Commentary by Kevin HassettSept. 22 (Bloomberg) -- The financial crisis of the past year has provided a number of surprising twists and turns, and from Bear Stearns Cos. to American International Group Inc., ambiguity has been a big part of the story.
Why did Bear Stearns fail, and how does that relate to AIG? It all seems so complex.
But really, it isn't. Enough cards on this table have been turned over that the story is now clear. The economic history books will describe this episode in simple and understandable terms: Fannie Mae and Freddie Mac exploded, and many bystanders were injured in the blast, some fatally.
Fannie and Freddie did this by becoming a key enabler of the mortgage crisis. They fueled Wall Street's efforts to securitize subprime loans by becoming the primary customer of all AAA-rated subprime-mortgage pools. In addition, they held an enormous portfolio of mortgages themselves.
In the times that Fannie and Freddie couldn't make the market, they became the market. Over the years, it added up to an enormous obligation. As of last June, Fannie alone owned or guaranteed more than $388 billion in high-risk mortgage investments. Their large presence created an environment within which even mortgage-backed securities assembled by others could find a ready home.
The problem was that the trillions of dollars in play were only low-risk investments if real estate prices continued to rise. Once they began to fall, the entire house of cards came down with them.
Turning PointTake away Fannie and Freddie, or regulate them more wisely, and it's hard to imagine how these highly liquid markets would ever have emerged. This whole mess would never have happened.
It is easy to identify the historical turning point that marked the beginning of the end.
Back in 2005, Fannie and Freddie were, after years of dominating Washington, on the ropes. They were enmeshed in accounting scandals that led to turnover at the top. At one telling moment in late 2004, captured in an article by my American Enterprise Institute colleague Peter Wallison, the Securities and Exchange Comiission's chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's position on the relevant accounting issue was not even ``on the page'' of allowable interpretations.
Then legislative momentum emerged for an attempt to create a ``world-class regulator'' that would oversee the pair more like banks, imposing strict requirements on their ability to take excessive risks. Politicians who previously had associated themselves proudly with the two accounting miscreants were less eager to be associated with them. The time was ripe.
Greenspan's WarningThe clear gravity of the situation pushed the legislation forward. Some might say the current mess couldn't be foreseen, yet in 2005 Alan Greenspan told Congress how urgent it was for it to act in the clearest possible terms: If Fannie and Freddie ``continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road,'' he said. ``We are placing the total financial system of the future at a substantial risk.''
What happened next was extraordinary. For the first time in history, a serious Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.
Different WorldIf that bill had become law, then the world today would be different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest and most venerable institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed.
But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.
That such a reckless political stand could have been taken by the Democrats was obscene even then. Wallison wrote at the time: ``It is a classic case of socializing the risk while privatizing the profit. The Democrats and the few Republicans who oppose portfolio limitations could not possibly do so if their constituents understood what they were doing.''
Mounds of MaterialsNow that the collapse has occurred, the roadblock built by Senate Democrats in 2005 is unforgivable. Many who opposed the bill doubtlessly did so for honorable reasons. Fannie and Freddie provided mounds of materials defending their practices. Perhaps some found their propaganda convincing.
But we now know that many of the senators who protected Fannie and Freddie, including Barack Obama, Hillary Clinton and Christopher Dodd, have received mind-boggling levels of financial support from them over the years.
Throughout his political career, Obama has gotten more than $125,000 in campaign contributions from employees and political action committees of Fannie Mae and Freddie Mac, second only to Dodd, the Senate Banking Committee chairman, who received more than $165,000.
Clinton, the 12th-ranked recipient of Fannie and Freddie PAC and employee contributions, has received more than $75,000 from the two enterprises and their employees. The private profit found its way back to the senators who killed the fix.
There has been a lot of talk about who is to blame for this crisis. A look back at the story of 2005 makes the answer pretty clear.
Oh, and there is one little footnote to the story that's worth keeping in mind while Democrats point fingers between now and Nov. 4: Senator John McCain was one of the three cosponsors of S.190, the bill that would have averted this mess.
(Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist. He is an adviser to Republican Senator John McCain of Arizona in the 2008 presidential election. The opinions expressed are his own.)
To contact the writer of this column: Kevin Hassett at khassett@aei.org
Last Updated: September 22, 2008 00:04 EDT
Marty's :
I'd be pleased to counter this blatant piece of pure partisan, manufactured, political bullshit. And I won't do it in the sense of a "Marty Memo", but rather in a dispassionate, factual manner...and I invite debate on what I have to say. Let's start tearing this asshole a new asshole. For openers, Fannie & Freddie, Frick & Frack, F&F, did NOT cause our present troubles by 'exploding' (jesus christ, "bystanders injured in the blast" is such a corny metaphor and sophomoric...and a tip-off of a populist propagandist...what dreck!). The root causes of the massive problems we now face go back to the repeal of the Glass-Steagle Act. Enacted during the depression, Glass-Steagle served us, the economy and the proper functioning of markets for decades, and it this did quite well, having survived the test of some 70 years. It did this by primarily delineating those areas in which financial institutions, companies, were allowed to operate and what the responsibilities, limitations and duties of these institutions were, and WERE NOT, within their respective, defined areas of operations. "Free marketers", the vested money class of the country, represented for the most part by the Republican party, felt that Glass-Steagle, and other laws and regulations, hampered their philosophy and constrained those activities which they felt would more clearly open markets to the free, unfettered, natural inclinations of markets and economic policies that, allowed to be free and unregulated, would benefit them and make for a better America. Spearheading the effort of the Republicans to accomplish the overthrow of Glass-Steagle was Phil Gramm...a country hick, jerkwater school econ prof from Texas turned politician. After the Republican "contract with America", Gingrich's manifesto to himself, of 1994...Gramm went to work and in 2000 Glass-Steagle was repealed...this was followed by enactment of the Gramm-Leach-Blifel Act. What his act effectively did was to permit every Tom, Dick and harry in the financial, and other, industry(s) to create, and sell, any financial department and product they wished. You could walk into a bank, open a traditional savings account, a demand deposit account, a money market account, buy a CD, and also buy stock and insurance...as could Prudential Insurance. While many technical, market restrictions and regulations were modified, the real bugaboo was the lack of enforcement of extant regulations, after all, the Federal Reserve, the Treasury, the Office of Thrift Supervision, the SEC and the FDIC were all headed and staffed by Republicans...shades of Goodling at the DOJ...markets were booming, banks were booming, construction was booming so, what the hell, let the good times roll...and if a big Wall Street firm, in conjunction with banks, hedge funds and private equity outfits were designing complex derivative products, such as credit default swaps...there are presently $50 TRILLION worth out there...and trading billions of dollars "OTC"...off markets and totally unregulated...why, not to worry, "free markets always correct themselves". (All of this, all of it, was fueled by Greenspan's monetary policy....money didn't cost anything...as Jack Welch, the GE icon, said just today). My ass! Designed to allay risk, swaps and other derivatives actually increased risk...a little sub firm of a big investment firm, having total capitalization of a mere $4.5M...wrote default swaps on a UBS deal of $1.5BILLION...!!! Talk about leverage!!! When the subprime crap started to hit the fan....incidentally, tell me 1 in 1000 home buyers that would understand these terms of their loan...."Purchase of a $200,000 house for $400,000...no money down, no substantiating documentation, a 30 year interest only with an amortization term with a 7 year call, a 3.5% starting rate for 3 months, then a flat 5% rate for 9 months, then an adjusting series of 6 month terms pegged to the 3 month LIBOR or the 11th District COF or the 12 month constant rate of the 5 year Treasury Note, whichever is higher, a 14% cap with a 4 point max in any one adjustment period with a 2% floor on the downside in the same period. negative ammo, no assumption and a pre-pay penalty. 2 points out front, $9,000 closing cost, to be added to the principal of the loan balance." Frick & Frack did NOT make this loan...F&F never originated loans...banks and mortgage companies made these types of loans to people they knew, actuarially, could not pay them back...but they couldn't care less as they immediately sold the loan to a packager who, in turn, designed various 'CDOs', collateralized debt obligations, depending on tranches, slices, of risk and returns...who in turn sold them to institutions, other packagers, pension plans, insurance companies, etc...all over the world. F&F, of course, as the largest buyer of mortgage loans in the country, facilitated the process..and over leveraged themselves like everyone else...but they did NOT MAKE these loans. In fact, truth be known, F&F was rather conservative, relative to the practices of other firms. The asshole that wrote this piece mentions Fannie owning $388B of "high-risk" mortgage investments.....oooh! scary, those bastards!!!...but wait a minute....what constitutes "hifg-risk"? will an enormous 20% be NG?...if so, that is a paltry $76B......and even that poetion can be sold for something....and what % of $5 TRILLION does $388B represent? Peanuts!! And, this asshole goes on to say, as if he is Solomon himself, "...trillions of dollars in play (this ain't no game, kid) were only low-risk investments if real estate prices continued to rise." Hey Solly, no shit!! Did F&F drive house prices down? Asshole goes on to say, "Back in 2005, Fannie and Freddie were, after years of dominating Washington, on the ropes." Let's cut the bullshit...anything after 2000 is on the Republicans' watch. Period. No if, but, dog, rabbit...its the Republicans' shit we are in. Here goes the asshole sophmore..."legislative momentum", "world-class regulator" (where did he get this...thin air...and stop with the hyphens), "two accounting miscreants" "were less eager to be associated with them. The time was ripe. (for what?)." I think I'm going to puke. Asshole continues, "In 2005,6, 7, a blizzard of terrible mortgage paper FLUTTERED OUT OF THE FANNIE AND FREDDIE CLOUDS, burying many of our oldest and most venerable institutions," I now have dry heaves. WHAT mortgage paper, name it! WHERE did it FLUTTER to? WHICH 'venerable' institutions were 'buried'? In 2005. 2006, 2007...NONE!! The FEC has published the total contributions made by F&F to 354, repeat, 354 members of Congress in the past 18 years. Of the top 25 recipients of F&F money, 12 are REPUBLICANS. Let me repeat this, of the top 25 recipients of Freddie and Fannie money, 12 are REPUBLICANS and 13 are Democrats...which is to be expected of the party holding the chairs...and 25 is not divisible evenly. Not only did asshole fail to cite this stat, while he cites Hillary being the 12th largest recipient of F&F largess...he conveniently omits REPUBLICAN Senator Bennett from Utah who received $107,999, only 18K less than Obama..and Bennett is guaranteed not to be the next president....and is in the minority to boot! And why did asshole omit good ole Rep. Bachus of AL...the Representative recipient of either party that received the most amount from F&F...$103,300. Asshole also failed to mention, of individual contributions, Dr. Strangelove, McCain, received MORE money from them than harry Reid, the Majority leader of the gd Senate! A SIN of omission is no less an insult to God, and a passport to hell, than a SIN of commission! (I'm surprised asshole didn't have some God and Bible bullshit flutter into his gobblygook distortions and lies, to enhance his faux attempt at legitimacy). 
I couldn't agree with deflation fears more. We certainly have all the ingredients for a perfect deflationary recipe. Weakening global economies, decreasing inflation rates (save Zimbabwe), rising unemployment, rising govt debt, declining aggregate demand, the ongoing housing bust, incredible excess capacity and mountainous debt, decreasing collateral values and increased credit restrictions...and a finite, corrective monetary policy at the end of the string....as Keith Jackson was wont to say, 'whoa Nellie!' There is nothing in history that says we couldn't emulate Japan's decade long malaise.
