THE BANKING AND FINANCIAL CRISIS - REDUX 48

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.