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Table of Contents & Introduction

January, 2012
www.futurecasts.com

FUTURECASTS JOURNAL

An Industrial Policy Horror Story

(with review of "Reckless Endangerment," by Gretchen Morgenson and Joshua Rosner)

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The masters of government industrial policy:

 

?

  The Credit Crunch recession is, among many other things, a cautionary tale - indeed, a horror story - of how even well intentioned government efforts to administer economic outcomes superior to what can be expected of the markets ultimately become instruments for the politically influential who pursue their own economic and political interests at the expense of the national interest.
 ?

  The causes of the Credit Crunch recession have already been the subject of numerous books and articles. See, Understanding the Credit Crunch; Tavakoli, "Dear Mr. Buffett;" Cooper, "Origin of Financial Crises." While adding significant details to the Credit Crunch story, the primary contribution of Gretchen Morgenson and Joshua Rosner in "Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon," is to demonstrate how government sponsored enterprises (GSEs) and "reform" legislation are perverted so that both market disciplines and regulatory constraints are weakened to favor the short term economic and political interests of the politically influential. The authors shine the spotlight on some of the most prominent Credit Crunch malefactors. These include

  • Fannie Mae executives James A. Johnson, Franklin Delano Raines, David O. Maxwell, Robert Zoellick, Thomas Donilon, Timothy Howard, Thomas Nides, Herb Moses, and Stephen Friedman, and Freddie Mac executive Leland Brendiel, who rode massive taxpayer credit subsidies to personal wealth and political influence.

  • Principal political supporters who benefited from the approximately $100 million in Fannie Mae political contributions and other favors, included Pres. William Jefferson Clinton, Reps. Barney Frank (D-Mass.), Henry B. Gonzalez (D-Tex.), Jim Leach ( R-Iowa), Thomas J. Bliley (R-Va.), Robert W. Ney (R-Ohio), Ed Royce (R-Cal.), and Bruce Vento (D-Minn.), Sens. Christopher Dodd (D-Conn.), Diane Feinstein (D-Cal.), Phil Gramm (R-Tex.),  Robert Bennett (R-Mont.), Kit Bond (R-Mo.), and Maxine Waters (D-Cal.). Political support was also provided by the Hispanic Congressional Caucus.

  • Executive branch supporters included Larry Summers, Robert Rubin, Richard Holbrooke, Robert Zoellick, Gary Gensler, Peter Orszag and John D. Hawke Jr..

  • Regulators who turned a blind eye on this massive perversion of economic policy and helped beat back the early efforts to disclose it include Alan Greenspan, Ben Bernanke, Timothy F. Geithner, Roger Ferguson, Andrew Cuomo, Robert Peach, John McCarthy, Frederic Mishkin. William Rutledge, John Dugan and Charles Himmelberg.

  • Private sector supporters who jumped on the gravy train included Sanford I. Weill, Angelo Mozilo, Wright H. Anderson Jr., William H. Andrews Jr., David Rosenblum, Peter Niculescu,Walter Falk, David Silipigno, J. Terrell Brown, Scott Hartman, W. Lance Anderson, Bruce Anderson, Bruce Karatz, Henry Cisneros, Murray Zouta, David McIntyre, and Louis Rampino.

  • Wall Street enablers, who made fortunes by providing massive financial support for this blatant raid on the nation's wealth, included major Wall Street firms like Goldman Sachs, Merrill Lynch, Morgan Stanley, Bear Stearns, Lehman Brothers, Deutsche Bank, and Greenwich Capital.

  • Ratings agencies Standard & Poor's, Moody's and Fitch readily succumbed to the conflicts of interest in their business model.

  • Advocacy organizations like the National Association of Real Estate Brokers, the National Association of Home Builders, the Mortgage Bankers Association, the Association of Community Organizations for Reform (ACORN), the National Council of La Raza, the National Low Income Housing Coalition, and the Urban Institute.

  • Intellectual rationalizations supporting the government's industrial policy were provided by Joseph Stiglitz,  Frederic S. Mishkin, Peter and Jonathan Orszag, R. Glenn Hubbard, William C. Dudley, Kenneth Temkin, George Galster, Robert Quercia and Sheila O'Leary.

   Today, as industrial policy enthusiasts glory in the Chinese economic success story that is increasingly characterized by government control and direction of its commanding heights economic entities, it is well to understand the inevitable outcome of such economic arrangements. It is, after all, China's vibrant, competitive private sector, drawing on the entrepreneurial energy of the Chinese people and the vast reservoir of China's low cost labor, that drives China's economic success and provides the resources for its bloated public sector economy. See, China's Economic Prospects, with a review of "The Party: the Secret World of China's Communist Rulers," by Richard McGregor, and U.S./China Power Relationship, with reviews of "The Future of Power," by Joseph S. Nye, Jr., and "Red Capitalism" by Carl E. Walter and Fraser J. T. Howie.
 ?
  At the end of 2011, Fannie Mae and Freddie Mac have cost taxpayers more than $140 billion with billions more going down the drain every quarter. The same cabal of mortgage brokers, realtors and developers and their political allies that prevented adequate regulation of Fannie and Freddie before the Credit Crunch and disabled the pertinent market disciplinary mechanisms now prevents the winding down of these financial zombies. Credit Crunch bank failures, on the other hand, have cost about $10 billion. The cost by 2014 is expected to be about another $20 billion. This is certainly more than just chicken scratch, but it is just a minor fraction of the cost of the GSE failures and it is the banks that are receiving all the heat and regulatory attention.
 ?
  Indeed, there are now renewed efforts by the old political and private sector cabal to reinvigorate the government's housing industrial policy and inflate a new housing bubble that can again enable the politically influential to reap riches at public expense.

  This book does not, of course, provide a complete picture of the boom and bust of the Credit Crunch recession. There may never be any one book that can achieve that. The book's coverage is sketchy at best of the roles of the major Wall Street firms and banks, their primary policy-making executives and their lobbying efforts. To a large extent - indeed to a much greater extent than the GSEs and their top executives - Wall Street has captured the economic policymaking and regulatory structure of the government.
 ?
  This is probably unavoidable as the government's economic role expands and industrial policy experiments proliferate. Unfortunately, there will always be efforts to shape government policy for private benefit and political advantage, and some of these efforts will inevitably succeed. Unfortunately, it is difficult to find the expertise for economic regulation and the implementation of economic policy except from Wall Street, increasing vulnerability to capture by private and political interests.

Affordable housing policy:

  The facilitation of homeownership has been government policy for many decades and the resources dedicated to that effort have persistently been increased over time. In the 1990s, that flow of resources became a deluge.
 ?

Homebuilding pumped significant sums into local economies and every electoral district had homebuilders, mortgage lenders and realtors who were reliable donors to political campaigns.

 

The policy obliterated the normal disciplinary constraints of the markets and imposed upon regulators the conflicting objectives of boosting the industries they were supposed to be policing. Both market and regulatory disciplinary constraints disappeared together.

  As usual, the policy was justified on the basis of the best of good intentions, but it didn't hurt that homebuilding pumped significant sums into local economies and every electoral district had homebuilders, mortgage lenders and realtors who were reliable donors to political campaigns. They, along with securities firms, were enlisted in a Clinton administration public-private partnership to boost homeownership from about 64% of households to 70%.
 ?
  The policy would achieve this noble goal by "making homeownership more affordable, expanding creative financing, simplifying the home buying process, reducing the transaction costs, changing conventional methods of design and building less expensive houses, and other means." Most important, the policy obliterated the normal disciplinary constraints of the markets and imposed upon regulators the conflicting objectives of boosting the industries they were supposed to be policing. Both market and regulatory disciplinary constraints disappeared together.

  "[In] just a few short years, all of the venerable rules governing the relationship between borrower and lender went out the window, starting with the elimination of the requirements that a borrower put down a substantial amount of cash in a property, verify his income, and demonstrate an ability to service his debts."

  With the advent of the Credit Crunch recession about a dozen years later, homeownership was transformed from the foundation of middle class welfare and security to a financial trap that destroyed jobs, net worth, and retirement accounts.
 ?

The perversion of Fannie Mae:

  James A. Johnson is presented as the primary villain in the story. As chief executive officer of Fannie Mae, Johnson dominated the financial and political environment of the real estate industry, amassing great personal wealth in the process.
 ?

Much of the gain in earnings that justified rapid increases in executive pay and bonuses was based on creative accounting that ignored the massive increase in risks assumed in the process.

  The implied taxpayer subsidy for Fannie Mae credit permitted Johnson to balloon its activities. However, much of the gain in earnings that justified rapid increases in executive pay and bonuses was based on creative accounting that ignored the massive increase in risks assumed in the process.
 ?
  The Fannie Mae Foundation was munificently funded by Fannie and was used to provide grants to charities and nonprofits associated with political supporters of Fannie or active in their districts. During a New Hampshire primary campaign, it bought adds attacking Steve Forbes' flat tax proposal, while insouciantly denying any intent to affect voters. It funded a variety of reliably left wing ethnic political organizations. A variety of highly visible charities received support from the foundation providing Johnson with frequent opportunities for favorable publicity. With its foundation, Fannie Mae provided $100 million for lobbying and political contributions that made it the master over its political and regulatory masters.
 ?

With its foundation, Fannie Mae provided $100 million for lobbying and political contributions that made it the master over its political and regulatory masters.

  Fannie sought to influence pertinent intellectual discourse through its Fannie Mae Papers studies and its support of influential publications like "Housing Policy Debate" and "Journal of Housing Research," which rarely published anything that questioned Fannie and Freddie finances. Intellectuals like Joseph Stiglitz and Peter and Jonathan Orszag criticized the critics of Fannie and Freddie finances. They produced risk assessments that were wildly optimistic. R. Glenn Hubbard, dean of the Columbia Graduate School of Business, defended Fannie's risk management practices in late 2003 - just before the Fannie and Freddie accounting scandals broke. Fannie had effectively bought off almost all the intellectual experts in the field.

  "Fannie Mae's financing of academic research on such a large scale meant that few housing experts were left to argue the other side of any debate involving the company. Any discussion involving Fannie Mae in these papers was designed to defend the status quo."

  Wall Street and business interests do the same thing using grants, consulting contracts and lucrative positions on boards of directors. The analytical efforts of business school and economics department faculty have become riddled with conflicts of interest. Add ideological and political interests, and there is good reason for a high degree of skepticism for the analytical product of the nation's intellectual community and the academic output of its most influential universities.

Barney Frank, perhaps the most prominent of the political supporters of the housing policy, brushed off fears of collapse with the insouciant comment: "We'll deal with that problem if it happens." Neither he nor the other government masters of industrial policy have yet to "deal" with that problem.

  Fannie Mae encouraged the relaxation of lending standards and the elimination of the traditional due diligence practices of mortgage lending. Wall Street profited handsomely by providing financing for the effort. "Without Wall Street firms giving billions of dollars to reckless lenders, hundreds of billions of bad loans would never have been made."
 ?
  Fanny Mae and Wall Street constituted a powerful lobbying group
that was able to enlist legislators and executive branch government officials to support the industrial policy effort, undermine regulation, smash opposition and ridicule critics. Barney Frank (D-Mass.), perhaps the most prominent of the political supporters of the housing policy, brushed off fears of collapse with the insouciant comment: "We'll deal with that problem if it happens." Neither he nor the other government masters of industrial policy have yet to "deal" with that problem.

  "All the critics were either willfully ignored or silenced by well funded, self-interested, and sometimes vicious opposition. Their voices were drowned out by the homeownership trust, a vertically integrated, public-private housing machine whose members were driven either by ideology or the vast profits that rising homeownership would provide.
 ?
  "The consortium was too big and too powerful for anyone to take on. It's reach extended from the mortgage broker on Main Street to the Wall Street traders and finally to the hallowed halls of Congress."

The program was facilitated by those who profited from the program and spread by an uncritical mass media, much of which is prone to applaud government industrial policy efforts.

 

Government unleashed the mortgage mania and undermined both its own regulators and ordinary market disciplines.

  Inevitably, the entire program became a massive government-led fraud on the public, supported by an increasing web of lies and invalid rationalizations. It was facilitated by those who profited from the program and spread by an uncritical mass media, much of which is prone to applaud government industrial policy efforts.

  However, the markets ultimately reject such lies and invalid rationalizations. The markets are remorseless and inexorable. They can be influenced and even pushed around for awhile, but they ultimately always win - viciously - over such efforts. Ultimately, it was the markets that brought an end to this increasingly massive fraudulent program - just as they are currently if belatedly disciplining profligate governments in Europe despite cries of anguish and vehement protestations that "we are not Greece." The regulators on both sides of the Atlantic were both late and ineffectual.

  Market failure was widely criticized for the Credit Crunch, but authors Morgenson and Rosner place the blame squarely with government. Real estate, securities and banking, after all, are among the most heavily regulated sectors of the economy. Government unleashed the mortgage mania and undermined both its own regulators and ordinary market disciplines.

  "Then its policy makers looked the other way as the mortgage binge enriched a few and imperiled many. Even after the disaster hit and the trillion-dollar bailouts began, Congress and administration officials did little to repair the damaged system and ensure that such a travesty could not happen again."

Advantages included an implicit taxpayer guarantee of GSE credit that reduced borrowing costs by about a vital half a percentage point, a $2.5 billion line of credit with the U.S. Treasure, exemption from state and local taxes, and freedom from SEC financial reporting requirements.

  Massive taxpayer advantages were bestowed on the GSEs Fannie Mae and Freddie Mac. They used these advantages to push aside private competition.

  The single payer "option" for health care insurance will do the same. There is no such thing as "fair competition" with government sponsored entities.

  These advantages included an implicit taxpayer guarantee of their credit that reduced their borrowing costs by about a vital half a percentage point, a $2.5 billion line of credit with the U.S. Treasury, exemption from state and local taxes, and freedom from Securities and Exchange Commission (SEC) financial reporting requirements. The authors assert that these advantages were worth billions of dollars and that Johnson redirected about one third of it for shareholders, executive compensation and lobbying expenses.
 ?

Perversion of "safety and soundness" legislation:

  Johnson took over Fannie Mae in 1991. He energetically silenced critics by showering Fannie Mae grants on some - like the Association of Community Organizations for Reform (ACORN) - and funding their favorite housing programs.
 ?

The legislation could not be defeated, so it was perverted by adding multiple objectives that conflicted with the safety and soundness objectives. In practice, the added objectives would take precedence over safety and soundness.

  However, the Savings and Loan crisis and a crisis involving Citibank generated pressure for strict regulatory requirements. Thus, Johnson was initially faced with the regulatory constraints in proposed "safety and soundness" legislation, the Federal Housing Enterprise Safety and Soundness Act. The ostensible purpose of the legislation was to strengthen regulation and increase capital requirements to protect taxpayers from losses.
 ?
  Johnson deployed his lobbying forces and the congressional influence he obtained through political donations and favors. The legislation could not be defeated, so it was perverted by adding multiple objectives that conflicted with the safety and soundness objectives. In practice, the added objectives would take precedence over safety and soundness. Rep. Henry B. Gonzalez (D-Tex.), chairman of the House Banking Committee, was especially useful in undermining the ostensible safety and soundness purpose of the legislation.
 ?

    Johnson and Fannie Mae were not alone in loading taxpayers with financial risks. The New Deal deposit insurance safety net that worked so well when limited to deposits in heavily regulated banks that paid fees into an insurance fund was also being perverted. It was being expanded - massively - to cover insurance companies and even investment banks that were not subject to heavy federal regulation. Christopher Dodd (D-Conn.) slipped the provision into the 1991 Federal Deposit Insurance Corporation Improvement Act (FDICIA), another legislative effort designed to protect taxpayers that was surreptitiously hijacked for the benefit of special interests.

  In a similar manner, the multiple explicit and implicit objectives imposed on the Federal Reserve System always take precedence over the "strong dollar" objective that was ostensibly one of its primary reasons for existence. Congress can never resist the temptation to impose additional objectives on its executive instruments regardless of the conflicting nature of the objectives. Today explicit and implicit Fed objectives include:

  • Maintain the purchasing power of the dollar.
  • Lender of last resort - but today to the entire economy - and a good part of the world.
  • Stability of the financial system.
  • Stability of exchange rates.
  • Maintain low unemployment.
  • Maintain low interest rates.
  • Guaranty the credit of too-big-to-fail corporations.
  • Support Treasury debt issues.
  • Allocate credit into the housing market.
  • Boost the economy during election years.
  • Act as scapegoat when things go wrong.

  These objectives are so clearly contradictory on so many different levels that the Fed must ultimately fail at all of them.

"Affordable housing," "low- and moderate-income housing," and "inner cities" housing requirements provided statutory support for regulatory acceptance of a massive reduction in safety and soundness lending standards and the abandonment of financial prudence.

 

As lending risks were increased, financial prudence and lending standards were massively decreased.

  Requirements for "affordable housing," "low- and moderate-income housing," and "inner cities" housing, were inserted into the safety and soundness legislation. These requirements provided statutory support for regulatory acceptance of a massive reduction in safety and soundness lending standards and the abandonment of financial prudence. The reduction to 5% of traditional 20% down payment requirements and the reduction of borrower income requirements were justified by the affordable housing objectives.
 ?
  As the 1990s progressed, persistent industry pressure and lobbying, supported by fundamentalist views of the adequacy of market disciplinary mechanisms, led to substantial reductions of regulatory oversight and requirements.

    Market mechanisms didn't fail. The government had disabled them.
  ?
 
What was being ignored was that Fannie and its supporters in Congress along with other powerful assorted economic and political interests were actively disabling all the most important market disciplinary mechanisms.

  • Interest rates kept artificially low distorted the "time cost of money" calculation and disabled the interest rate disciplines that regulate the allocation of credit.
  • Taxpayer explicit and implicit "moral hazard" guarantees transformed creditors from credit market vigilantes into credit market enablers. Why worry about borrower defaults if the taxpayers - poor schnooks - are on the hook to cover them.
  • Equity capital was burdened by taxes, liability risks, and regulatory burdens that massively increased the attractiveness of debt capital, leading to persistently increasing leverage levels in the economy.
  • The massive allocation of financial resources into housing undermined the market's basic supply and demand functions. See, Monetary Inflation & Business Cycle Volatility, and Lies, Damn Lies and Projections.

  Capital adequacy requirements for Fannie and Freddie were reduced to just 2.5% to enable them to borrow massive sums to finance their affordable housing goals. Prudent capital adequacy for mortgage lenders had generally been about 10%. Thus, as lending risks were increased, financial prudence and lending standards were massively decreased.
 ?

"Any congressman or -woman who objected would instantly be labeled anti-housing, elitist, or an enemy of the American Dream." 

 

OFHEO was subjected to extraordinary Congressional oversight of its regulatory efforts and budget.

 

"Amid cries of racial discrimination, risk-averse practices were jettisoned."

  The affordable housing goals provided political leverage for Johnson's ambitious expansion plans. He could always argue that his reductions in safety and soundness practices were essential to provide the resources for his laudable affordable housing efforts. "Any congressman or -woman who objected would instantly be labeled anti-housing, elitist, or an enemy of the American Dream." Of course, expansion of mortgage lending activities also justified bodacious increases in executive pay and bonuses at Fannie and Freddie.
 ?
  The "safety and soundness" legislation also assured that regulation would be controlled by the regulated industry. Regulatory jurisdiction was retained by the generally inept Housing and Urban Development Department (HUD) and its Office of Federal Housing Enterprise Oversight (OFHEO). However, OFHEO was subjected to extraordinary Congressional oversight of its regulatory efforts and budget. Johnson could rely on his allies in Congress to shape regulation to his desires.
 ?
  The left wing emphasis on "fairness" would be employed to justify the undermining of safety and soundness requirements.

  "Underwriting flexibilities. New products. Expanding outreach efforts. All were code words for loosening underwriting standards and lending to people whose income, assets, or abilities to pay fell far below the traditional homeowner spectrum. No longer would Fannie Mae stick to its practice of ensuring that borrowers could meet their obligations and, therefore, that the loans it purchased carried relatively low risk. These standards had for decades acted as a kind of governor on lax lending among banks interested in selling loans to Fannie. But amid cries of racial discrimination, risk-averse practices were jettisoned."

Reliance on borrower credit history was abandoned and high levels of  existing borrower expenses were ignored. Gifts from municipal agencies and nonprofits became acceptable for meeting down payment requirements - and predictably characterized the mortgages that suffered the highest default rates.

  Left wing attacks on discriminatory lending practices further drove abandonment of lending standards and financial prudence. ACORN was joined by advocacy groups such as the National Council of La Raza, the National Low Income Housing Coalition, and business groups such as the National Association of Real Estate Brokers in the frenzied effort to brush aside all lending constraints. The Boston Federal Reserve Bank was especially active in justifying the abandonment of prudence.
 ?
  Reliance on borrower credit history was abandoned and high levels of  existing borrower expenses were ignored. Gifts from municipal agencies and nonprofits became acceptable for meeting down payment requirements - and predictably characterized the mortgages that suffered the highest default rates. Not to worry, however! These dodgy loans could be offloaded to Fannie and Freddie - and the taxpayers. The tide of rising default rates lay in the future.
 ?
  By ignoring the costs of the increase in risks, the massive increase in its mortgage portfolio initially permitted Fannie to report great income level increases that financed massive lobbying efforts and justified great increases in dividends and executive compensation. This was the outcome of the perverted 1992 Federal Housing Enterprise Safety and Soundness Act (the "safety and soundness" reform legislation) and the 1991 Federal Deposit Insurance Corporation Improvement Act (FDICIA).
 ?

Subprime mortgages:

 "This AAA rating was crucial. Analyzing one mortgage to try to predict its performance was hard enough. Assessing the risks in a security that contained thousands of loans was beyond complex."

  In the summer of 1993, United Companies Financial pooled $165 million of its mortgages into a mortgage-backed security and sold it to investors after receiving a triple-A rating for it from the rating agencies. This was the first time such mortgage securities had been passed on to private investors rather than to the GSEs.

  "This AAA rating was crucial. Analyzing one mortgage to try to predict its performance was hard enough. Assessing the risks in a security that contained thousands of loans was beyond complex. If the ratings agencies were convinced that the securities were good enough to assign them a triple-A rating, then most investors were happy to go along."

Subprime borrowers were suddenly welcomed. Subprime borrowers paid higher fees and interest rates, and credit risk was passed on to investors or Fannie or Freddie.

  It was a good idea. However, like any credit vehicle, it could be abused - and it was - big time. In 2003, $467 billion in mortgage-backed securities were sold to investors.
 ?
  This business was very attractive. Subprime borrowers were suddenly welcomed. Subprime borrowers paid higher fees and interest rates, after all, and credit risk was passed on to investors or Fannie or Freddie. Lending standards were persistently lowered by "new era" type rationalizations that were readily promoted and accepted by those competing for the fees generated by this business model.
 ?
  Fannie and Freddie responded by lowering their standards for the mortgages they would accept. Their "Alternate Qualifying" program abandoned the requirements that monthly housing payments not exceed 28% of borrower income and existing debt not exceed 36% of income. Reductions in down payment requirements soon followed as fee income incentives quickly dominated credit risk concerns.
 ?
  HUD accepted and even applauded the disabling of regulatory safeguards
and accepted relaxed appraisal rules that allowed lenders to hire their own appraisers for mortgaged property. Henry Cisneros applauded Johnson for ballooning Fannie's portfolio even as its capital adequacy ratio fell towards 50-to-1.
 ?

Fannie's affordable housing cabal:

  Johnson invoked the affordable housing objective to justify loading taxpayers with this massive increase in Fannie Mae risk.
 ?

Millions of unsuspecting people would soon find themselves trapped in high-cost loans that they could not afford as a result of this brilliant example of government industrial policy.

  To shield Fannie from its critics, $1 trillion was allocated to minority and low income housing mortgages. The lending process was to be automated. Mortgage lenders like Countrywide Financial quickly climbed on board. Millions of unsuspecting people would soon find themselves trapped in high-cost loans that they could not afford as a result of this brilliant example of government industrial policy.
 ?
  Johnson opened local Fannie "partnership" offices
across the nation to partner with state and local housing initiatives, generating widespread goodwill and political support. Politicians from both parties were glad to be associated with these noble programs and to be seen in support at local Fannie events. Fannie event supporters included Sens. Ted Kennedy (D-Mass.), Christopher S. Bond (R-Mo.), and Rep. Newt Gingrich (R- Ga.). Relatives and former staffers of elected officials were prominent among the executive employees at these new partnership offices. Among the legislators favored in this way were Sens. Robert Bennett (R-Utah) and Tom Daschle (D-SD.). 

  "The projects undertaken by the [partnership offices] always involved a close collaboration between homebuilders, Realtors, banks, housing agencies, local advocacy groups, and even corporations, such as retail chains, that would seem to have nothing to do with housing."

  Thus, prominent supporters and lenders were readily enlisted to oppose any legislation or regulation that might constrain Fannie activities. In Kansas City, for example, notables climbing aboard Fannie's bandwagon included Richard Moore, president of Commerce Mortgage Corp.; Richard Stanley, chief executive of Payless Cashways; and Colleen Hernandez, executive director of the Kansas City Neighborhood Alliance. This was repeated all across the nation, creating an army of influential supporters ready to quash any opposition.
 ?

  Fannie's exemption from local taxes - a perquisite worth annually about $300 million - was targeted by D.C. council member William P. Lightfoot. This was money desperately needed in D.C. at that time. However, the D.C. council was quickly swamped with opposition from local activists and educators who even marshaled school children to protect Fannie's tax exemption. When Rep. Pete Stark (D-Cal.) tried to schedule hearings on the matter, he couldn't find any witnesses willing to support Lightfoot's initiative. By allocating tens of millions of dollars for local projects, Fannie was able to avoid $300 million in annual local taxes.
 ?
  Similar tactics were employed in 1998 to quash a proposal to require Fannie to pay the usual fees to register its securities.
 ?
  Similar Fannie and Freddie lobbying tactics were employed to squelch the 2000 Housing Finance Regulatory Improvement Act, which was supported by Richard Baker (R-La.)  in an attempt to remove the $2.5 billion line of credit at the Treasury and strengthen federal regulatory oversight .
 ?

By 2010, Frank had a sudden loss of memory about the 1992 reform legislation and his role in gutting it.

 

Summers demanded changes in the report that resulted in a watered down, noncommittal report ending with the politically convenient recommendation for further studies.

  Barney Frank (D-Mass.), chairman of the House Financial Services Committee during periods of Democratic control of the House, was continuously courted by Johnson and other Fannie executives with campaign donations, the hiring of Frank protégés and other favors. Frank responded by remaining a powerful supporter of Fannie programs. Frank and Henry Gonzalez (D-Tex.), for example, fiercely attacked Congressional Budget Office director Robert D. Reischauer when he testified in May 1991 in favor of imposing visibility, safety and soundness constraints on Fannie and Freddie.
 ?
  Frank was still fiercely castigating those raising safety and soundness concerns until just before the Fannie and Freddie bubbles burst. By 2010, Frank had a sudden loss of memory about the 1992 reform legislation and his role in gutting it.
 ?
  The Treasury drafted a report on GSE privatization options in 1996. It candidly evaluating the benefits in terms of reduced taxpayer risk. Johnson and Leland Brendsel, his counterpart at Freddie Mac, met with high level Treasury officials, including Tim Howard, Robert Zoellick and Larry Summers. Summers thereafter demanded changes in the report that resulted in a watered down, noncommittal report ending with the politically convenient recommendation for further studies.
 ?
  The nonpartisan Congressional Budget Office (CBO) also posed a threat with a statistical study of the value to Fannie and Freddie of the implied government guarantee subsidy and how little of the subsidy was actually passed on to borrowers. CBO staff member Marvin Phaup had already come up with a figure of $40 million for the student loan agency Sally Mae. For Fannie and Freddie, the figure was $7 billion in 1995. Of this, $2.1 billion was funneled to shareholders and Fannie expenses, including executive salaries and bonuses and other activities.

  "Holding on to so much of its subsidy let Fannie Mae fund its elaborate self-preservation scheme, make its massive charitable contributions, pay for its extensive 'political outreach,' and hire academics to write favorable studies about its role in the mortgage market."

Over $2 billion was a clearly exorbitant price to pay for the slim reduction in borrowing costs and other homeowner benefits offered by Fannie and Freddie. Moreover, the huge and growing credit risks posed by the implied taxpayer guarantees was an immense cost that was not being assessed against Fannie and Freddie.

  Fannie and Freddie were "spongy conduits" for government largesse, Phaup concluded. Over $2 billion was a clearly exorbitant price to pay for the slim reduction in borrowing costs and other homeowner benefits offered by Fannie and Freddie. Moreover, the huge and growing credit risks posed by the implied taxpayer guarantees was an immense cost that was not being assessed against Fannie and Freddie.
 ?
  With respect to executive compensation, the CBO said: "In the context of a government-sponsored enterprise, in which management controls taxpayer subsidies to a significant extent, those compensation agreements can be inconsistent with the interests of taxpayers and the government." It recommended that Congress examine the "special relationship" of the government and its sponsored mortgage enterprises.
 ?
  As with the Treasury report, a high level meeting between Johnson supporters Fred Raines and Robert Zoellick and CBO head June O'Neill took place before the study was sent to Congress. However, the attack in no way undermined study calculations. It presented just "soft counters to the CBO's hard facts." As a result, O'Neill told Raines and Zoellick the analysis would be sent to Congress.
 ?
  Fannie countered with an all-out publicity campaign assaulting the character and expertise of the responsible CBO staff members. Assertions of mental problems were leveled at Phaup. They armed members of the House Banking and Financial Services Committee with harsh and pointed questions for O'Neill's hearing and reminders of all the benefits delivered by Fannie and Freddie to member districts.
 ?
  O'Neill testified that the $7 billion taxpayer subsidy created by the implied guarantee of Fannie and Freddie debts was neither understood nor controlled by Congress, with the result that some significant proportion was diverted for private interests. However, all the Committee members were beneficiaries of Fannie largesse and most read defenses scripted by Fannie. Zoellick testified in defense of the status quo, asserting that the benefits of Fannie programs were greater than the mere statistics implied.
 ?

  Congress thus rejected full privatization, and still maintains Fannie and Freddie, now as financial zombies soaking up tens of billions of dollars in losses. However, the CBO study emboldened others to take a close look at Fannie and Freddie. The Government Accountability Office (GAO) and the Federal Reserve Bank of Minneapolis generated critical studies of the two mortgage agencies but did not recommend the ending of the "special relationship." Among the defenders of Fannie and Freddie were Sen. Diane Feinstein (D-Cal.) and Angelo Mozilo of Countrywide Financial.

  "Even though it had successfully run the privatization gauntlet, Fannie continued its lobbying efforts with the help of no fewer than thirty-six registered lobbyists in 1996. The company  gave almost $200,000 to political parties that year while its employees contributed almost $113,000 to congressional and presidential candidates."

  Today, the government has created a whole financial sector of too-big-to-fail enterprises enjoying vast subsidies in the form of taxpayer guarantees of their debt. Instead of ending this deplorable practice, Washington more than ever is providing taxpayer subsidies to increase the private profits of Wall Street and the big banks. In return, these too-big-to-fail entities and their executives have become reliable major contributors to the political reelection campaigns of incumbent politicians.

Ignoring the death of the canary:

 

 

?

  The subprime loan business for used cars crashed in 1997 and 1998. Mercury Finance, Jayhawk Acceptance, and First Merchant Acceptance Corp. failed in a practically exact rehearsal of the housing mortgage boom and bust of a decade later. Most of the other subprime auto-lenders failed or were merged into larger businesses or were greatly scaled back, but the subprime mortgage lending and securitization business continued to charge forward.
 ?

  Early casualties among the subprime mortgage lenders were Cityscape Financial and Greentree Financial. David Grafman, an S&P analyst, warned of the risks of allowing mortgage lenders to book earnings when mortgage securities were sold despite continuing risks from defaults and prepayments. When losses occurred and had to be booked, the share prices of high flying mortgage lenders fell dramatically. However, larger mortgage financial entities began buying these hot mortgage lenders, providing legitimacy to the industry.
 ?
  The industry was a tottering upside-down pyramid, and the Russian debt crisis brought down a host of subprime lenders along with the hedge fund Long Term Capital Management. Bear Stearns took a big hit because of its slipshod due diligence in making major financial commitments to one of these lenders. Weak due diligence at Bear Stearns would continue until its demise a decade later.
 ?

Becoming too-big-to-fail:

  The massive benefits of implicit taxpayer credit guarantees can be enjoyed - and are increasingly enjoyed - by other private sector financial and business entities. All they need to do is become too-big-to-fail.
 ?

Mergers and acquisitions designed to create too-big-to-fail financial institutions are thus very popular.

 

  Now, commercial banks were free to expand into other risky activities and merge with investment banks to grow too-big-to-fail. A boom in bank mergers soon followed, spawning a whole industry of too-big-to-fail financial institutions.

  If their size and the scope of their financial activities are such as to make their failure a threat to the entire financial system, government would be forced to bail out their creditors in the event of a default. These taxpayer guarantees were needed to sustain the levels of confidence essential for an increasingly leveraged financial system. These taxpayer guarantees substantially reduce the borrowing costs of too-big-to-fail financial institutions, providing them with a valuable competitive advantage over smaller rivals.
 ?
  Mergers and acquisitions designed to create too-big-to-fail financial institutions are thus very popular. However, they were often blocked by the New Deal Glass-Steagall Act. Elimination of Glass-Steagall constraints was thus a top financial sector priority. This was achieved in 1999. Sponsors of the repeal legislation were Sens. Phil Gramm (R-Tex.) Jim Leach (R-Iowa), and Thomas J. Bliley (R-Va.). Heading an army of lobbyists were Greenspan, Summers, Comptroller of the Currency John D. Hawke Jr., and Treasury undersecretary Gary Gensler.
 ?
  Sanford I. Weill was one of the initiators and early beneficiaries of the repeal effort. His Travelers Group was thus enabled to complete its merger with Citibank. Robert Rubin and economist William C. Dudley, who rose to become president of the N.Y. Fed, provided intellectual firepower in support of repeal. Sen. Byron Dorgan (D-ND.) was a prominent Cassandra, presciently warning that repeal would be looked upon with regret in about a decade. Becoming vice chairman of the merged Citigroup, Rubin became fabulously wealthy as one of the leaders taking the now giant financial institution recklessly through the boom years before its collapse during the Credit Crunch recession.
 ?
  Now, commercial banks were free to expand into other risky activities and merge with investment banks to grow too-big-to-fail. A boom in bank mergers soon followed, spawning a whole industry of too-big-to-fail financial institutions.

    Investment banks that had been run as partnerships where the partners bore all of the risks of their activities went public to offload most of their risks onto shareholders, and then expanded to become too-big-to-fail.

  The new financial world of moral hazard began with the 1999 bailout of the creditors of the hedge fund Long Term Capital Management. In 1990, Drexel Burnham creditors had received no such bailout, yet the financial world did not collapse. However, N.Y. Fed president William J. McDonough, along with Greenspan, Summers and Rubin, arranged the bailout of Long Term Capital Management. Major Wall Street firms provided the bailout, but the N.Y. Fed provided the financial muscle.
 ?

Bubble mania:

 

?

  As commercial banks were freed to move into risky financial sectors, regulatory constraints and oversight were persistently reduced. Morgenson and Rosner explain some of the more prominent steps in the reduction of regulatory safeguards.
 ?

Once again, the bureaucrats and politicians were not being guided by intellectual analysis. They were instead generating the analyses they wanted. Opposing analytical efforts were either ignored or disparaged.

  Greenspan and other market fundamentalists provided the intellectual support for this remarkable policy progression. Everyone was invited to the speculative bonanza prior to the Credit Crunch - with the ultimate risks passed by moral hazard policies to the taxpayer.
 ?
  The Office of Thrift Supervision reduced its regulatory constraints on subprime mortgages. Andrew Cuomo, then the director of HUD, actively encouraged Fannie and Freddie to increase their acquisition of subprime mortgages. "Pushed to buy subprime loans, the degradation of underwriting standards was now under way." Intellectual studies were arranged criticizing lending standards as discriminatory to minorities and low income borrowers. A study by the Urban Institute authors Kenneth Temkin, George Galster, Robert Quercia and Sheila O'Leary was especially influential.
 ?
  Once again, the bureaucrats and politicians were not being guided by intellectual analysis. They were instead generating the analyses they wanted. Opposing analytical efforts were either ignored or disparaged.
 ?

Johnson was Washingtonian magazine's Washingtonian of the year.

  Andrew Cuomo at HUD raised Fannie and Freddie subprime lending requirements to 50% in 1999 based on this kind of intellectual support. Raines and Charles Ruma of Fannie Mae were among the celebrants at the policy announcement, as well as Fannie grant recipients like Bart Harvey of the Maryland nonprofit Enterprise Foundation. Pres. Clinton cheered the new policy.
 ?
  Subprime mortgage underwriting rose from $40 billion annually to $332 billion in a decade. Almost half the total - some $1.6 trillion in toxic mortgages - would be purchased by Fannie and Freddie by 2008. At first, it was all presented as a magnificent success, boosting earnings that justified the munificent salaries and bonuses of Johnson and other GSE and banking executives.
 ?
  Fannie's mortgage financing reached $1 trillion in 1998, and Johnson was Washingtonian magazine's Washingtonian of the year. However, Fannie's capital was now just 3.64% of assets. FDIC insured banks were then at 8.22%. In 1999, Johnson joined the board of Goldman Sachs.

  "With Goldman's former head on Fannie's board and Fannie's former chief on Goldman's, a close relationship between the two companies was assured. And it was one that would last well into the financial crisis years."

Accounting fraud:

  Creative accounting came to the rescue when the Russian debt default undermined earnings and threatened pay levels and bonuses.
 ?

  Fannie improperly used low-income tax credits received by the company to justify both record high reported earnings and high bonuses. Leanne Spencer was then one of Fannie's finance officials. In subsequent years, Goldman helped Fannie manipulate its earnings.

  "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 each year. Between 1998 and 2002, actual earnings and the bonus payout target differed by a fraction of a cent, the investigators found."

  When OFHEO finally discovered the ongoing accounting fraud in 2005, Franklin Raines was in charge at Fannie. Although it had begun under Johnson, Johnson was never charged. It was determined that, without fraud, there would have been no executive bonuses in 1998.

  "During his years at Fannie Mae, making a cool $100 million, [Johnson] made sure to arrange for an inflation-adjusted consulting contract with the company that began at $390,000 a year. His pension - around $900,000 a year - was secure and so were company-paid perquisites such as a car and driver for him and his wife, office space at the prestigious Watergate complex, and the services of two employees."

  Johnson became chairman of the Brookings Institution and head of the John F. Kennedy Center for the Performing Arts, and a director with Target Corp., United Healthcare, and later with Goldman.
 ?

Asleep at the Fed:

 

?

  The extraordinary 1998 bailout of Long Term Capital Management was recognized by the Fed as a wakeup call about modern interconnected markets. However, as with the earlier subprime auto-loan crisis, it was quickly forgotten and no defensive measures were taken.
 ?

"The belief that the free market could police itself better than any government regulator had already taken hold."

  Greenspan remained insouciantly asleep at the switch. "The belief that the free market could police itself better than any government regulator had already taken hold." (Of course, the free market police force had been disarmed and reduced to part time employment.)
 ?
  Fed officials wanted to even further loosen capital adequacy requirements. Fed board member Roger Ferguson was a strong advocate for banking interests. He became Fed vice chairman in 1999. As the Fed's point man on the international Basil Committee, he was a persistent advocate for looser banking regulation worldwide.
 ?

Risk assessments were based on experience during the 1990s  - a period of practically uninterrupted prosperity.

 

"In the pre-crisis days, the information the Fed wanted to withhold was critical to the public understanding of proposed changes to bank capital rules and posed no threat to world markets. As a result, the Fed's actions were dubious at best and manipulative at worst."

  The FDIC was alarmed at the impact on its insurance fund in the event of defaults among the rapidly expanding large banks. It calculated that proposed regulatory changes would reduce minimum capital requirements by 40%, and questioned the internal risk assessment methods on which the regulatory change proposals were based. These risk assessments were based on experience during the 1990s  - a period of practically uninterrupted prosperity.
 ?
  However, the Fed, the Comptroller of the Currency, and the Office of Thrift Supervision had no such qualms. Greenspan accepted the use of central bank resources to supplant much of the capital required of large banks - in effect allowing the large banks to reap private profits from a public subsidy.

  "The Fed has always been highly secretive about its operations, routinely arguing that disclosure of its actions and deliberations could threaten the financial system. But some in the regulatory community were disturbed by the Fed's secrecy in the years leading up to the crisis because it seemed to indicate a desire by the Fed to manipulate the debate on crucial decisions. In the pre-crisis days, the information the Fed wanted to withhold was critical to the public understanding of proposed changes to bank capital rules and posed no threat to world markets. As a result, the Fed's actions were dubious at best and manipulative at worst."

  Fortunately, the proposed capital adequacy requirement reductions were never implemented. However, the capital adequacy requirements for asset securities like mortgage-backed securities were considerably reduced by the Basil Committee - with drastic consequences.

  "By reducing the amount of capital banks had to set aside on their holdings of privately issued securities, regulators were essentially encouraging banks to purchase them. And by allowing lower-risk weightings for securities that carried specific grades from Standard & Poor's, Moody's, and Fitch Ratings, regulators were blessing these companies' ratings, forcing investors to rely on them whether or not they were worthy."

The ratings agencies:

  The failings of the ratings agencies are subjected to scathing criticism from Morgenson and Rosner.
 ?

  Fundamental data like borrower debt-to-income ratios, the type of property assessment relied upon and the identity of the loan originator were not required by the ratings agencies. They merely accepted uncritically the information provided to them by the securitization banks.

  "That the agencies preferred to await the information from issuers rather than seek it out seemed to indicate that they were not the cop on the beat that investors thought they were. Furthermore, their passivity in the information-gathering process practically guaranteed that they would not be ahead of the curve when problems erupted. They would be likely to downgrade only when loan woes became clear and apparent."

The subprime mortgage bubble expanded swiftly, generating lending fees, interest payments, loan purchase fees, underwriting revenues, and profits from retail lending for Wall Street. With years of artificially low interest rates, the Fed created a seriously distorted financial climate and incentives that further stimulated bubble mania.

  Nevertheless, the regulations of the Basel Committee continued to rely on the opinions of the ratings agencies. Asset-backed securities rated triple-A or double-A were classed with GSE-issued mortgage securities as requiring lower capital set-asides. Ignored was the lack of rating agency experience with respect to the new complex asset-backed securities. In November 2001, bank regulators in the U.S. followed the Basel Committee lead.
 ?
  The subprime mortgage bubble expanded swiftly, generating lending fees, interest payments, loan purchase fees, underwriting revenues, and profits from retail lending for Wall Street. With years of artificially low interest rates, the Fed created a seriously distorted financial climate and incentives that further stimulated bubble mania. Among many other things, artificially low interest rates provided - and still provide - powerful incentives for investors to abandon conservative bonds to seek the higher yields of mortgage-backed securities.
 ?
  Regulators not only accepted but demanded that banks take mortgage loans from riskier borrowers. The regulators also pretended that sovereign debt was risk-free. They thus forced banks to hold sovereign debt. Regulatory requirements forced big banks to all hold the same risky capital.
 ?

"In 2008 and after, every Fed rescue, every Fed solution seemed designed to benefit the major banks at the expense of the taxpayers."

  Collateralized debt obligations (CDOs) were diverse types of debt instruments that were supposed to be resistant to economic contractions. Nevertheless, they collapsed with the broader economy during the dot-com bust. American Express, for example, reported a $1 billion loss. However, this was ignored by the regulators. It was small potatoes compared to the mortgage-backed securities bubble already vigorously expanding.

   "The Fed's determinedly bank-centric approach in the years leading up to the 2008 credit crisis meant banks were dangerously undercapitalized just when they most needed large cash cushions to protect against losses. But even after it had become clear that the Fed had been wrong to push for relaxed capital standards, the regulator continued to take a pro-bank worldview in its various rescues of big banks hobbled by bad credit decisions. In 2008 and after, every Fed rescue, every Fed solution seemed designed to benefit the major banks at the expense of the taxpayers."

  In Washington, the "taxpayers" are a joke!

  Efforts to restrain predatory lending practices were strenuously opposed by the ratings agencies and subprime industry lobbyists like William H. Andrews, Jr.
 ?
  When the Georgia Fair Lending Practices Act was introduced by Georgia state senator Vincent D. Fort, actively supported by legal aid attorney William J. Brennan Jr., industry opposition was fierce. Gov. Roy Barnes nevertheless signed the bill. It imposed care and prudence requirements on everyone in the securitization process - even those separated by several steps from the mortgage originator. Countrywide and NovaStar Financial threatened to pull out of the state as a result of the legal risks imposed by the new law.
 ?
  However, the death blow for the law came when all three rating agencies said they would no longer rate securities that included Georgia mortgages. "Transaction parties in securitizations, including depositors, issuers and servicers, might all be subject to penalties for violations," S&P explained. The ratings agencies, too, were dependent on the massive new flow of mortgage securities for their recent substantial increases in ratings business profits. The Georgia Fair Lending Act was quickly watered down - and Georgia would be one of the hardest-hit states during the Credit Crunch.
 ?

Even after Enron and WorldCom, government regulations continued to rely on ratings agency opinions

 

The rating agency claim that they are mere opinion providers and occasional victims of accounting fraud is rejected by the authors by, among other things, pointing out that the ratings agencies have privileged access to confidential financial information from their clients.

  The abuses of the ratings agencies are explained in some detail by Morgenson and Rosner. The ratings agencies made substantial fees rating GSE securities, so they were especially kind to Fannie and Freddie. The highly leveraged GSEs were awarded high investment grade ratings by S&P up to a few weeks before the two GSEs collapsed. These ratings were clearly based on the implied taxpayer guarantees enjoyed by the GSEs - even though the Fed, Treasury and Barney Frank persisted in denying that GSE creditors were indeed protected. However, at least for purchasers of GSE preferred securities the guarantees proved illusory.
 ?
  In 2005, a Congressional effort to increase regulatory oversight of Fannie and Freddie was torpedoed by the ratings agencies. The ratings agencies threatened to downgrade the GSEs if anything diluted the special relationship between the GSEs and Congress. A downgrade would have meant vast losses on the $4 trillion of GSE debt held by private and government institutions worldwide.

  "By threatening to create titanic losses for holders of Fannie and Freddie debt -- and these holders included foreign countries as well as large domestic institutions -- the ratings agencies helped shift those losses into the future and onto the shoulders of the U.S. taxpayers."

  A few years later, when the markets demonstrated that they would not respond to such considerations, the government bailed out the creditors who had enabled GSE excesses and imposed all the credit losses on the innocent taxpayers.

  Enron had been highly rated by all the ratings agencies until four days of its collapse. As with the GSEs, the ratings agencies were blind to the risks retained from off-balance-sheet financial arrangements. WorldCom had been highly rated until a month before its collapse. Nevertheless, government regulations continue to rely on ratings agency opinions.
 ?
  Morgenson and Rosner summarize the origination and expansion of this vastly lucrative status that government regulators have bestowed on the ratings agencies. The rating agency claim that they are mere opinion providers and occasional victims of accounting fraud is rejected by the authors by, among other things, pointing out that the ratings agencies have privileged access to confidential financial information from their clients. SEC oversight of the ratings agencies was authorized in 2007 - clearly too little, too late.

  Without these defenses, the ratings agencies might be forced to reject their regulatory role or greatly expand their procedures. Government regulators lack the ability to do such assessments themselves. At the very least, alternatives would be very costly - and would still probably be of dubious effectiveness. The bottom line is that there is simply no efficient and effective way to relieve investors of their ultimate responsibility for doing their own due diligence - or for rejecting investments that they do not understand.

Goldman Sachs:

 

 

?

  The relationship between Fannie and Goldman Sachs was especially tight. In 1999, Johnson became a member of the Goldman board where he chaired the firm's compensation committee. Stephen Friedman, Goldman chairman from 1992 to 1994, became a member of Fannie's board in 1996 and sat on its compensation committee and other powerful committees.
 ?

Goldman executives, including David Rosenblum and Peter Niculescu, devised an accounting scheme that permitted Fannie to shift earnings from one accounting period to another to assure earnings growth after 2001.

  An OFHEO report charged Fannie's board with accepting earnings targets so low that they were sure to be met. These low targets were used to justify high pay and bonus levels for executives. Henry M. Paulson, Jr., became chairman of Goldman in 1999. As Treasury Secretary, he would later oversee Fannie's bailout during the Credit Crunch.
 ?
  Johnson sat on several corporate boards, and always chaired their compensation committees. Law suits later forced rescission of Johnson-approved pay packages at KB Homes and United Healthcare. Goldman executives, including David Rosenblum and Peter Niculescu, devised an accounting scheme that permitted Fannie to shift earnings from one accounting period to another to assure earnings growth after 2001. For these transactions, Goldman received $625,000 in fees.
 ?

Intentional ignorance in Washington:

  The practices and risks of Fannie and Freddie and their supporters were set forth in some detail in a 2002 Washingtonian article by Ross Gruberman. The article explained the threats Fannie employed to silence critics.
 ?

Fannie transparency, mission, business practices and culture were "best in class," Raines testified.

  The taxpayers are on the hook for hundreds of billions of dollars if Fannie and Freddie stumble, Gruberman presciently warned. Ralph Nader was one of the prominent supporters of the article.
 ?
  However, in congressional testimony, Raines cited a Fannie Mae report by Peter and Jonathan Orszag and Nobel Prize winner Joseph Stiglitz that evaluated the risk at less than 1-in-500,000. As usual, Raines could cite the vast support provided by Fannie and Freddie for homeownership policy. Raines also boasted of Fannies corporate governance. Its transparency, mission, business practices and culture were "best in class," he insisted. He was supported in these assertions by Standard & Poors which provided Fannie a corporate governance rating that was at that time unique.
 ?
  Lawmakers yet again failed to act. However, the Fed did explain why it refused to purchase GSE securities as part of its monetary policy operations.

  "Greenspan's Fed was no longer pussyfooting around the systemic risk posed by the government-sponsored enterprises. The Fed's paper said that its purchase of Fannie and Freddie obligations could 'inappropriately foster the ability of the G.S.E.'s to expand their operations; this expansion could further affect credit allocation and increase systemic risk."

  The Bernanke Fed has no such qualms. Bernanke has acquired substantially more than $1 trillion in mortgage-backed securities.

The Bush (II) administration was even more aggressive than the Clinton administration in dispensing with lending standard constraints. Down-payment assistance, "affordability products" mortgages with low initial interest rates and little relationship to equity in the home, and the Greenspan Fed maintaining 1% discount, federal funds and bill rates loosed a wild boom in housing and mortgage securities.

  The risks of catastrophic financial contagion created by Fannie and Freddie practices were explained in no uncertain terms in a 2003 letter from OFHEO head Armando Falcon to financial committee heads Richard Shelby (R-Ala.) and Michael Oxley (R-Ohio) and ranking Democrats Paul Sarbanes (D-Md.) and Barney Frank (D-Mass.). As the mortgage market bubble began its final most exuberant phase, these legislators did nothing - and the Bush (II) administration immediately demanded Falcon's resignation. As replacement, they nominated Mark C. Brickell. Brickell had been a high level J. P. Morgan executive and had lobbied successfully against regulation of over-the-counter derivatives trading.
 ?
  The Bush (II) administration was even more aggressive than the Clinton administration in dispensing with lending standard constraints. Down-payment assistance, "affordability products" mortgages with low initial interest rates and little relationship to equity in the home, and the Greenspan Fed maintaining 1% discount, federal funds and bill rates loosed a wild boom in housing and mortgage securities.

  Today, years of even lower artificial rates increase economic distortions. Defined benefit pension schemes are being undermined on a vast scale. Bond funds have become a vast bubble, and the Fed itself is now loaded with bubbly low interest rate bonds and mortgages whose value will plummet when interest rates are allowed to rise towards market levels. Business plans everywhere are at risk due to the absence of a realistic measure of their time-cost-of-money. Bernanke remains determinedly oblivious to all of this. All that matters to him is that interest rates remain down through the 2012 election cycle.

In 2006, Fed supervision head William Rutledge pronounced that Citi had made "significant progress" in improving compliance and risk management.

  The risks posed by "too-big-to-fail" financial institutions was also being determinedly ignored at the Fed. In 2005, Minneapolis Fed president Gary Stearn coauthored with Ron Feldman "Too Big To Fail: The Hazard of Bank Bailouts." However, the warnings were quickly countered by Frederic S. Mishkin of the Columbia Business School with a 2005 NBER working paper "How Big is Too Bid To Fail?" which was published in 2006 in the "Journal of Economic Literature." Mishkin touted the reforms of the 1991 FDICIA banking reform law and banking business practices as adequate safeguards. Mishkin was thereafter a Bush (II) appointee to the Fed Board of Governors. He resigned after the Bear Stearns collapse.
 ?
  The Fed also joined with the banks in pressuring the Financial Accounting Standards Board to adopt loose financial standards for "special purpose vehicles" called "variable interest vehicles" that allowed financial institutions to park major financial activities off their books. Such conduits had played a major role in the Enron collapse, and now they were allowed to become major repositories of subprime mortgage-backed securities that often could not be marketed elsewhere. Citigroup was a major employer of this practice.

  "The largest financial institution overseen be the Federal Reserve Bank of New York, Citigroup was headed by Sanford I. Weill. He was the deal maker who had gotten Robert Rubin and others in Washington to approve the merger of Citi and Travelers eight years earlier, even before they had successfully repealed Glass-Steagall. Rubin was a senior Citi executive, having joined the bank in 1999; he was a mentor to Geithner when the younger man worked under him at Treasury in the 1990s, during the Clinton administration. Now Geithner was president of the powerful and secretive New York Fed."

  In 2006, Fed supervision head William Rutledge pronounced that Citi had made "significant progress" in improving compliance and risk management.
 ?

Mozilo of Countrywide Financial:

  Angelo R. Mozilo of Countrywide Finance was already a prime driving force in the mortgage bubble mania.
 ?

Adjustable rate loans, liar loans, no document loans, no equity loans - all were pushed by Countrywide, while Fannie Mae cheered and pushed for more. But Countrywide was profiting by imposing high rates, costs and prepayment fees on naïve, low income borrowers. 

  Countrywide "Fast-N-Easy" loans required no documentation of the borrower's income or assets and accepted borrowers whose debt-to-income levels were as high as 50%. Countrywide was the leading lender to minority homebuyers. When Maxine Waters (D-Cal.) wanted lenders to dispense with even the 5% down payment, Countrywide obliged. Adjustable rate loans, liar loans, no document loans, no equity loans - all were pushed by Countrywide, while Fannie Mae cheered and pushed for more. But Countrywide was profiting by imposing high rates, costs and prepayment fees on naïve, low income borrowers. 

  "For all Mozilo's talk of wanting to help minorities and low income people secure a mortgage, the company's systems were designed to increase costs for precisely these borrowers."

  Consumer advocates like Robert Graizada of Greenlining Institute, a Berkeley, California nonprofit, complained that unsophisticated minority borrowers were provided with incomprehensible loan documents that trapped them in untenable mortgages.
 ?
  Fannie ardently supported Countrywide. Fannie charged Countrywide far lower guarantee fees than it charged Countrywide's competitors. Countrywide was supplying about a quarter of the loans purchased by Fannie. Countrywide earnings grew from $180 million to $2.2 billion in ten years, and its stock price rose five fold. In 2004, Countrywide became the nation's largest mortgage lender. Mozilo became fabulously wealthy.
 ?

  Mozilo adopted the same tactics against critics of his reckless lending practices as had Johnson at Fannie. Lobbying expenses rose from $60,000 in 1998 to $1.1 million in 2003 and $1.52 million in 2005. Along with GSE lobbyists, Countrywide lobbyists supported the exclusion of mortgage foreclosures from bankruptcy law protection.
 ?
  Political heavyweights Henry G. Cisneros and Robert T. Parry were brought onto the Countrywide board. Countrywide provided "VIP Program" loans at very favorable terms to Johnson, Richard Holbrooke, Donna Shelala, Alfonso Jackson, Clinton Jones III, Chris Dodd (D- Conn.), Kent Conrad (D-SD.), and Barbara Boxer (D-Cal.). The relatives and protégés of legislators like Robert Bennett (R-Utah) and Nancy Pelosi (D-Cal.) received VIP Program loans or were hired for executive positions with Countrywide.
 ?

  KB Home Mortgage was a Countrywide partner in the housing and mortgage business. It was run by Bruce Karatz. Johnson was on its board. Henry Cisneros was a partner in a disastrous affordable housing development that saddled HUD and the Federal Housing Authority with abandoned houses and massive losses from defaulted mortgages.
 ?
  In 2004, internal Countrywide audits
pursuant to HUD requirements showed a troubled loan rate of one loan in eight in six major market regions. Although HUD requirements called for corrective action, no such action was taken. Half a year later, the troubled loan rate in these markets reached almost one in five. Top management was warned by its risk-management team in 2004 of the danger to the company.
 ?
  When its business model collapsed during the Credit Crunch, Countrywide was acquired by Bank of America at a fire sale price. (Bank of America shareholders have not fared well from this and its other Credit Crunch acquisitions.) Mozilo ultimately paid a $67.5 million SEC fine - without admitting guilt - most of which was covered by Bank of America insurance.
 ?

The NovaStar debacle:

 

 

 

?

  NovaStar Financial, originated in Kansas by Scott Hartman and W. Lance Anderson, was one of the host of mortgage originators that rushed to get on the subprime gravy train. They expanded NovaStar nationwide.

  "Thanks to wheeler-dealer management, unscrupulous mortgage brokers, inert regulators, and a crowd of stock promoters touting its shares, NovaStar's stock market value climbed to $1.6 billion at its peak."

Numerous dubious NovaStar accounting tricks were evident to Cohodes, including overstated property assessments and gain-on-sale accounting of income that ignored default rates.

  Marc Cohodes, a Wall Street bear, knew a rat when he smelled it. To start the stock on its downward track so he could profit on his short sales, he began sending his information to the SEC, where it landed on the desk of Amy Miller, a young attorney with the enforcement division. Numerous dubious NovaStar accounting tricks were evident to Cohodes, including overstated property assessments and gain-on-sale accounting of income that ignored default rates. NovaStar lending practices were lax and permeated by hidden fees that often undermined the already shaky finances of its subprime borrowers. But the SEC would not act.
 ?

  It was state regulators in Massachusetts and Nevada in 2004 that first reacted - issuing cease and desist orders that drove NovaStar out of those states. A Wall Street article followed that resulted in a 30% drop in the NovaStar stock price. A HUD report sharply criticized NovaStar's business practices. Its leading mortgage insurer, PMI, stopped insuring its loans.
 ?
  NovaStar responded by hiring Lanny Davis, who had been Pres. Clinton's Monica Lewinski scandal special counsel. The SEC, however, remained clueless.

  "[Cohodes] sent them information about the company, including the NovaStar flyers indicating its anything-goes lending practices. He even went so far as to annotate the transcript of one of NovaStar's conference calls with analysts and investors, pointing out to the investigators the many inaccurate public statements made by the company's executives."

  Even the failure to disclose the adverse actions of PMI and state regulators and the HUD  report failed to move the SEC. Cohodes revealed that many of the branch mortgage-origination offices boasted of in NovaStar financial reports were phony. The SEC even failed to respond to a 2003 ABN AMRO Mortgage Group suit against NovaStar for fraud, breach of contract and negligence. The suit alleged phony borrowers and inflated appraisals in the NovaStar originated mortgages that ABN AMRO had invested in. Additional law suits followed.
 ?
  In 2004, even Lehman Brothers stopped including NovaStar mortgages in the mortgage-backed securities Lehman was packaging. Lehman due diligence disclosed undisclosed fees, and grossly overstated property assessments and borrower income statements. Amy Lewis, the young attorney handling the case at the SEC, went on maternity leave and was soon working both the case and diapers.
 ?

  Between 2004 and 2007, NovaStar raised more than $400 million from investors while the SEC dithered. The disclosure documents disclosed almost nothing of the firm's difficulties. However, lawsuits and market information were running against NovaStar and its stock price was in sharp decline - to $5 per share in 2007. The company imploded. Its shareholders lost about $1 billion in market value. Losses on the more than $10 billion in the mortgages it originated may be much more than $1 billion.

  "But NovaStar's cofounders did just fine. Between 2003 and 2008, both Anderson and Hartman made $8 million in salary, bonuses, and stock grants."

  Anderson still runs what's left of NovaStar as a property appraiser and financial services firm.
 ?

Bubble? What Bubble?

 

?

  Among the analysts who raised alarms about the blossoming housing and mortgage-backed securities bubbles were one of the authors, Joshua Rosner as early as 2001, and Dean Baker of the Washington D.C. Center for Economic Policy Research in 2002. Baker determinedly circulated his article among Fed analysts, but they just as determinedly ignored his efforts.
 ?

Greenspan and Bernanke cast doubt on the existence of an asset bubble and denied any Fed role in limiting asset bubbles. "[The] Fed was flying into the biggest credit storm in almost a century without instruments."

  After all, rising housing prices were viewed as a marvelous generator of wealth and economic prosperity by Greenspan and Bernanke. Morgenson and Rosner explain some of the gross weaknesses of the pertinent analytical methods used by Fed economists. Most Fed analysts determinedly discounted the existence of the housing bubble mania. In 2005, N.Y. Fed senior economist Charles Himmelberg with two co-authors explained in detail why there was no bubble in housing. Some Fed researchers generated such papers to satisfy Fed supervisors who wanted to counter increasing fears of bubble mania.
 ?
  N.Y. Fed senior economist Jonathan McCarthy and vice president Richard Peach provided a particularly egregious example in 2004. Their deeply flawed analysis was widely circulated, frequently presented at industry gatherings, and cited in the popular press which as always was eager to play its role as the primary conduit for authoritative misinformation. Timothy Geithner was at that time president of the N.Y. Fed.
 ?
  Greenspan and Bernanke cast doubt on the existence of an asset bubble and denied any Fed role in limiting asset bubbles. "[The] Fed was flying into the biggest credit storm in almost a century without instruments."

  Can the Fed ever be expected to bring a substantial asset bubble to an early and less damaging end?  After all, the Fed would expose itself to vicious criticism for the recession that would be sure to follow any action to end a major asset bubble - as happened in the early 1920s and even in 1929. See, Friedman & Schwartz, Monetary History of U.S., Part II: Roaring Twenties Boom - Great Depression Bust (1921-1933) and Meltzer, History of Federal Reserve, Part II: The Engine of Deflation (1923-1933).
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Paul Volcker needed the courageous political cover provided by Ronald Reagan to put the nation through the austerity recession of 1981-1982 required to bring the Keynesian inflationary decade of the 1970s to an end and establish the financial basis for the next two prosperous decades.

Creative accounting:

 

 

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  GSE accounting scandals began to emerge in 2002. They were diligently reported along with various GSE political and public relations maneuvers by the new "GSE Report," originated by lobbyist Anne Canfield of Canfield Associates. The report shed a disinfecting light on GSE activities. In 2003, heads began to role at Freddie Mac. OFHEO, now under Armando Falcon, was flexing some regulatory muscle.
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The National Association of Realtors and the National Association of Homebuilders threw their considerable lobbying weight against the regulatory reform legislation, characterizing it as a threat to affordable housing objectives that would hurt the poor and minorities. The legislation died.

  Fannie had to marshal Congressional supporters such as Robert W. Ney (R-Ohio) and Ed Royce (R-Cal.) to block new regulatory legislation that was supported by Sens. Chuck Hagel (R-Neb.), Elizabeth Dole (R-NC.) and John Sununu (R-NH.) and Rep. Richard Baker (R-La.). Reps. Barney Frank (D-Mass.) and Maxine Waters (D-Cal.) were especially active in blocking Bush (II) legislation designed to move regulatory oversight to Treasury. The National Association of Realtors and the National Association of Homebuilders threw their considerable lobbying weight against the legislation, characterizing it as a threat to affordable housing objectives that would hurt the poor and minorities. The legislation died.
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  A draft white paper from Fed economist Wayne Passmore assessed the costs and benefits of the implied taxpayer guarantees of GSE credit. His conclusions were similar to those of Marvin Phaup of the CBO in 1996. Borrower interest rates were reduced by only .07% by Fannie and Freddie activities, while the GSEs reaped annual benefits of between $119 billion and $164 billion, almost $100 billion of which were retained for shareholders, executive compensation and GSE activities.
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  Fannie again responded by drawing on its Congressional supporters for defense of its interests. A letter from the Congressional Hispanic Caucus emphasized the benefits from GSE programs and urged Greenspan to block publication of the paper. Sen. Chris Dodd (D-Conn.) also emphasized the benefits of GSE programs. However, the Fed published the paper anyway, and Greenspan added his heavyweight testimony in favor of stronger GSE regulatory oversight. He noted their interest rate and prepayment risk concentrations and paper thin capital cushions. He emphasized the likelihood of future difficulties and the benefits bestowed on the GSEs by the implied taxpayer guarantee of their credit.
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  After a scathing OFHEO report on Freddie Mac accounting irregularities, OFHEO received funding and Congressional support for a 2004 investigation of Fannie Mae accounting practices. The 2004 presidential election year would be a critical year for Fannie. It would be the year that market pressures would force the Fed to allow interest rates to increase, putting pressure on all manner of credit bubbles. By the end of the year, Raines would be out, "accused of a litany of ethical lapses and corporate chicanery that could make Enron executives blush." Sen. Kit Bond (R-Mo.) responded by requesting a counter investigation of OFHEO, but the tide had turned against the GSEs.
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"Much of the manipulation was designed to trigger executive bonuses. Indeed, of the more than $90 million in executive compensation received by Raines from 1998 through 2003, over $52 million was directly tied to achieving earnings-per-share targets through phony accounting."

 

  Although Jim Johnson was not named, Deloitte found that these irregularities were in existence during his administration.

  OFHEO hired Deloitte and Touche to examine Freddie's accounting practices. The lead accountant had led the Enron examination. Support was growing in the Bush (II) administration and the Republican Congress for stronger regulatory oversight. Fannie supporters Jim Johnson, Peter Orszag, Robert Rubin and Tim Geithner moved to become part of the political team for the presidential run of Sen. John Kerry (D-Mass.). If Kerry could get the Democratic nomination and win the 2004 election, all these problems could be made to go away.
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  By September, 2004, OFHEO was using an interim Deloitte report to pressure the Fannie board of directors to remove certain executives and directors.

  "OFHEO found, among other things, that Fannie had orchestrated a 'concerted effort' to develop and adopt accounting policies allowing it to spread income or expenses over multiple reporting periods; that it adjusted financial statements for the sole purpose of minimizing volatility and achieving desired financial results; that it forecast and managed unrecognized income and costs to maintain a 'cookie jar' of reserves for bad times; and that it applied discretion to the selection of market rate assumptions in order to achieve desired accounting results.
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  "Much of the manipulation was designed to trigger executive bonuses. Indeed, of the more than $90 million in executive compensation received by Raines from 1998 through 2003, over $52 million was directly tied to achieving earnings-per-share targets through phony accounting."

  Although Jim Johnson was not named, Deloitte found that these irregularities were in existence during his administration.
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HUD had bought toxic mortgage securities that had passed through Fannie without required reports. HUD investigation into Fannie nonprofit partnership offices found them basically corrupt.

  Fannie was now also getting grief from HUD, which had bought toxic mortgage securities that had passed through Fannie without required reports. HUD investigation into Fannie nonprofit partnership offices found them basically corrupt. "A disproportionate percentage of their money had gone to support lobbying efforts and the dispensing of favors in violation of their nonprofit status or reporting requirements."
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  Rep Richard Baker (R-La.) was able to force Fannie to disclose the compensation of its top twenty executives. Fannie did not surrender this information easily. It delayed as long as it could and hired attorney Kenneth Starr of Whitewater scandal fame who threatened Baker with criminal and ethical proceedings if the information was released, but the crap had hit the fan. Even Barney Frank began retreating from his support for Fannie, but he was still insisting that the GSEs were well managed. "I think it serves us badly to raise safety and soundness as a kind of general shibboleth, when it doe not seem to be an issue," he stated.
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  By November, 2004, Fannie was being directed by its lawyers. It missed its deadline for financial statements and closed its public relations and lobbying efforts. HUD began circulating the OFHEO report among legislators. But the HUD inspector general was busy impuning OFHEO and its report.
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  Barney Frank released and supported the inspector general report. Frank told a reporter:  "The senior management of OFHEO appears to have run roughshod over the judgment of professional staff and seriously compromised OFHEO's credibility as a financial regulator." He asserted that a leadership change at OFHEO was "overdue." Sen. Kit Bond also blasted OFHEO and blocked an increase in OFHEO funding.
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  However, the SEC was now finally fully involved, and the HUD inspector general report had no legs. That December, SEC chief accountant Donald Nicolaiser blasted Fannie derivatives accounting practices. Raines finally had no counter move. Fannie suffered a $6.3 billion reduction in previously reported earnings. Multiple investigations were now in progress. Fannie stock hit the skids. OFHEO announced that Fannie was "significantly undercapitalized," and heads began to role - including Raines'.
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  However, Fannie executives were allowed to retire with munificent retirement packages. KPMG was removed as Fannie's auditor. OFHEO regulation was extensively strengthened. Nevertheless, Fannie and Freddie still were able to participate aggressively in the worst of the housing and mortgage bubble leading to their ignominious failure in 2008.

  "The taxpayer bailout of the companies, an event so many of its defenders in Congress had refused to believe possible, had occurred. Even after the accounting disasters at both companies, no criminal charges were ever filed against any of their employees or executives."

  Shareholder suits, however, are another matter. Of course, taxpayers are still paying the legal bills - in excess of $24 million - of Fannie executives Raines, Leanne Spencer and Timothy Howard.
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Wall Street:

 

 

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  The most prestigious firms on Wall Street were happy to reap the profits for providing the financing for the housing and mortgage-backed securities bubbles. These firms claim to be - and in many instances actually are - the smartest participants in the markets and could not help but be aware of the dodgy assets they were packaging for sale to clients.
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  Bear Stearns, Lehman Brothers, Morgan Stanley, Merrill Lynch and many smaller firms were active financial enablers of bubble-mania. However, none were more cynical in their involvement than Goldman Sachs, which by the middle of the last decade was betting against the securities it was selling to clients. Its extensive arrangements with mortgage originator Fremont Investment and Loan and its chairman James McIntyre is described at length by Morgenson and Rosner.
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  When interest rates began to rise in 2004, Wall Street was propelled into more creative, higher risk practices to maintain profits. By 2005, Fed interest rates were 4.5%. Interest only mortgages and negative amortization loans increased from 6% of originations in 2003 to 29% in 2005. No document loans and liar loans that required no proof of asserted income or asset holdings soon amounted to 45% of subprime loans. 40% of these loans were for more than the value in the home, locking borrowers into their high cost loans.
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  However, by 2005, there was growing unease among some of the more observant investors. PIMCO's Scott Simon warned that his mortgage-backed securities unit was reducing its exposure to the lower grade segments of CDO pools. By the fourth quarter, profit at Freemont and other aggressive originators was plummeting. By 2006, the independent due diligence firms were confidentially reporting to their Wall Street clients that huge numbers of loans - as much as 60% of a mortgage pool - didn't meet underwriting standards.
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  This created a conundrum. If the originators were forced to take these mortgages back, the originators would be bankrupted and the lucrative mortgage security market would be ruined. Instead, the Wall Street packagers forced originators to accept enormous discounts on originator fees. Protective language inserted in their massive prospectuses included the lawyerly boilerplate: "The pool may contain underwriting exceptions and these exceptions, at times, may be material." By midyear, 2006, with default rates soaring, Wall Street was finally slamming the brakes on the riskiest lending practices.
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    Regulators issued new guidelines on subprime lending late in 2006. The ability of the borrower "to make payments over the life of the loan" should be considered. Regina Louise of the Mortgage Bankers Association blasted the guidance as regulatory overreach and a threat to affordable housing objectives. Comptroller of the Currency John Dugan even at this late date downplayed the threat to the banking system of the mortgage mania. However, by 2007, ratings agencies were forced to severely downgrade CDOs loaded with nonperforming loans. Investors were abandoning the collateralized debt obligation (CDO) market.

  "While Goldman's salespeople were busy bundling and selling as many Fremont loans as they could, executives inside the firm were scurrying to off-load mortgages that were still on their books. It was a race against time inside Goldman in early 2007, as internal e-mails produced to Congress show. The paramount goal was to get rid of toxic mortgages."

Wall Street "greed and self-interest took the mortgage mania to heights -- or depths, depending on your view -- it could not possibly have reached without Wall Street's involvement. And in so doing, Wall Street helped propel world financial markets to the brink of collapse."

  Warning of the impending CDO market meltdown was provided in February 2007 by author Joshua Rosner with Joseph Mason. Goldman began taking write-downs on toxic mortgage assets, and began trying to get originators like New Century, WAMU and Freemont to take them back "as there seem to be issues potentially including some fraud at origination, but resolution will take months and be contentious." As Goldman continued to push massive amounts of subprime mortgage securities out to investors, its traders were betting the investors would be massive losers.

  "While nobody mistook Wall Street banks for charity organizations, the degree to which these firms embraced and facilitated corrupt mortgage lending was stunning. Their greed and self-interest took the mortgage mania to heights -- or depths, depending on your view -- it could not possibly have reached without Wall Street's involvement. And in so doing, Wall Street helped propel world financial markets to the brink of collapse."

The bubbles burst:

 

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  Even as market collapse proceeded, Bernanke and Geithner at the Fed remained clueless. Along with Paulson at Treasury, they played the confidence game that March, providing authoritative assurances that mortgage market problems could be contained.
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  However, a suit by the California insurance commissioner and an FDIC cease and desist order doomed Freemont. Insiders like chairman McIntyre offloaded Fremont stock and stuffed employee retirement accounts with it. New Century went bankrupt, but Fremont took another year to die a lingering death. Bear Stearns, Fannie and Freddie, Lehman Brothers and AIG Group failed in 2008, costing taxpayers hundreds of billions of dollars.

  "In addition to beggaring the American people, the twin rescues of Fannie and Freddie made liars out of many people. First among them was Johnson, who claimed that Fannie would never cost the taxpayers a dime. Barney Frank, Fannie's ardent supporter, was also proven wrong in his assessment that the company posed no threat to the public."

  They demonstrated how a well-meaning industrial policy like the homeownership policy could be corrupted into something that could poison the global economy. However, most of the malefactors have simply moved on, sometimes to bigger and better things.
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Malfeasors:

 

 

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  Most the miscreants avoided damage to their careers or fortunes. Morgenson and Rosner mention Treasury Secretary Timothy Geithner; Obama national security adviser Tom Donilong; New York Governor Andrew Cuomo; William Daley, now White House chief of staff; and Thomas R. Nides, who was a State Department nominee as of the writing of the book.
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The Dodd-Frank reform legislation fails to protect taxpayers.

  Two prime miscreants, Chris Dodd and Barney Frank, sponsored Washington's legislative reform response. Its fifteen hundred pages, however, fail to protect taxpayers. There are no size reductions required for too-big-to-fail institutions. These institutions earn private profits from the valuable taxpayer guarantees of their credit. Nor did the legislation increase the accountability of their executives. Fannie and Freddie remain on their taxpayer life-support with costs in excess of $140 billion and rising. Barney Frank was still denying that Fannie and Freddie played any role in the Credit Crunch crisis.

  Others who faired well include:
  • Jim Johnson, Brookings Institution trustee emeritus, board member of Target and Goldman Sachs.
  • Robert Zoellick, president of World Bank.
  • Robert Rubin, trustee Brookings Institution, trustee and counselor for hedge fund Centerview Partners.
  • Larry Summers, Harvard economist, resigned from Obama National Economic Council in 2010.
  • Roger Ferguson, chief executive officer of TIAA-CREF pension fund.
  • Stephen Friedman, chairman of Obama Intelligence Oversight Board.
  • Peter Niculesco, partner in risk management firm CMRA.
  • Peter Orszag, vice chairman Citigroup.
  • Robert Pearl and John McCarthy, remain Fed economists.
  • David Rosenblum, remains at Goldman Sachs.

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