Liberal "Capitalist Cronyism" and Housing Affirmative Action = SUBPRIME MELTDOWN

So now I shall continue from where I left off in my last blog. At about seven this morning, I followed my usual routine of walking into the gym with protein shake in one hand and today's copy of Investor's Business Daily in the other. The front page article in today's IBD, as well as a subsequent editorial, trace the steps, in very logical and sequential order, that ultimately led to the subprime mortgage lending meltdown that caused the current financial disaster in which our nation now finds itself.

Since the current situation on Wall Street can indeed be labeled a DISASTER (worthy in the eyes of our own treasury department of a $700 billion bailout), I'm reminded of the words announced during the opening credits of every episode of "Seconds From Disaster" on the National Geograhic channel:

"Disasters don't just happen . . . they're a chain of critical events. Unravel the clues, and count down those final . . . Seconds To Disaster."


The first "clue" to what caused the financial disaster in which we now find ourselves is found on the Fannie Mae website itself in the company's introduction booklet:

"At Fannie Mae, we exist to serve America's housing market. We procide a critical source of liquidity, stability (not anymore lol), and affordability to America's housing system . . . We provide our lenders the support and resources they need to run their business and make mortgage loans. We raise capital from Wall Street and from investors in the U.S. around th globe by selling our debt securities (uh-oh) and use the proceeds to buy mortgages and to finance housing in the United States. We also help lenders package the home loans they make into mortgage-backed securities, making the loans easier fr lenders to sell (s t starting to make sense). These activities expand and replenish the flow of mortgage capital across the nation, making mortgages more affordable and more available."

*Let's stop right here for a minute. All of this is a great idea and wlll work the way it is supposed to, ASSUMING THE MORTGAGES DON'T DEFAULT! Once the defaults start, take cover!!!


Now, onto Fannie's history:

"Fannie Mae was created in 1938 at the request of President Franklin Roosevelt. At the time, millions of Americans could not become homeowners, or risked losing their homes, for lack of a consiten supply of mortgage fnds throghout the United States. At first, Fannie Mae, as a government agency, was authorized to only buy Federal Housing Administration (FHA)- insured mortgages, thereby replenishing the supply of lendable money for these government-backed loans.
In 1968 (and here's where the problem REALLY starts), Fannie Mae became a privately-owned company operatng with private capital on a self-sustaining basis. Its role was expanded to buy mortgages beyond FHA-insured mortgages, thereby reaching out to a broader cross section of Americans."

*Despite the fact that Fannie became "privately-owned" in 1968, in order raise private capital from investors to enable it to operate, shares of the company had to be offered and traded on Wall Street. And what do investors always want? PROFIT! The more Fannie backed mortgages, the more profit for the company, the higher return to shareholders. Again, the engine of this machine will continue running smoothly AS LONG AS THE MORTGAGES DON'T DEFAULT.


Now here's where things REALLY start to fall into place for a turn for the worst:

"In 1992, major legisation was enacted to modernize (nice way of putting it) to modernize the regulatory framework applicable to the corporation. Regulatory responsibility was given to a newly created Office of Federal Housing Enterprise Oversight (OFHEO) within the office of Housing and Urban Development (HUD). The new law included modernized capital standards and new affordable housing goals for Fannie Mae."

Unfortunately, in order to meet those "goals," Fannie eventually had to start backing mortgages to people who normally wouldn't even come CLOSE to qualifying. How was this accomplished? You got it- Subprime Lending!

Fannie Mae leaves out another very significant event in its history. In 1977, President Jimmy Carter, in one of his many brilliant economic moves, signed into law the Community Reinvestment Act (CRA), placing increaed pressure on Fannie and Freddie to lend to minority groups who, at the time, represented a disproportionately low percentage of American homeowners. This legislation, in its own words proclaimed that:

"Regulated financial institutions have continuing and affirmative obligation to help meet the credit needs of the local communities in which they are chartered" and allowed greater regulatory oversight "to encourage (in other words require) such institutions to help meet the credit needs of local communities in which they are chartered consistent with the safe and sound operation of such instiutions."

Banks with a low CRA ranking risked denial of applicaions to lend in new markets, open new deposit facilities, and merge with sister financial institutions, by the federal regulators such as the Federal Reserve Board. As you can imagine, the banking industry absolutely balked at this legislation from the moment it was introduced, fearing that this further tightrning of the regulatory "noose" would end up forcing financal institutions to do things that might threatenen their very livelhood and existence. Despite these protests, the act passed nonetheless, most likely with the expectation that it would remedy the "injustice" of the times. After all, wasn't the banks' protection ensured by the "safe and sound operation" provision found in the act? Perhaps in theory,

However, the IBD article states that in practice, this was hardly the case, starting from when the law was first implemented:

"The CRA forced banks and instiutions- then, far more heavily regulated than they are today- to make loans to poor, often uncreditworthy minority borrowers . . . Regulators didn't need to do much policing; they let that job fall to radical community groups . . . The commuity groups booked thousands of dollars in fees for every loan. And loans often required recipents to become active in radical causes- what's today called community organizing." Hmmmmm . . . sound familiar?

IBD proceeds to explain that during Bill Clinton's presidency, Fannie and Freddie began "buying up bad loans from banks, and securtizing them for sale on world markets. The seeds of the subprime meltdown were planted."

Furthermore, the CRA's "safe and sound" provision was further thrown own the window during the Clinton years. In the name of President Clinton's utopian and politically correct housing policies, he strengthened the CRA, and Fannie and Freddie gained even more leverage, effectively becoming "a government-run, privately owned home finance monopoly."

Of course, no good deed ever goes unrewarded. Fannie and Freddie demonstated their gratitude by providing generous campaign donations to Democrats in Congress who would protect them from much needed reforms that, if implemented, could have at least minimized the fallout we are now witnessing. Earlier this week, a bloomberg economist wrote, "We now know that many of the senators wo protected Fannie and Freddie, including BARRACK OBAMA, Hillary Clinton, and Christopher Dodd, received mind-boggling levels of financial support from them over the years." This sounds to me like a modern day "Keating Five" scandal.

(As I mentioned in my prior post, Obama was second only to Senator Dodd, who heads the Senate Banking panel, in the amount of campaign contributions received from the two mortgage behemoths).

Tucked into the back pages of today's IBD was an editoral by Fred L. Smith, Jr., president of Competitive Enterprise Institute. He experienced first-hand the sheer futility of attempting to take on this "capitalist cronyism" when he testified in 2000 before the House Financial Services Committee. Smith recalls warning the committee that "Fannie Mae and Freddie Mac's special privileges create a serious hazard to the market, to taxpayers, and to the economy . . . the rapid growth of their debt portfolios and the new risks Fanie and Freddie are taking on . . . will certainly increase the likelihood of a Fannie-Freddie default."

However, Smith's warnings fell on deaf ears, and were even ridiculed by some. One committee member, Pennsylvania Democrat Paul Kanjorski, dismissed his arguments as "almost fallacious." Another, New York Democrat Carolyn Maloney, didn't seem to grasp the seriousness of the situation because Fannie and Freddie, at that time had not yet needed to tap into their $2 billion credit line from the Treasury Department. As it stands now however, the department is now proposing to cough up over 300 times that amount (thus far) in an emergency "bailout." The situation has become so dire that I doubt Mr. Smith is in any mood to celebrate and jeer "told you so, told you so."

The precise problem with "crony capitalism" is that it is really not capitalism at all. In a genuine capitalist, free-market economy, the government allows the market to operate without excessive regulatory interference, and the natural rules of the market to dictate how things are done. In such an economy, people are taken seriously when they assert, as Mr. Smith attempted to, that tight government controls are suffocating the market's attempts to operate naturally. I guarantee you that were th houing market been allowed to operate in such a manner, there is no way on earth that $500,000 mortgages would have been reflexively doled out to families earning less than $50,000 per year.

A 1999 article in the New York Times reveals for us the root causes of the Fannie-Freddie fiasco (and thank you, Jared, for unearthing this article) :

"Fannie Mae, th nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton administration to expand mortgage loans among low and moderate income people and felt pressure from stockholders to maintain its phenomenal growth in profits."

I just wonder how all of those stockholders feel now after losing all the money they invested in the artificially inflated "mortgage boom" when it finally went bust.

In the same New York Times article, then-Fannie CEO Franklin Raines proudly proclaimed, "Fannie Mae has expanded home ownership for millions of families in the 1990's." When Raines left his post in 2005, he reportedly had taken in nearly $100 million for himself. I wonder how the stockholders feel about that.

And whatever happened to Mr. Raines himself, you ask? He's currently an advisor to the presidential campaign of- you guessed it- Barack Obama.