In my essay, The Banking and Financial Crisis, I blamed the officials in the financial institutions and both political parties. If the impression I gave was that Democrats and Republicans should be equally blamed, then consider the following facts in contemplating who is more culpable:
In 2001, Bush’s chief economist, N. Gregory Mankiw, warned that the government’s “implicit subsidy” of Freddie Mac and Fannie Mae, combined with loans to unqualified borrowers, was creating a huge risk for the entire financial system. Barney Frank (D-MA) denounced Mankiw, saying he had no “concern about housing.” The New York Times reported that Fannie Mae and Freddie Mac were “under heavy assault by the Republicans,” but these entities still had “important political allies in the Democrats.”
April 2001 – The 2002 budget request by the Bush Administration said that the size of Freddie Mac (FHLMC) and Fannie Mae (FNMA) was a “potential problem.” “Financial trouble in either could cause strong repercussions in financial markets.”
2003 – The Bush administration upgraded its warning to: “Systemic risk could spread beyond the housing sector.”
Sept. 2003 – The Bush administration pushed Congress hard to create a new federal agency to regulate and supervise FHLMC & FNMA. Barney Frank pushed back saying, “Freddie Mac and Fannie Mae are not in a crisis. The federal government should be doing more to get more low-income families in houses. Too many people have a sky is falling mentality which I do not see.” The legislation was blocked.
Feb. 2005 – Federal Reserve chief Allen Greenspan testified before Congress after officials at FHLMC & FNMA admitted there were accounting screw-ups: “Enabling these institutions to increase in size – and they will once this crisis, in their judgment, [has] passed, [is] placing the total financial system of the future at a substantial risk.”
April 2005 – Allen Greenspan: “If we fail to strengthen GSE [Government Sponsors of Enterprises] regulation we increase the possibility of insolvency and crisis.”
April 2005 – Senator Charles Schumer (D-NY): “I think Freddie Mac and Fannie Mae over the years have done an incredible job and are an intrinsic part of making America the best housed people in the world. If you look over the last 20 or whatever years, they have done a very, very good job.”
John McCain (R-AZ) in 2006 co-sponsored a bill in the Senate: “For years I have been concerned about the regulatory structure that governs Freddie Mac and Fannie Mae …. and the sheer magnitude of these companies and the role they play in the housing market. They need to be reformed without delay.” All of the Democrats voted against this bill in committee so the Republicans, fearing they could not get it passed, did not submit it to the full senate. Obama did not weigh in on it.
During the Clinton administration, the federal government put pressure on banks to grant more mortgages to the poor and minorities. Clinton’s Secretary of Housing and Urban Development, Andrew Cuomo, investigated Fannie Mae for racial discrimination and proposed that 50% of Fannie Mae and Freddie Mac’s portfolio be made up of loans to low-to-moderate-income borrowers by the year 2001. Threatening lawsuits, the Federal Reserve during the Clinton administration demanded that banks treat welfare payments and unemployment benefits as valid income sources to qualify for a mortgage.
There is also an accounting rule used now, which was not in force during the Savings and Loan scandal that would have worsened that financial crisis and which did not cause, but has exacerbated this one. The rule is this: financial institutions are forced to value the mortgages they hold at their current value rather than their long term value or even the amount of money these mortgages generate. Financial institutions typically loan 10 times as much money as the value of their capital. Therefore, if a financial institution such as a bank or a mortgage company is forced to write down say $10 billion worth of their capital due to the short term fall of their real estate holdings then their ability to give loans will be reduced by $100 billion. The Security and Exchange Commission (SEC) could change this requirement immediately.
Friday, September 26, 2008
Friday, September 19, 2008
THE BANKING AND FINANCIAL CRISIS 47
What caused the current banking and financial crisis? Who is principally to blame, what is the best way to correct it, and should there be more government intervention and regulation or less? These are complex questions where only the politically biased with their paralogistic reasoning have simple answers. Before I attempt to expound on this, a history review is in order.
Every time there is a financial crisis, to some it is a new day. In fact it is history repeating itself in a new guise. It is widely believed that when the Great Depression descended upon the country, as well as much of the world, President Hoover did nothing while President Franklin Delano Roosevelt, when he came into office, brought the country out of the depression with massive government intervention and myriad federal programs. A review of the data does not support this belief. Hoover used the federal government to try to correct the situation without success. He actually made the economic depression worst by, among other schemes, pushing for and signing the Smoot-Hawley Tariff Act, which more accurately could be called the Hoover-Smoot-Hawley Act. This Act greatly restricted imports to America to protect American producers. Of course other countries retaliated so world trade was reduced thereby further slowing economic activity.
What is the evidence that the federal programs of Roosevelt did not bring the country out of the depression? Consider: The United States unemployment rate was 16% in 1931 and 19% in 1938, after nine years of the New Deal – three under Hoover and six under Roosevelt. The unemployment rate in 1929 just prior to the stock market crash was 3.2%. There was an intensifying of the recession in 1937. The stock market went into a nosedive and by November 1937 unemployment had soared to 11 million with another 3 million working only part time. Statistics showed that the United States was lagging far behind other countries in recovering from the depression. American national income in 1937 was 86% of the 1929 high water mark while Great Britain’s was 124%. Japan’s employment figure was 75% above the 1929 number. Chile, Sweden, and Australia had economic growth rates in the range of 20% compared to the United States’ dismal -7%.
In the late 1980’s there was the Savings & Loan scandal. Then in 2000-2002 the high tech bubble burst causing the NASDAQ index to go from more than 5000 to around 1000. The early 2000’s was the era of the brigands of Enron, WorldCom, Global Crossing, Arkadelphia, et.al. Now is the time of the banking and financial institutions meltdown. Do you get the idea that these crises reoccur, but with different sectors of the economy? Does anyone want to bet this pattern will not happen in the future?
Who are the bad actors in this current climacteric of many of the banking and financial institutions? Let us start with the officials at Freddie Mac (FHLMC) and Fannie Mae (FNMA). Franklin Raines, currently an advisor to Barack Obama, was the CEO of FNMA from 1999 to 2004 when guaranteeing of mortgages and other real estate loans given without down payments and weak financial backgrounds to home buyers and investors was getting underway. Later it got even more irresponsible when paperwork was not required for many of these loan recipients. During his six year tenure at FNMA, Raines took home $90 million. Jim Johnson was CEO of FNMA before Raines and made $21 million in his shorter tenure. When he retired in 1998 he got a $600,000 per year consulting contract. This clown who also is an Obama advisor and headed Obama’s vice-presidential search committee worked at Lehman Brothers.
Another Scaramouch is the infamous Jamie Gorelick. Remember her? She was Deputy Attorney General under Janet Reno. In that position Gorelick was primarily responsible for maintaining and strengthening the wall of separation between the CIA and the FBI. To say the least it did not help to prevent, if it had been possible, 9/11. In 1978 Sen. Frank Church (D-ID) was the driving force behind the passage of the Foreign Surveillance Act which set up this wall between the CIA and FBI. As with all such actions, the intent was good, but the country paid for it later. At any rate, Gorelick was appointed to the bipartisan 9/11 Commission (set up in November 2002) by then senate Majority Leader Tom Daschle. Daschle and the Democrats wanted Gorelick on the commission so she could not be subpoenaed to testify before the commission on her role in handicapping the FBI and CIA. In the spirit of bipartisanship the Republicans stupidly went along with Daschle.
Gorelick was vice-chairman of FNMA from 1997 to 2003 and collected $26 million during that time. All of these people were appointed by President Bill Clinton. Before Republicans start to say “see it is all the fault of the Democrats” I would opine that the current crew at FHLMC & FNMA were appointed by Bush and did not seem to be any more aware or competent than their Democrat predecessors.
There are more scoundrels. Sen. Christopher J. Dodd (D-CT) is the chairman of the banking committee in the senate. What did he do to try to forestall this banking problem? Nothing that I can discern. Rep. Barnett (Barney) Frank (D-MA), who strangely or maybe not is unmarried, is chairman of the Financial Services Committee. What did he do? Again the answer is nothing – in fact in both cases it is less than nothing. Dodd received more political contributions from FHLMC/FNMA than anyone in congress. Obama was third on the list of most contributions.
Carl Rove said that the Bush administration tried to get laws passed to reform the banks and financial institutions, but was stymied by the Democrats in congress and especially Frank and Dodd. While there is no reason to disbelieve Rove, the president has a bully pulpit (as expressed by Teddy Roosevelt) so he could have done what Ronald Reagan would sometimes do, that is, go over the head of congress directly to the people. Fact is that at one time even Bush bragged about how many Americans owned their homes. As it turned out, the problem was that too many of these people didn’t really own their homes; the banks did much to the chagrin of both nominal home owners and the banks. Suppose that the Bush administration and Republicans in congress had insisted that these credit institutions not allow people with bad credit history and few assets or poor income prospects to obtain mortgages. What do you think the reaction would have been from the Democrats in congress and the Main Stream Media as well? How about something along the lines of “There the Republicans, the party of the rich, go again in favoring the wealthy and discriminating against the poor.” Before the crisis occurred and especially if it had then been averted, what defense could the Republicans have used? It would have been impossible to prove that a financial crisis would have happened but for the prudent policy of the GOP.
My purpose in discussing the Great Depression was to issue a cautionary note about assuming that more government regulation and involvement in this banking and financial situation will be the denouement. It goes back to the warning by President Eisenhower at the end of his 2nd term about the military-industrial complex. Money corrupts the system such that government regulators are co-opted by the industries they are supposed to regulate. Even if there is honest regulation that does not mean the problems will be ameliorated.
The solution for this current financial mess by both major political parties as well as the overwhelming majority of Americans is for more federal government oversight and control. That has not worked well in the past so why should one expect it to work now? What then to do? Clearly at this point there has to be government intervention via financial bailouts to keep the credit and equity markets from truly collapsing. When this crisis is over and before the next one occurs, as it surely will, there should be a firm commitment by the federal government to yes, enforce existing laws by convicting greedy and culpable corporate and political knaves and prevent collusion between institutions, but to generally maintain a hands off position from private enterprises. To quote economist Walter Williams in a recent column who quoted English philosopher Herbert Spencer: "The ultimate result of shielding men from the effects of folly is to fill the world with fools."
Every time there is a financial crisis, to some it is a new day. In fact it is history repeating itself in a new guise. It is widely believed that when the Great Depression descended upon the country, as well as much of the world, President Hoover did nothing while President Franklin Delano Roosevelt, when he came into office, brought the country out of the depression with massive government intervention and myriad federal programs. A review of the data does not support this belief. Hoover used the federal government to try to correct the situation without success. He actually made the economic depression worst by, among other schemes, pushing for and signing the Smoot-Hawley Tariff Act, which more accurately could be called the Hoover-Smoot-Hawley Act. This Act greatly restricted imports to America to protect American producers. Of course other countries retaliated so world trade was reduced thereby further slowing economic activity.
What is the evidence that the federal programs of Roosevelt did not bring the country out of the depression? Consider: The United States unemployment rate was 16% in 1931 and 19% in 1938, after nine years of the New Deal – three under Hoover and six under Roosevelt. The unemployment rate in 1929 just prior to the stock market crash was 3.2%. There was an intensifying of the recession in 1937. The stock market went into a nosedive and by November 1937 unemployment had soared to 11 million with another 3 million working only part time. Statistics showed that the United States was lagging far behind other countries in recovering from the depression. American national income in 1937 was 86% of the 1929 high water mark while Great Britain’s was 124%. Japan’s employment figure was 75% above the 1929 number. Chile, Sweden, and Australia had economic growth rates in the range of 20% compared to the United States’ dismal -7%.
In the late 1980’s there was the Savings & Loan scandal. Then in 2000-2002 the high tech bubble burst causing the NASDAQ index to go from more than 5000 to around 1000. The early 2000’s was the era of the brigands of Enron, WorldCom, Global Crossing, Arkadelphia, et.al. Now is the time of the banking and financial institutions meltdown. Do you get the idea that these crises reoccur, but with different sectors of the economy? Does anyone want to bet this pattern will not happen in the future?
Who are the bad actors in this current climacteric of many of the banking and financial institutions? Let us start with the officials at Freddie Mac (FHLMC) and Fannie Mae (FNMA). Franklin Raines, currently an advisor to Barack Obama, was the CEO of FNMA from 1999 to 2004 when guaranteeing of mortgages and other real estate loans given without down payments and weak financial backgrounds to home buyers and investors was getting underway. Later it got even more irresponsible when paperwork was not required for many of these loan recipients. During his six year tenure at FNMA, Raines took home $90 million. Jim Johnson was CEO of FNMA before Raines and made $21 million in his shorter tenure. When he retired in 1998 he got a $600,000 per year consulting contract. This clown who also is an Obama advisor and headed Obama’s vice-presidential search committee worked at Lehman Brothers.
Another Scaramouch is the infamous Jamie Gorelick. Remember her? She was Deputy Attorney General under Janet Reno. In that position Gorelick was primarily responsible for maintaining and strengthening the wall of separation between the CIA and the FBI. To say the least it did not help to prevent, if it had been possible, 9/11. In 1978 Sen. Frank Church (D-ID) was the driving force behind the passage of the Foreign Surveillance Act which set up this wall between the CIA and FBI. As with all such actions, the intent was good, but the country paid for it later. At any rate, Gorelick was appointed to the bipartisan 9/11 Commission (set up in November 2002) by then senate Majority Leader Tom Daschle. Daschle and the Democrats wanted Gorelick on the commission so she could not be subpoenaed to testify before the commission on her role in handicapping the FBI and CIA. In the spirit of bipartisanship the Republicans stupidly went along with Daschle.
Gorelick was vice-chairman of FNMA from 1997 to 2003 and collected $26 million during that time. All of these people were appointed by President Bill Clinton. Before Republicans start to say “see it is all the fault of the Democrats” I would opine that the current crew at FHLMC & FNMA were appointed by Bush and did not seem to be any more aware or competent than their Democrat predecessors.
There are more scoundrels. Sen. Christopher J. Dodd (D-CT) is the chairman of the banking committee in the senate. What did he do to try to forestall this banking problem? Nothing that I can discern. Rep. Barnett (Barney) Frank (D-MA), who strangely or maybe not is unmarried, is chairman of the Financial Services Committee. What did he do? Again the answer is nothing – in fact in both cases it is less than nothing. Dodd received more political contributions from FHLMC/FNMA than anyone in congress. Obama was third on the list of most contributions.
Carl Rove said that the Bush administration tried to get laws passed to reform the banks and financial institutions, but was stymied by the Democrats in congress and especially Frank and Dodd. While there is no reason to disbelieve Rove, the president has a bully pulpit (as expressed by Teddy Roosevelt) so he could have done what Ronald Reagan would sometimes do, that is, go over the head of congress directly to the people. Fact is that at one time even Bush bragged about how many Americans owned their homes. As it turned out, the problem was that too many of these people didn’t really own their homes; the banks did much to the chagrin of both nominal home owners and the banks. Suppose that the Bush administration and Republicans in congress had insisted that these credit institutions not allow people with bad credit history and few assets or poor income prospects to obtain mortgages. What do you think the reaction would have been from the Democrats in congress and the Main Stream Media as well? How about something along the lines of “There the Republicans, the party of the rich, go again in favoring the wealthy and discriminating against the poor.” Before the crisis occurred and especially if it had then been averted, what defense could the Republicans have used? It would have been impossible to prove that a financial crisis would have happened but for the prudent policy of the GOP.
My purpose in discussing the Great Depression was to issue a cautionary note about assuming that more government regulation and involvement in this banking and financial situation will be the denouement. It goes back to the warning by President Eisenhower at the end of his 2nd term about the military-industrial complex. Money corrupts the system such that government regulators are co-opted by the industries they are supposed to regulate. Even if there is honest regulation that does not mean the problems will be ameliorated.
The solution for this current financial mess by both major political parties as well as the overwhelming majority of Americans is for more federal government oversight and control. That has not worked well in the past so why should one expect it to work now? What then to do? Clearly at this point there has to be government intervention via financial bailouts to keep the credit and equity markets from truly collapsing. When this crisis is over and before the next one occurs, as it surely will, there should be a firm commitment by the federal government to yes, enforce existing laws by convicting greedy and culpable corporate and political knaves and prevent collusion between institutions, but to generally maintain a hands off position from private enterprises. To quote economist Walter Williams in a recent column who quoted English philosopher Herbert Spencer: "The ultimate result of shielding men from the effects of folly is to fill the world with fools."
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