Review - Reckless Endangerment:How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon Review

After the financial collapse as I expected a flood of books swept the market to explain why it happened. Some were written by people on the right and some by people on the left. If you’re interested in reading a book that explains how the housing bubble burst and, more important, how it was inflated in the first place from a non-ideological source I recommend Reckless Endangerment. The authors do a good job of detailing how the people within Fannie Mae cooked the books and used various means to ensure folks who normally wouldn’t qualify for loans got them. It also details how some within government, both Republicans and Democrats, defended Fannie Mae.

Gretchen Morgenson, the lead author, is a business reporter and writes the Fair Game column in The New York Times. She won a Pulitzer Prize in 2002 for her coverage of Wall Street. Her co-author, Joshua Rosner is a partner at Graham Fisher & Co., an independent research consultancy.

Morgenson and Rosner report how Barney Frank and Chris Dodd vigorously defended Fannie/Freddie against various people who questioned the economic wisdom of what they were doing.

It’s not a perfect book but it details the greed that drove the key participants within these organizations. It’s ironic because the only time I recall the media or liberals use the word greed was to chastise Wall Street’s role, not those within government and the Government Sponsored Enterprises, Fannie Mae and Freddie Mac. As the authors say:

We found that this was a crisis that crept up, building almost imperceptibly over the past two decades. More disturbing, it was the result of actions taken by people at the height of power in both the public and private sectors, people who continue, even now, to hold sway in the corridors of Washington and Wall Street.

Reckless Endangerment is a story of what happens when unfettered risk taking, with an eye to huge personal paydays, gains the upper hand in corporate executive suites and on Wall Street trading floors. It is a story of the consequences of regulators who are captured by the institutions they are charged with regulating. And it is story of what happens when Washington decides, in its infinite wisdom, that every living, breathing citizen should own a home.

They don’t use these terms but Reckless Endangerment exams the perils of crony capitalism. I’d also reverse their order of cause and effect: government policies to encourage home ownership lead to the formation of GSEs which blend the private and public sectors.

Reckless Endangerment shows that the seeds were set several decades before 2008. The change in the tax code in 1986 eliminated the interest deduction on debt except for mortgages thus setting the stage for making housing “Americans’ most favored asset.” Then in 1994 President Clinton launched the National Partners in Homeownership, a private-public cooperative with one goal: raising the numbers of homeowners across America. As they point out this cooperative had a problematic feature: it teamed regulators with the organizations they were supposed to be policing.

The book then shifts to the role of James Johnson who took over Fannie Mae and began relaxing loan underwriting standards. In addition the executive pay structure changed. “Compensation became tied almost solely to earnings growth.”

[CBO study revealed that] the companies passed on to borrowers only about two thirds of the billions in benefits they received. Fannie and Freddie kept $2.1 billion for themselves and their shareholders. … [It became clear] how Fannie Mae could pay its executives as much as they did. Equally evident: Holding on to so much of its subsidy let Fannie Mae fund its elaborate self-preservation scheme, make its massive charitable contributions, pay for it extensive ‘political outreach,’ and hire academics to write favorable studies about its role in the mortgage market.

Federal investigators later found that you could predict what Fannie’s earnings-per-share would be at year-end, almost to the penny, if you knew the maximum earnings-per-share bonus payout target set by management at the beginning of the year.

Towards the end of the book Morgenson comments on the attempt to “fix” the earliest abuses by passing the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. “The irony of having two of the nation’s most strident defenders of Fannie Mae sponsoring the new reform act was lost on few of those who knew the sordid Fannie story.”

While Reckless Endangerment nicely reports on the shenanigans of those in government, the GSEs and on Wall Street it suffers from a lack of a clear understanding of free market economics. Nor does it address the philosophical premises that support the efforts to expand home ownership. For a nice analysis with a philosophical explanation check out Altruism: The Moral Root of the Financial Crisis by Richard M. Salsman. I would add that those who pushed for home ownership did indeed justify it by pointing out that people who normally couldn’t afford homes now could but a number of those advocates obviously had purely self-promoting reasons for doing so such as the Fannie Mae execs who reaped huge bonuses for their “selfless” work. So you end up with deadly recipe for disaster: altruistic justification for bad policies, profit taking by those who administered the GSEs, politicians who made political hay with their support, financiers who sold derivatives that rested on an inherently faulty foundation, regulators and financial rating agencies who turned a blind eye and finally (as covered in the book) academics who cooked their numbers in their analyses to hide the flaws.

I’d like to say we (speaking collectively) learned a lesson from all of this but based on the passage of the Dodd-Frank bill plus other more recent developments I’m afraid we’re no better off than we were before the 2008 crash. In other words Reckless Endangerment continues.

“Altruism: The Moral Root of the Financial Crisis” by Richard M. Salsman

This article presents a different explanation for the current financial mess. Salsman rejects the commonly offered explanation that the inherent flaws of the free market caused the recession. His economic explanation is not unique. Others, like Thomas Sowell, have shown that government policies, not fatal flaws in capitalism, thrust us into the present mess. Salsman takes a critical step not evident in other free market based explanations. He identifies the ethical ideas behind certain policies: these ideas, accepted by Republicans and Democrats, pushed an altruist agenda in order to help folks without the necessary financial means buy houses. This was a recipe for disaster.

Those who claim greed caused are partially (and only partially) right. While Salsman explains how banks were "encouraged" by the certain politicians to lower lending standards I'm sure it's also true that some institutions and individuals were motivated by greed to play along and even profit from these lowered standards. This would include those who managed Freddie Mac and Freddie Mae as well as their political buddies who protected them. Greed by itself doesn't explain why the housing market imploded. Otherwise it would happen all the time and not just in the housing market. (Do we see this happening, say, in the cell phone market? Or with PC's? Or food?) You need something to prevent the market from correcting itself. In this case one of the factors was the unhealthy alliance between those who ran Freddie Mac and Freddie Mae and those who "regulated" them and the banking industries. Greed certainly was a factor but not the sole or even the main one.

“Altruism: The Moral Root of the Financial Crisis” by Richard M. Salsman

This article presents a different explanation for the current financial mess. Salsman rejects the commonly offered explanation that the inherent flaws of the free market caused the recession. His economic explanation is not unique. Others, like Thomas Sowell, have shown that government policies, not fatal flaws in capitalism, thrust us into the present mess. Salsman takes a critical step not evident in other free market based explanations. He identifies the ethical ideas behind certain policies: these ideas, accepted by Republicans and Democrats, pushed an altruist agenda in order to help folks without the necessary financial means buy houses. This was a recipe for disaster.

Those who claim greed caused are partially (and only partially) right. While Salsman explains how banks were "encouraged" by the certain politicians to lower lending standards I'm sure it's also true that some institutions and individuals were motivated by greed to play along and even profit from these lowered standards. This would include those who managed Freddie Mac and Freddie Mae as well as their political buddies who protected them. Greed by itself doesn't explain why the housing market imploded. Otherwise it would happen all the time and not just in the housing market. (Do we see this happening, say, in the cell phone market? Or with PC's? Or food?) You need something to prevent the market from correcting itself. In this case one of the factors was the unhealthy alliance between those who ran Freddie Mac and Freddie Mae and those who "regulated" them and the banking industries. Greed certainly was a factor but not the sole or even the main one.

“Altruism: The Moral Root of the Financial Crisis” by Richard M. Salsman

Stimulus Package: Saving us from … our saviors?

Historic' Stimulus Is Egregious Waste
Taxing The Truth

These two editorials from Investor’s Business Daily touch on the errors of the stimulus package. In earlier blog posts I’ve discussed how government policies that encouraged banks to loosen their lending policies and the role of Freddie Mac and Fannie Mae have helped set the stage for the current crisis. Seeing all of the drama and demagoguery surrounding the stimulus package brings to mind an analogy: our current situation is similar to a doctor injecting poison into the victim’s blood, causing a person to almost die, then the same doctor heroically tries to “stimulate” the victim’s heart back to life. We’re supposed to gratefully grovel to the same person who induced the illness in the first place! It would be funny if it wasn’t going to cost us nearly a trillion dollars.

Did Deregulation Get Us Into This Mess?

I've said in earlier posts before the Presidential election that Obama and his fellow Democrats repeated the mantra that our economic crisis resulted from the deregulatory policies of the Bush administration. In saying this the Democrats were trying to convince people that a return to regulation was needed to "fix" things. Jeff Jacoby, columnist for the Boston Globe, paints a different picture in his "The great Bush ‘deregulation’ myth" that apeared in the Jewish World Review. (Thanks to Stephen Hicks for this link. See the December 19 entry.)

Making Sense of the Current Crisis

Greg Ransom has a nice compendium of articles at PrestoPundit that explain the current financial crisis primarily from the Austrian economics point of view. (This is the school of thought that includes Ludwig von Mises and Friedrich Hayek.)

He also has a long post on "Who Is Barack Obama" that I also recommend.

The cause of our problems: the perils of a liberal Republican administration – Addendum

In my earlier post I provided the rankings the Fraser Institute gave to the U.S. and other countries using a number of different criteria. As I dug deeper into their report several more interesting facts come out that shed light on the claims that our financial problems are caused by 8 years of unfettered capitalism.

Consider this. The U.S. ranks as follows in these categories. The country in parenthesis ranked first in that category.

Credit market regulations: 23 (New Zealand)
Business regulations: 25 (Iceland)
Size of government: 42 (Hong Kong)
Legal system and property rights: 21 (Finland)

Not one of the U.S. rating falls in the top ten. Doesn’t exactly paint the picture of rampant capitalism, does it?

The cause of our problems: the perils of a liberal Republican administration

While researching recent posts on the financial crisis I found a publication by the Fraser Institute, a Canadian based organization “measures and studies the impact of markets and government interventions on the welfare of individuals. In our research, we bring together academics, economists, and policy analysts from around the world. The Institute's list of researchers has grown to include more than 350 authors in 22 countries (six of whom have been awarded Nobel Prizes), comprising more than 600 Institute publications and thousands of articles.” The publication, titled “Economic Freedom of the World: 2006 Annual Report,” contains some interesting tidbits that undercuts the accusations that “unfettered capitalism” caused our recent financial woes.

The report analyzes economic freedom in 42 different measures falling into four broad categories:

1. personal choice
2. voluntary exchange coordinated by markets
3. freedom to enter and compete in markets
4. protection of persons and their property from aggression by others.

Results? The U.S. ranks 8^th out of 141 countries. The countries ahead of us (starting with #1): Hong Kong, Singapore, New Zealand, Switzerland, the United Kingdom, Chile, Canada and Australia.

I find it interesting the Switzerland is the only European country ahead of us even though it is clear that Obama’s and the Left’s agenda is to turn the U.S. into another European socialist/welfare state. We can see how well that’s working!

The report reaches several conclusions. The following list is quoted verbatim.

1. Countries with more economic freedom have substantially higher per-capita incomes.
2. Countries with more economic freedom have higher growth rates.
3. Countries with more economic freedom attract more foreign investment.
4. Total investment is slightly higher in countries with more economic freedom.
5. Private investment spending is much higher in countries with more economic freedom.
6. The share of income by the poorest 10% of the population is unrelated to the degree of economic freedom in a nation.
7. The amount of per capita, as opposed to the share, of income going to the poorest 10% of the population is much greater in nations with the most economic freedom than it is in those with the least. [HCS note: the average annual income in the least free quartile is a measly $961 as compared to $8,730 in the most free quartile.]

You might say, so what? Maybe economic freedom isn’t all that it’s cracked up to be, that there are other things more important than making money. Fair enough. Let’s take a look at the rest of the conclusions the report draws from their data.

8. Life expectancy is over 20 years longer in countries with the most economic freedom than it is in those with the least.
9. With fewer regulations, taxes, and tariffs, economic freedom reduces the opportunities for corruption on the part of public officials.
10. Political rights (e.g., free and fair elections) and civil liberties (e.g., freedom of speech) go hand in hand with economic freedom.
11. Environmental stresses on human health are lower and ecosystem vitality is greater in countries with more economic freedom.

However, a closer look at the data in this report also refutes the claims that the 8 years of Republican deregulation lead us to our current financial predicament. The Fraser Report provides the previous freedom rankings all the way back to 1970. Here are the rankings broken down by President.

Reagan (1981 – 1989): rank increased from 4th to 3^rd, economic freedom score increased from 7.5 to 8.3 (with 10 being the maximum score).

Clinton (1993 – 2001): rank stayed at 3^rd, score dropped from 8.3 to 8.2 but peaked at 8.6 in 2000.

Bush (2001 – 2009): rank dropped from 3^rd to 8^th (!), score continued to drop to 8.0 in 2006, the last date available.

Conclusions: economic freedom increased 0.6 points during the Reagan years and peaked during the Clinton administration but started to drop before the end of his term. More importantly, our ranking and score dropped 0.6 points and our ranking slipped 5 spots during the Bush years. To be fair the comparative ranking could indicate that other countries overtook us. However, the decline in our overall freedom score shows that we’re back to where we were in 1990, the end of Bush Senior’s term. How about that for irony!

What Caused the Loan Crisis

The following condensation of a series from the Investor's Business Daily explaining "What Caused the Loan Crisis" has been circulated via e-mail. (Hat tip to Frank for sending this to me.)

1977: Pres. Jimmy Carter signs into Law the Community Reinvestment Act the foundation and cornerstone for the impending disaster.. The law pressured financial institutions to extend home loans to those who would otherwise not qualify.

The publicized premise: Home ownership would improve poor and crime-ridden communities and neighborhoods in terms of crime, investment, jobs, etc.

The Results: Statistics bear out that it did not help.

How did the government get so deeply involved in the housing market?

Answer: Bill Clinton wanted it that way.

1992: Republican representative Jim Leach (IO) warned of the danger that Fannie and Freddie were changing from being agencies of the public at large to money machines for the principals and the stock-holding few.

1993: Clinton extensively rewrote Fannie Mae and Freddie Mac's rules turning the quasi-private mortgage-funding firms into semi-nationalized monopolies dispensing cash and loans to large Democratic voting blocks and handing favors, jobs and contributions to political allies. This potent mix led inevitably to corruption and now the collapse of Freddie and Fannie.

1994: Despite warnings, Clinton unveiled his National Home-Ownership Strategy, which broadened the CRA in ways congress never intended.

1995: Congress, about to change from a Democrat majority to Republican. Clinton orders Robert Rubin's Treasury Dept to rewrite the rules. Robt. Rubin's Treasury reworked rules, forcing banks to satisfy quotas for sub-prime and minority loans to get a satisfactory CRA rating. The rating was key to expansion or mergers for banks. Loans began to be made on the basis of race and little else.

1997 - 1999: Clinton, bypassing Republicans in Congress, enlisted Andrew Cuomo, then Secretary of Housing and Urban Dev elopement, allowing Freddie and Fannie to get into the sub-prime market in a BIG way. Led by Rep. Barney Frank and Sen. Chris Dodd, congress doubled down on the risk by easing capital limits and allowing them to hold just 2.5% of capital to back their investments vs. 10% for banks. Since they could borrow at lower rates than banks their enterprises boomed.

With incentives in place, banks poured billions in loans into poor communities, often "no doc", "no income", requiring no money down and no verification of income. Worse still was the cronyism: Fannie and Freddie became home to out-of work-politicians, mostly Clinton Democrats. 384 politicians got big campaign donations from Fannie and Freddie. Over $200 million had been spent on lobbying and political activities. During the 1990's Fannie and Freddie enjoyed a subsidy of as much as $182 Billion, most of it going to principals and shareholders, not poor borrowers as claimed.

Did it work? Minorities made up 49% of the 12.5 million new homeowners but many of those loans have gone bad and the minority homeownership rates are shrinking fast.

1999: New Treasury Secretary, Lawrence Summers, became alarmed at Fannie and Freddie's excesses. Congress held hearings the ensuing year but nothing was done because Fannie and Freddie had donated millions to key congressmen and radical groups, ensuring no meaningful changes would take place. "We manage our political risk with the same intensity that we manage our credit and interest rate risks," Fannie CEO Franklin Raines, a former Clinton official and current Barack Obama advisor, bragged to investors in 1999.

2000: Secretary Summers sent Undersecretary Gary Gensler to Congress seeking an end to the "special status". Democrats raised a ruckus as did Fannie and Freddie, headed by politically connected CEO's who knew how to reward and punish. "We think that the statements evidence a contempt for the nation's housing and mortgage markets" Freddie spokesperson Sharon McHale said. It was the last chance during the Clinton era for reform.

2001: Republicans try repeatedly to bring fiscal sanity to Fannie and Freddie but Democrats blocked any attempt at reform; especially Rep. Barney Frank and Sen.Chris Dodd who now run key banking committees and were huge beneficiaries of campaign contributions from the mortgage giants.

2003: Bush proposes what the NY Times called "the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago". Even after discovering a scheme by Fannie and Freddie to overstate earnings by $10.6 billion to boost their bonuses, the Democrats killed reform.

2005: Then Fed chairman Alan Greenspan warns Congress: "We are placing the total financial system at substantial risk". Sen. McCain, with two others, sponsored a Fannie/Freddie reform bill and said, "If congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system and the economy as a whole". Sen. Harry Reid accused the GOP ;of trying to "cripple the ability of Fannie and Freddie to carry out their mission of expanding homeownership" The bill went nowhere.

2007: By now Fannie and Freddie own or guarantee over HALF of the $12 trillion US mortgage market. The mortgage giants, whose executive suites were top-heavy with former Democratic officials, had been working with Wall St. to repackage the bad loans and sell them to investors. As the housing market fell in '07, sub prime mortgage portfolios suffered major losses. The crisis was on, though it was 15 years in the making.

2008: McCain has repeatedly called for reforming the behemoths, Bush urged reform 17 times. Still the media have repeated Democrats' talking points about this being a "Republican" disaster. A few Republicans are complicit but Fannie and Freddie were created by Democrats, regulated by Democrats, largely run by Democrats and protected by Democrats. That's why taxpayers are now being asked for $700 billion!!

Postscript: ACORN is one of the principal beneficiaries of Fannie/ Freddie's slush funds. They are currently under indictment or investigation in many states. Barack Obama served as their legal counsel, defending their activities for several years.

Federal Reserve and the financial crisis: "Coin in the fuse box"

Much of the commentary from the free market economists has centered on the role of Fannie Mae, Freddie Mac and the Community Reinvestment Act have in creating the housing bubble which lead to our current financial woes. The Federal Reserve hasn't been mentioned as much. The Prudent Bear has a good article explaining how the Fed "helped" by artificially lowering interest rates. (Hat tip to Greg Nyquist.) Ironically the term "coin in the fuse box" comes from an article Alan Greenspan wrote before he was Fed chairman.

The Fannie Mae Implosion: A bolt out of the blue? Don’t think so!

Robert Bidinotto has posted a link to a damning video showing Congressmen including Barney Frank chastising Armando Falcon, director of the Office of Federal Housing Oversight, who blew the whistle on Fannie Mae in 2004. If you’re interested here are links to the web site and to the most recent (2006) report. The report runs 348 pages but reading the 13 page executive summary gives the lowlights of this appalling story. I have provided some quotes below.

What is even more sickening is the fact that the same web page lists reports going back to 2003. All of them share the same theme: Fannie Mae violated standard accounting rules and engaged in dubious (to put it mildly) practices to accomplish the goals of senior management.

When Franklin Raines became Chairman and Chief Executive Officer (CEO) of Fannie Mae in 1999, he sought to lead the Enterprise into a new era of growth in business volumes and profits by challenging senior management and employees to double EPS in five years. Mr. Raines also made changes in Fannie Mae’s compensation programs that enhanced incentives to achieve that goal.

A combination of factors led Fannie Mae senior management, through their actions and inactions, to commit or tolerate a wide variety of unsafe and unsound practices and conditions. Those factors included the Enterprise’s enormous financial resources and political influence, the expectation that senior management could write the rules that applied to Fannie Mae, financial rewards tied to a measure of profits that management could easily manipulate, and the relative disinterest of senior executives in adhering to standards of prudent business operations.

Fannie Mae’s Board of Directors contributed to those problems by failing to be sufficiently informed and to act independently of its chairman, Franklin Raines, and senior management, and by failing to exercise the requisite oversight over the Enterprise’s operations.

That misconduct ultimately led to the Securities and Exchange Commission (SEC) directing Fannie Mae to restate its financial results for 2002 through mid-2004, the departure of Mr. Raines and the Enterprise’s Chief Financial Officer (CFO), Timothy Howard, losses of tens of billions of dollars in market capitalization for Fannie Mae shareholders, and expenses for the restatement process, regulatory examinations, investigations, and litigation that the Enterprise has recently estimated will exceed $1.3 billion in 2005 and 2006 alone.

Improper earnings management at Fannie Mae increased the annual bonuses and other compensation linked to EPS that senior management received. Compensation for senior executives that was driven by or linked to EPS dwarfed basic salary and benefits. For CEO Franklin Raines, for example, two compensation components directly tied to meeting EPS goals accounted for more than $20 million for the six years from 1998 through 2003. Three-year EPS goals also played a crucial role in determining the size of the approximately $32 million awarded to Mr. Raines during that six-year period under a long-term executive compensation program. In total, over $52 million of Mr. Raines’ compensation of $90 million during the period was directly tied to achieving EPS targets.

The image of Fannie Mae communicated by Mr. Raines and his inner circle and promoted by the Enterprise’s corporate culture was false. In the words of one current member of Fannie Mae’s Board of Directors, the picture of the Enterprise as a “best-in-class” financial institution was a “façade.” To maintain that façade, senior executives worked strenuously to hide Fannie Mae’s operational deficiencies and significant risk exposures from outside observers—the Board of Directors, its external auditor, OFHEO, the Congress, and the public. The illusory nature of the Enterprise’s public image and senior management’s efforts at concealment were the two essential features of the Enterprise’s corporate culture. Those features, which were both supported by repeated improper manipulation of earnings, are a major theme of the report.

The Bailout: An Alternate View

Before I start here are two links to helpful explanations of the economic "crisis." Both come from the Ludwig von Mises Institute. The first, titled The Bailout Reader, lists various articles on their web site. The second, titled The Housing Bubble in 4 Easy Steps, explains how the Fed's manipulations of the interest rate contributed to the housing market bubble. See more below but first I'd like to make a comment on what passes for explanations in the media and among many politicians.

When a systemic problem surfaces like this we need to look at something that leads people to act in a certain way. The popular "explanation" is to lay the blame at the greed of Wall Street and bankers. Question: why didn't bankers greedily loan money to poor folks before the passing of the Community Reinvestment Act during the Carter era and the strengthened enforcement imposed by the Clinton administration? If bankers didn't act this way previously we need to look at a deeper, more plausible reason than greed. Answer: because the change in laws and its enforcement dictated these poor loan choices. Before these laws went into effect the bank's underwriters knew that the rate of default on the loans would make this practice unprofitable. In fact, the people who pushed for these laws did so because the argued banks were "redlining" [not loaning to certain groups of people] and therefore needed to be encouraged [i.e., forced] to do so.

Returning back to the Ludwig von Mises Institute to which I refer at the beginning. I was lucky enough to go to Grove City College for my degree in chemical engineering. Why? At the time I was not aware of Grove City's strong free market economics department, headed by Hans Sennholz, an advocate of the Austrian school of economics. This school, which includes Friedrich Hayek (author of The Road to Serfdom) and Ludwig von Mises, proposed a theory of money, banking and business cycles at odds with the Keynesian model. I happened to become friends with several older students (including Robert Bidinotto) who were taking economics. Out of curiosity I started to monitor Sennholz's classes. What he said made sense so I sat in as many of his classes (with Sennholz's permission) as I could. Sennholz even offered to award me a minor in economics if I paid the school for the credits (which unfortunately I couldn't afford).

I'm probably doing it an injustice in trying to summarise the Austrian approach but in essence they argue that government attempts to foster economic growth by controlling and manipulating the money supply and interest rates ultimately create boom-and-bust cycles that are much more extreme than would occur in an economy where interest rates responded to market signals. Having centrally controlled interest rates leads to mis-investment as businesses plan their future and expansion plans on false information. The analogy which I've drawn in an earlier post is similar to government setting price controls. The inevitable result of government price controls leads to shortages or overstock because no bureaucrat, no matter how brilliant, can predict better than the pricing system of a free market.

The Austrian economists also argue against other attempts by the government to "steer" the economy via legislation. Their arguments are based on economics while others argue that it is immoral for politicians to redistribute wealth by using the full enforcement power of government to ensure we abide by its edicts.

The current financial situation perfectly illustrates both follies of artificially depressing interest rates while forcing banks to make loans to people who normally wouldn't qualify. These policies have resulted in the exact opposite outcomes as the stated intentions of its advocates. Instead of boosting low-income neighbors it will cause them to deteriorate (while leading to frantic calls for even more government "solutions" to fix the problems caused by previous government policies). In a way their egalitarian goals are accomplished but by an opposite mechanism. Instead of helping improve the economic welfare of their intended beneficiaries, the actions of egalitarian motivated politicians makes life more difficult for the middle class, thus pushing them down.

Anyway, I hope you check out the two links at the beginning of this post. Their explanations of what happened makes much more sense than the conventional explanations.

10 Minute Explanation of the Subprime Mess

If you have 10 minutes to spare check out this clip that explains how the subprime mess happened. (Thanks to Robert Bidinotto who posted this clip on his blog.)

Fannie Mae/Freddie Mac Mess: A good explanation

Here is a link to a Fox News bit that does a nice job of explaining what happened with Freddie Mac and Fannie Mae.

Chickens coming home to roost on the house of cards

As the financial markets roil with the latest developments Democrats like Nancy Pelosi, Barney Frank and even Barack Obama are distancing themselves from the legacy of policies they have endorsed or proposed. They try to blame this mess on Bush’s last 8 years where in fact the roots of this dilemma go back to Clinton and earlier. As this article in Investor’s Business Daily says the main motive of the policies leading up to this was to provide people without good credit ratings to buy homes. So lenders were strong armed into lending to risks they normally wouldn’t have to avoid the wrath of the regulators.

The regulation grew to monstrous proportions during the Clinton administration, obsessed as it was with multiculturalism. Amendments to the CRA [Community Reinvestment Act] in the mid-1990s dramatically raised the amount of home loans to otherwise unqualified low-income borrowers.

The revisions also allowed for the first time the securitization of CRA-regulated loans containing subprime mortgages. The changes came as radical "housing rights" groups led by ACORN lobbied for such loans. ACORN at the time was represented by a young public-interest lawyer in Chicago by the name of Barack Obama.

HUD, in turn, pressured Fannie Mae and Freddie Mac to purchase more subprime mortgages, and Fannie and Freddie, in turn, donated to the campaigns of leading Democrats like Barney Frank and Pelosi who throttled investigations into fraud at the agencies.

The problem is that all of us will pay for the sins of these policies while the true perpetrators pontificate about the greed of Wall Street and the “failure” of the market. Most people don’t understand economics (like many politicians) so it’s appallingly easy to throw “bad guys” (i.e., Wall Street) as chum into the water. Meanwhile the true lesson will be lost in this feeding frenzy: when the government tries to force the market to behave in a certain way to achieve egalitarian goals this goal to make everyone equal indeed does becomes reality but not in the way that was intended. We’re all made equal – in terms of financial losses and the pain that goes with it. Instead of a rising tide of prosperity lifting all of our boats we’re drowning in the rising tide of tears and pain, the inevitable consequences of bad premises.

Freddie Mac and Fannie Mae: The New Deal Legacy Comes Home to Roost

With the Fed pondering what to do to stave off the collapse of Freddie Mac and Fannie Mae it’s only a matter of time before the pundits start intoning about yet another alleged failure of the market. The Von Mises Foundation has posted several good articles explaining the history of these institutions and their impact on the financial markets.

Freddie, Fannie, and Curses on FDR

Ludwig von Mises had a theory about interventionism:

It doesn't accomplish its stated ends. Instead it distorts the market. That distortion cries out for a fix. The fix can consist in pulling back and freeing the market or taking further steps toward intervention. The State nearly always chooses the latter course, unless forced to do otherwise. The result is more distortion, leading eventually, by small steps, toward ever more nationalization and its attendant stagnation and bankruptcy.

Government intervention is like a vial of mutating poison in the water supply. We can get by for a long time and no one seems really worse off. One day we wake up and everyone is desperately ill, and blaming not the poison but the water itself. So it is with the housing crisis. Lenders are being blamed for the entire fiasco, and capitalism is going to be subjected to a beating as usual, since Freddie and Fannie are traded in public markets. But the fact remains that there is only one reason that this went on as long as it did and became as bad as it is. It was that vial of government poison.

Freddie Mac: A Mercantilist Enterprise

While these institutions have been privatized to a degree, they still remain tied to the federal government in some important respects. In fact, Fannie Mae and Freddie Mac have access to a guaranteed line of credit of $2.25 billion with the U.S. treasury. This guarantee, coupled by the perception that federal money would be used beyond the extent of the credit limit, allows both companies to maintain lower borrowing costs than would otherwise be the case. In many cases, the companies are able to sell bonds yielding only a few dozen basis points above U.S. treasury benchmarks. If the government's guarantee disappeared, the borrowing spreads for both companies would widen. Beyond the government's line of credit, these companies are also exempt from state and local income taxation and are exempt from SEC filings. Moreover, their securities are listed as government securities and can be held by banks and thrifts as low-risk bonds. These benefits provide a significant advantage since such privileges are not offered to other financial institutions.

Fannie Mae: Another New Deal Monstrosity

Fannie Mae is not a free-market entity, nor is it a private body that must compete on the same playing field as its competitors. Fannie Mae is representative of all that's wrong with central planning institutions: it is a government-created conduit for carefully crafted financial and market socialism that the bureaucrats uphold for the purpose of propping up their fantasies for pandemic social engineering.

There's nothing "American" about this dream. In the eyes of the Republic's visionaries, this particular dream has turned into a nightmare.