Kinder, gentler lending and the Panic of '08, Part II

There is a Canadian notion that America is the land of unfettered capitalism, where government dares not intrude in the natural course of economic events, and declines to police even the more bandit-like of business behavior. It is commonly found on college campuses, the CBC, etc., and I believed it myself once. But it turns out that there is a positively Canadian level of government intervention in the economy even in the post-Reagan United States, and particularly in mortgages and financing.

Far from hesitating to intervene in the economy for the protection of the poor and the destitute, the U.S. government has been overriding normal business practice in order to put poor folks into $100,000 homes, and effectively guaranteeing the gamble with taxpayer dollars. It is that massive government intervention which is at the root of this financial crisis -- not some pro-business deregulation, but affordable housing affirmative action.

It's bad form to be so partisan, but a disservice has been done to that unloveable bunch called Republicans, and in the spirit of this newspaper's mission statement about wrong not thriving unopposed, the record ought to be set straight. Republicans are being blamed for policies they never supported, while the very Democrats who championed the disaster are sought out for guidance. It is blaming the fire on the fireman, and entrusting the fire department to the arsonist.

And the blame ought not be put on either the borrowers or the lenders, who were only taking advantage of a perfectly legal -- and encouraged -- government-ordained system. That irresponsible borrowing and lending was precisely what the federal government had intended.

The federal government under President Clinton in the good-timing 1990s directed Fannie Mae and Freddie Mac to take on what would become $1 trillion in dodgy mortgages, and to spread the risk among other financial institutions, in order to meet their federal mandates for affordable housing.

Because Fannie Mae and Freddie Mac were creatures of the federal government, any financial outfit was happy to have their liability on its books, the assumption being that, if the bottom dropped out, the U.S. Treasury would be good for any paper with "Fannie" or "Freddie" on it. The reward may have been privatized, but the risk was socialized, in a perverse inversion of the principle behind trusting the market to make the best decisions.

Such deregulation as there was in this area had to do with an old chestnut from President Roosevelt's New Deal called the Glass-Steagall Act of 1933, which was repealed in 1999. That was a deregulation, sure enough, and one supported by Republicans, as well as President Clinton and Congressional Democrats. But allowing the combining of commercial and investment banking services as the Europeans do enabled neither subprime lending nor the over-leveraged securitizing that spread the subprime risk far and wide. The chief effect of Glass-Steagall's repeal here, in fact, has been to allow the formation of the few major financial institutions that are still standing.

President Clinton himself was not always so enthusiastic about this social engineering through government-mandated lending. Clinton in 1994 -- like President Bush in 2003 and Congressional Republicans in 2005-6 -- tried to fix the Fannie and Freddie problem while it was still fixable. Clinton's own account of what became of those attempted reforms may be the last word, as it is a noteworthy thing when Bill Clinton feels compelled to point a finger at his own side: "I think the responsibility that the Democrats have may rest more in resisting any efforts by Republicans in the Congress or by me when I was president, to put some standards and tighten up a little on Fannie Mae and Freddie Mac."

When it is occasionally conceded that Republicans opposed this mortgage monkey-business all along, the argument goes that they must be to blame nonetheless, because they controlled both houses of Congress for four of President Bush's eight years. It looks good on paper, but it's not the way things work in practice in the United States Senate.

Democrats have controlled the Senate for half of Bush's presidency, and the House for a quarter. And for the four years from '03 to '07 in which Democrats were minorities in both houses of Congress, they were never fewer than 45 percent of the Senate -- four seats to spare over the 41 percent necessary to effectively kill presidential initiatives and Congressional legislation. The Democratic minority's ability to deny cloture motions alone was enough to block reforms from consideration by the full Senate.

If all the keys to Washington are to be handed to this crowd who were still cheerleading for Fannie and Freddie as late as July, and who are even now blaming some imaginary deregulation for the failings in government direction of the housing and financial sectors, then it is difficult to see how the wreck can be put right before it has landed the advanced economies in a protracted contraction.

One day, the history of subprime lending and the Panic of '08 will be written, and it will bear little resemblance to the first draft, with all its "blame Bush" and "Republican deregulation" and "collapse of capitalism" boilerplate. It had precious little to do with President Bush or pro-business deregulation or even capitalism itself. It was government mandates to put poor folks into homes they could not afford, and effective government guarantees to financial firms for playing along with the racket, to bail them out at taxpayers' expense when the whole crazy social engineering project came crashing down.

Andrew W. Smith, Published in The Chronicle-Herald, Halifax, Nova Scotia

How kinder, gentler lending caused the Panic of '08

Today it's called "subprime lending," or, if you're of a more Marxist bent, "predatory lending." But back before the bubble burst, it was called "affordable housing." Today it's called "greed" and "corruption," but until the bottom fell out it was progress for "minorities and the poor."

Sloganeering has been a handy stand-in for understanding of this credit crisis. "Crony capitalism," "neocons," "politics of greed," and on and on. That may have been good enough for Soviet poster printers, but it does nothing to explain exactly what happened.

Between 2000 and 2006, the average home price in the United States rose by some 93 percent. It was the good times for that mania of these first years of the 21st Century: house-flipping. A fixer-upper might be bought for $100,000, renovated for $35,000, and re-sold for $200,000. But it was all too far, too fast. Inflation at that rate was insupportable, and the painful but necessary correction started in 2006.

In the boom years of '00 to '06, a fellow who found himself unable to manage his mortgage payments might simply put his house up for sale, and sell it within a few months for considerably more than he had paid for it. And the lender which had approved that bad mortgage was not much bothered by the borrower being a bad risk, so long as there was an out -- a quick turnaround in a market that could only go up.

But then, interest rates returned to more realistic levels. And the other side in the bargain -- the people who buy homes -- decided that home prices were getting to be higher than home values. Buying slowed, and the music stopped in the musical chairs game of moving from home to better home. New home construction slowed. Existing home prices deflated. Then the bad risk borrowers were back on the hook, and started defaulting. And finally the lenders and securitizers found themselves holding "bad paper."

It may fairly be said that conservatives had no problem at all with sellers and lenders playing the housing game and getting rich quick. And until 2007, the Bush Administration often touted the record numbers of home owners, and the new stake in America for millions which that homeownership represented. But there was nothing very conservative or capitalistic about lending to bad risks in the first place. That was a policy of progressives, leftists, and Democrats.

It all started with President Carter's Community Reinvestment Act of 1977, revised and enhanced in 1995 under President Clinton. The progressive set urged and mandated lax lending practices, particularly through Fannie Mae and Freddie Mac -- the two formerly quasi-governmental lending houses which accounted for the largest share of American mortgage holdings. The idea was to open homeownership to the sort of people who had traditionally been shut out of it, for the now clearly sensible reason that they were unlikely to meet their mortgage payments. Bad risks. Or, according to the CRA's supporters, "minorities and the poor."

The election-season fever-dream, that subprime lending was some Bush Administration/John McCain "neocon" ponzi scheme, is perverse. Fannie Mae and Freddie Mac are no friends of conservatives and Republicans. Their address books and campaign contributions skew in the other direction. And as it happens, the Bush Administration proposed that Fannie and Freddie be subject to "the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis," all of five years ago, in September of 2003.

This has been the way. The Administration tried to open domestic oil drilling in 2001 and 2005, when limited supply first started driving oil prices into troubling territory. The Administration made a Quixotic run at reforming Social Security in 2005, trying to move younger Americans off of Social Security dependence before the Baby Boomer retirement tab came due.

And cranky old John McCain was about the most vicious critic of Fannie Mae and Freddie Mac in American public life. In 2005, McCain co-sponsored the Federal Housing Enterprise Regulatory Reform Act, and assailed Fannie and Freddie as monstrosities, exposing the market and the taxpayer to untold risk.

But all these measures were blocked in Congress by a certain party which considers it a Golden Rule that any and every utterance and action by the president and his party must necessarily be wrong, stupid, and bad. The 2003 Bush Administration attempt to regulate Fannie Mae and Freddie Mac was received by the Fannie and Freddie Party as an assault on the poor, and on the good work of those two progressive friends of the little guy. Fannie and Freddie were "not facing any kind of financial crisis,'' and ''the more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.'' That, according to the now-Chairman of the House Financial Services Committee.

The true indictment against the Bush Administration is that they failed to fight and win those political battles, not that they didn't see the trainwrecks coming, or that they supported the status quo. They saw the problems clearly enough. But their proposed fixes were pronounced "dead on arrival," in the words of a Senate Majority Leader, and the Administration invariably dropped the issue and returned to fighting wars, or other more immediate concerns.

The Panic of '08 was not the product of some scam to take from the poor and give to the rich; it was the end result of government-directed "kinder, gentler" lending that spiralled into the stratosphere when it combined with low interest rates and the housing boom. But what's done is done. Now all that's left is to absorb the bad debt and restrict the bad risks -- as the U.S. government is doing -- and let America get back to business. And save the musty Socialist rhetoric for the museums.

Andrew W. Smith

Published in The Chronicle-Herald, Halifax, Nova Scotia