in the mess, only to be stopped by filibusters from Senator “Countrywide” Dodd and tantrums by Barney “Fannie Ranger” Franks. FOAD, dumbass.
Idiots. When you force banks to lend to a quota of unqualified minority borrowers and penalize them when they don’t make these bad investments, the market will collapse. Sorry, people on wellfare cannot and should not live in the same house as someone making 100k a year, just like the guy making 100k a year shouldnt be living in the same house as someone making a million a year. Its funny how “fairness” only matters for people who vote democrat (ie, the new middle class, which to the dems apparently consists of the lower class, minus the homeless- the former middle class is now “the rich’).
I hate these people, primarily because they will never, ever admit they’re wrong.
So much BS to wade through; it’s amazing how these hacks continue to get jobs, eh?
Putting aside for a moment, the CRA repurchasing targets, that reached levels of 50% of all FNMA transactions under, surprise!, Andrew Cuomo during the Clinton administration, what part of “No other mortgage banker/bundlers in the nation carried, implied or otherwise, the backing of the full faith and credit of the US government” doesn’t Hirsch understand.
Or that the total value that FNMA was “on the hook for”, between the paper they directly owned and that which they guaranteed, was nearly 7 trillion dollars out of the roughly 10.8 trillion total outstanding in December 2008; a staggeringly high percentage.
What Mr. Hirsch is not saying is that all of that “risk spread through the system” was either done directly by, or with the blessing of, FNMA.
And he conveniently leaves out the 17 times that Bush and the Rethugs! tried to do something about Fan/Fred; do something as in more tightly regulate the GSEs…
Also make no mistake. This is the dissemination of talking points in advance of the hearings that will most certainly be held by the next congress; that this one chose to avoid because of the bad light it would have revealed the long term policy to have been, as well as who was fundamentally responsible for that policy’s direction.
This is an attempt to head that argument off at the pass.
Matt, the rot goes deeper than that: if you can’t apply standards to everyone, then you can’t apply them to anyone.
Jeff, I think you missed the second set of blockquote tags.
No. Tyrants love their sycophants.
Fannie and Freddie were positively integral to the evolution of the credit crisis–which was essentially an institutional liquidity crisis–as the terminus of mortgage trading, but in terms of the collapse they had no real part.
The collapse was purely a function of leverage (over) extension, the attendant withdrawal of liquidity from bond market after bond market and then, the collapse of overnight funding.
We can thank the elimination of Glass-Stegall for this, which was formalized in 1999 but had been incrementally dismantled throughout the 1980s and early 1990s. Banks were able to sweep deposits and use that capital to instantly become thrice the size of Goldman and Merrill. In turn, everyone levered up dozens of times to compete; what they levered with and what they offered as overnight loan collateral was (increasingly subprime) mortgage collateral. Much hilarity did not ensue.
Fannie (FNMA) and Freddie (FHLMC) are guilty of so many sins that one cannot track them in a comment. They brilliantly executed what they were CHARTERED to do, which was eliminate the national disparity in mortgage rates and, via a sponsored secondary market, allow for banks–especially thrifts and smaller community banks–to compete for business with the big boys. For real: the US is one fo the last of the major nations to have community banks. They exist only because they can offer mortgages, which they can offload to the GSEs.
As privatized ventures, they had every incentive to forget their charter and grow, grow, grow their portfolios. This introduced interest rate risk to an extent they had never had; when the pols, Dodd and Frank ( But dozens of other too) got involved, they added a third mission: affordable housing. This coupled rate risk (convexity and duration) with credit risk.
The few pols, Baker in the house and Sessions in the senate, willing to criticize this growth and mission creep were having to stare down the affordable housing axis. As white southern males, this was a difficult sell. That, and the biggest players in this shit on the origination side were all GOP stalwarts.
When they started to topple, Treasury stepped in so it was always business as usual for them.
Hirsch is broadly correct, in other words. I have no idea about his conclusion though.
My book goes into this. I hope many people buy it.
Without Fannie and Freddie this crisis likely would not have happened. The fact that the paper they pooped out had the sheen of being “safe” was enough to cause the majority of the problem, and we know that most of the paper went through them at some point. Hirsch’s willingness to give Fannie and Freddie a pass as “just another player” is telling enough for me to discount pretty much everything else he says. Hirsch is apparently interested in yet more government control, so I tend to discount what he says, because I don’t know what form his new regulations will take.
If the new regulations he desires involved changing the leverage limit to something sane, and stopped forcing banks to make loans to people who obviously could not pay them, that would be one thing. It’s more likely, however, that “de-regulation” is his code word for not implementing a lot more regulation. One wonders what regulations he would be advocating.
I need to fire my editor.
Talking point!
Everybody take a drink!
Interesting points Roddy. There were many factors in the crisis, to be sure. The GSE’s certainly were major players in the growth of the amount of the risky debt throughout the system. But you’re absolutely right to say that they weren’t the immediate cause of the credit crisis. But that doesn’t mean they weren’t a proximate cause. It’s hard to imaging that such a load of trash would have gotten into the system in the magnitude of dollars that it did if the GSEs weren’t spending nearly 50% of the dollars they transacted a year on buying and rebundling sketchy loans.
But you are correct that a great amount of the problem was the failure of the wizards of smart on Wall St to “get” the fact that regardless of what the rate of return the MBS they had claimed it would pay, it would be worthless if it were defaulted on. And they, as well as the insurers who wrote CDS, didn’t consider what would happen if it all hit the fan at once.
And I’m still amazed that a major investment bank like Lehman would have had such a large percentage of their capital tied up in any one kind of instrument! I mean, these were supposed to be professionals; I’m a dilletante at best, but even I realize that you should never have more than 20% of your eggs in any one basket.
I know you’ve researched this exhaustively, and are correct in saying that the cessation of lending was directly due to overleveraging. And that it was systemic, and not restricted to the investment houses only was due to a combination of the repeal of Glass-Steagall and the stipulation that all kinds of paper could count as assets as well as be used at the overnight window. And as you say, both sides were in on Glass-Steagall’s repeal; the same geniuses that were assuring us that globalization meant that we could dominate the financial markets and not have to, you know, engage in any silly manufacturing anymore-we didn’t need such calloused hands jobs. The service businesses would be enough, and, besides, everybody’s house was going to double in value every 7 years ad infinatum…
But I still think that without the activities of Fan/Fred over the years, regardless how well intentioned or how much they may have contributed to market stability, the magnitude of the crisis wouldn’t have been anywhere near as large.
That is, unless there is more European junk about to tank than anyone realizes! And the same banks would have been loaded up with that right now instead.
I’m looking forward to reading your book, It’s one of the ones I asked my wife to get me for Christmas.
Barney moves in mysterious ways.
Well, not really.
“That this will almost assuredly lead to corruption and a culture of crony capitalism that will become institutionalized and protected by the very government who has shown a canny ability to avoid ever investigating itself — well, that’s just nitpicking, now, isn’t it…?”
Isn’t that way already?
Oh, wait. I live in Illinois where it has always been that way. And after a fair and legal election Rham Emmanuel will be the next mayor of Chicago.
the biggest players in this shit on the origination side were all GOP stalwarts.
You going to have to expand on that since this all starts with a Carter program expanded by Bill Clinton. But sure, blame Republicans and bank deregulation if it makes you feel better. After all, the banks should have just taken the losses that social justice required them to take.
You are.
fimble fungered today iam.
” That, and the biggest players in this shit on the origination side were all GOP stalwarts.”
Yeah, I had questions about that too Ernst.
Who are the biggest players on the origination side again?
And what, exactly are we talking about? Loan origination or law origination?
As in: Damn those greedy loan officers for approving loans to people with no verifiable and/or insufficient income just because they’re[insert favored minority/aggreived party here]!
SLB, Ernst:
The sub-prime originators, to say nothing of the major moneycenter banks, were huge sources of political and intellectual support for the GOP. Ameriquest and Countrywide, to start, but then you’d have to just pick the city of Irvine and all the retard lenders based in and around there. Dont mistake me–they gave plenty to the Dems but their managements viewed themselves as Reagan Republicans.
Fannie and Freddie, though blanketing every known organism in the beltway with donations, were several levels smarter than the subprime set and fought a deep, backchannel game to keep restrictions off their portfolio growth.
Here’s the first book I would read if I were to read a book on the subject.
I want to read Sowells new one first though…
20. Both. How these guys were allowed to exist in the shape and size they did does not speak positively of the US and its system.
Crony capitalism, indeed. Jeff underplays his concern here.
Friends of Angelo were Republicans. Especially Chris Dodd.
The source of the Nile was the Community Reinvestment Act. Using the specter of racism and redlining the regulators forced the creation of mortgage products that never should have existed. To try and help out the banks, Cuomo had Fannie and Freddie promise to buy $2 trillion in “affordable” (read: bad) mortgages. Pretty simplified, but when you force banks to make bad loans, they are going to find a way to make at least some of their money back.
I was in the “low income housing” game back during the second Clinton Admin and I can tell you that the CRA and the creation of Economic Empowerment Zones made a lot of connected people a lot of money. Not me though, my conscience caught up with me and I moved on to a career with a more moral clew. Pimping.
17. The CRA (Community Reinvestment Act) loan performance has been sharply better than the IMC–Independant mortgage company–loan performance.
Massively so. Thats because the CRA loans forced people to at least show something about a job and income before approval; Countrywide, New Century and Ameriquest (often) did not.
What killed banks like Citi was keeping $40 bn of asset-backed paper off balance sheet in some land of clown formulation called a structured investment vehicle, to say nothing of issuing CDOs with put-back provisions in them if ratings were dropped (They were and they had to take $40bn back on their balance sheet.)
Playing with “risk assets” in that size and that degree had never been contemplated, let alone allowed, for a comml bank. Investment banks came and went with the wind…anyone remember Kidder or Drexel?
We’d be much much better off if they put FDRs big policy triumph back into effect.
Let me walk that back—Im glad the guy fought WWII the way he did….
Angelo was smart. He voted and gave GOP, but he was pretty smart about who he shot breaks to.
Look, Im not trying to crap on the GOP here, nor am I absolving the Dems, but Fannie and Freddie didnt cause this mess. They should never, ever have been allowed to grow like they did, but Bear, Lehman, Merrill, Citi, UBS, AIG had no GSE angle….none
Countrywide? Roddy? Countrywide!? That’d be the Friends of Angelo (Or whatever thge hell his name is) guys that caused Dodd’s early retirement? And if I remember right cost the Dems a Senate seat in ND (can’t remember the guy’s name) with another early retirement? Reagan Republicans huh?
JD beat me to the Countrywide punch.
Basic Economics is out in a 4th edition? Damnit! I just bought the 3rd less than a year ago! Sonofabitch!
And I’m pretty sure that if Fannie and Freddie hadn’t been allowed to grow like they did, Bear, Lehman, Merrill et. al. would have altered there behavior accordingly. Perverse incentives and all that.
I don’t disagree with you about there being plenty of blame to go around. Democrats may hate capitalism, but they love Big Business almost as much as Republicans. And Republicans love Business more than they love Markets.
Roddy, the Basel II Accords played a major role in this mess, too. I posted this at JOM last night…
No one has yet mentioned the debacle known as Basel I or Basel II. The relaxing of the fed requirements re the tranches that were required to jump on the bandwagon of global banking initiatives (aren’t we all just one big banking family???) really bolloxed up the works.
Banks (TBTFs) gleefully spent months salivating over the prospect of retranching their assets to the new global regulations (which required many of the assets to be moved from tranch to tranch which just so happened to require less reserves and really screwed with the fundamentals and the underlying securitizations). IIRC (and I do) Citi was the first US bank to voluntarily do so (Brer Rabbit – Brier Patch) and after Basel II the fed jumped the shark and moved from recommended to requiring that the largest banks in the US adopt those standards followed by the regionals a few years later. Most regionals had not converted to the new requirements, but all of the TBTFs pretty much had when the 08 blowup occurred.
IMO, if Basel adoption by the Feds had never happened, the retranching and repackaging would have never gotten out of hand, but Citi and the TBTFs used the retranching as cover to move their “problems” onto other companies and countries balance sheets never realizing that “everyone was doing it.” What resulted was “Boom” on a global scale thanks to Citi’s desire to stick it to BNP and BNPs desire to nail Ireland etc.
Just my two cents, but I spent months developing the software to move these assets around in a TBTF and saw the inherent risk in these moves and management’s salivary glands in action at the prospect of playing hot potato. It’s too bad that the whole potato-sack was hot and everyone was swearing to the next guy that they were just lukewarm.
And>>> In response to someone asking this ((From the Moore quote: “…packaging of the same bad mortgages over and over again into toxic collateralized debt obligation bundles….”
Would that have been through MERS assignments? Counting the same mtg more than once, just because it had been assigned multiple times?))
I responded:
…and packaged and rebundled into tranches multiple times, and sliced and diced to keep the bank’s capital requirements at a minimum. After 4 or 5 slices you could end up with a mortgage at 75-125% of the original note value in 3 – 6 different tranches and differing tiers and securitized at 9 different values based on the IRB that the bank assigned to each slice. Is the note not performing to tranch requirements? No problem – reassess the type of instrument it is and redivide it and re-rate it back into performing status. Remember, Basel II relies on IRB (internal rating based risk analysis) leaving the bank to determine the asset’s initial rating and tranch and, consequently and conveniently, capital requirements and the reevaluations of the asset in the hands of the bank itself subject to the definitions in the Accord which are clear as mud.
Why did banks want and need to keep their capital requirements undervalued? Lack of liquidity to cover actual risk, maybe?
The merry go round resulting from this led to banks re-assessing and reclassifying assets (and in some cases the collateral and the customer) to keep them in performing status thereby keeping capital requirements minimized.
One of the weirdest classifications I ever saw involved an instrument with prominent DC names (Ds, of course) that had never had a payment posted to the instrument (the very definition of non-performing – IRB rating a minimum 100%), was 405 days past due and had the most favorable methodologies applied. It was listed as “performing – preferred status and it’s resulting IRB rating was 10%.” You should have seen the contortions the computer code looked like to result in that classification.
IMO Basel is a backdoor to zero regulations on capitalization. Under the accord, banks are actually penalized should they decide to used standard risk ratings which rely on outside parties assigning the ratings for instruments on a much stricter criteria than IRB allows. Needless to say, all banks following Basel have (to my knowledge) elected to go the IRB route.
Wouldn’t you like to tell the bank when you apply for a loan that you have a house worth X and have assigned yourself a rating of “Awesome Goddess of Credit Worthiness” and therefore they should base their decisions on that? That is what Basel allows the banks to do to its stockholders, creditors and regulators. Just which of those dopes is going to demand to see the actual collateral anyways?
That is the atmosphere in which all securitized assets (not just mortgages) were being moved and played. Any wonder they can’t unwind what they did? And is it any wonder that they all began hoarding cash?
As far as I could tell, each bank had it’s very own “Super Smart” credentialed morons making these decisions and each “Super Smart” moron was convinced all the other “Not Quite as Super Smart” morons at the other banks and their creditors and the regulators and the stockholders were suckers to be played. They never realized that maybe some of those other guys were doing to them what they were doing to others – after all they were Credentialed and Super Smart Kings of the World – they could never be outplayed!!
Dopes.
And don’t even get me started on inventories and their valuations at telecoms and IT manufacturers, and the shenanigans I saw to disguise that shit circa 1997-2001.
The discussion and relevant links by McGuire and others are on this posting:
http://justoneminute.typepad.com/main/2010/12/the-financial-crisis/comments/page/1/#comments
There are alot of folks at that site that understand the market side of this stuff and one is close to Santelli, so I take what they say about that side as extremely valuable…
“Look, Im not trying to crap on the GOP here, nor am I absolving the Dems, but Fannie and Freddie didnt cause this mess.”
You’re not? But this is what you said in comment #10:
“the biggest players in this shit on the origination side were all GOP stalwarts ”
All. Origination side.
Lost My Cookies has a truer take on things I think.
Sorry for the long post, but y’all are only seeing half the picture. The Basel Accords made it very advantageous to the banks to play with capitalizations on all assets not just MBSs and alot of the 08 problems were banks playing each other for fools. And that does include the brokerage houses that invested in these instruments with the banks guarandamnteeing that these assets were teh awesome. No one thought to ask for the Carfax on this mess if you get my drift…
Well it’s true that the working poor do have an annoying habit of paying their mortgage, but the products that were invented in order to avoid scrutiny under the CRA went (in modern art) viral. The underlying issue is still the relaxing of normal underwriting standards via (supposedly well-intentioned) regulation. And I’ll also agree that our friend W was a big proponent of this.
But the GSE’s can’t get off scott free, either. HUD wanted them to have about half their portfolio in low-income mortgages by the time I quit that job and they did, and probably do, get tax incentives for buying mortgage backed securities. Most of which weren’t worth the pixels they were scanned on.
And that creates a market. Is what I would have typed at the end there if my phone hadn’t rang.
Umm, the friends of angelo program is a sweetheart deal that was cut to grease pols….it wasnt a partisan program.
CW–yes, Ernst, Countrywide–worked hand in hand with the Bush administration to help ensure that no substantive reforms were enacted that would shut down the sub-prime spigot. Dodd and the FoA paid their mortgages; millions of other shit loans they made are in default.
Ameriquest and its execs gave 20mm between 01-06..I could go on. You wanna get granular? The homebuilders, both trades and the companies, are like a GOP farm team. Anything that threatened to slow down the pace of new home starts was fought tooth and nail.
Ernst, LB: lets focus in, respectfully. This post is about FNMA and FHLMC. More directly, about a fellow named Hirsch who wrote some leading-with-his-chin piece destined to be picked up and posted by the Dem blogs as gospel. My argument is that Fannie and Freddie played a huge role in the run-up, but the crisis was all bank and broker. In the main, it seems this fellow Hirsch has defensible points.
Would have never happened in Glass-Steagall times is my point.
Ill give Stephanie and LMC props for substantive input and criticism as well.
The rules are there for reasons. We strip them away at our cost. If I started a red v blue debate, accept my apologies.
Thanks Roddy, but I’d like to note that the “rules stripping” that was done via Basel was under the auspices of enhancing globalization of banking. All of us as one big happy global economy and all except that the rules implemented did the exact opposite of what was intended and in direct contradiction to the progs/tranzis vocalizations of the need for regulations. The rules, enacted by the tranzis, themselves were deregulating and what led to the banks being able to do their risk based analysis and capitalization of themselves. Opposite results to their stated mantra. The severity of the global problem would have never been as bad if the Accord had not been enacted. The feds prior capital requirements and regulations were much more robust at keeping the wolves at bay. Almost as if they have ulterior motives or that they indeed are too stupid to recognize cause and effect. Most likely a combination of the two as false choicings are sooo 1990s.
Fannie Freddie played no small part in providing cover for the shenanigans that were happening, too. Think of it as a two pronged approach to killing the patient. Banking regulations were the culprit in it spreading worldwide. In spades. Who would think that the regulations would actually be changed to require the fox to guard the hen house? And as for Glass Steagall, had that been in place, the effects on Basel and its aftermath would have been minimal in the banking sector’s meltdown. Most of the shenanigans that Basel allowed to develop involved bank to bank transactions across international borders. Glass Steagall never had the capacity to address that.
BTW, one of the motives for repealing GS was that the US operated at a disadvantage to other nation’s banking systems because they allowed banks to securitize and that by allowing ours to do so the diversification of the risk would ameliorate any damage that might be caused, so we should go full on retard (EU) and adopt the world wide standards.
Ever notice how whenever globalization and diversity are advocated, in whatever venue – be it finance, human rights or whatever, the results are usually for shit? Almost as if the universe is trying to send a message, eh?
Saturday links…
Investing in lawsuits The US needs tort reform Using Seinfeld to teach economics Katrina: “The Louisiana governor froze.” Death tax: The Roosevelts Would Be Appalled It’s all about me: Obama reads his children’s book to 2nd graders NPR and PB…