In the midst of our current economic crisis it is natural for many people to lay the blame at the feet of the most convenient targets; perhaps as an emotionally driven response to an emotion filled situation, but as Americans we would be better served to dig deeper into the details and let the facts we uncover be our barometer. It is then we can root out the chief perpetrators of our Fannie Mae & Freddie Mac crisis and start holding those officials involved accountable for their part in this crisis.
This commentary is not an exhaustive review of everything that led up to the collapse of Fannie Mae and Freddie Mac, but it does highlight many aspects that have been underreported. This information comes from a summary of a five part series recently published by Investor's Business Daily as well as other sources.
We face big fiscal problems in this country and there is no shortage of political incompetence from our elected representatives on both sides of the isle. There were also irresponsible choices made on both Main Street and Wall Street. I believe it is going to take some critical thinking on the part of all Americans to get us out of this fiasco. I believe we live in a great country, enjoy tremendous freedoms and have opportunities available to us that can be found nowhere else on this planet. With our freedoms come responsibilities, both as an individual and a citizen, and I am encouraging you to examine how our government works and why it may not be taking your best interests into account.
$700 billion dollar problems rarely happen overnight and as you will learn, this problem has been in the making for decades. The current credit market problems came to roost at the government sponsored enterprises, Fannie Mae and Freddie Mac. To understand how they were able to operate in a manner that allowed them to cause so much damage to our economy, we need to go back in history to President Jimmy Carter and 1977.
It was during that year that some well meaning Democrats in congress brought the Community Reinvestment Act (CRA) into law. Democratic Senator William Proxmire described the intention of CRA from the Senate floor as "to eliminate the practice of redlining by lending institutions." During the 70's, "redlining" was the term used to describe the practice of taking deposits from a low-income part of town and loaning the funds to higher-income areas. The practice left minority communities starved of capital for housing and needed to be addressed.
Community activists viewed the law as a necessary step to bring the American dream to low-income families. Initially the CRA was supposed to extend lending to poor areas based on principals "consistent with safe and sound lending practices." So far so good, but the latter provision was ignored as CRA was implemented and, as you will learn, later modified.
Regulators largely left policing of CRA to community groups like ACORN (Association of Community Organizations for Reform Now) and NACA (Neighborhood Assistance Corporation of America). During the process those organizations diverted billions of dollars from banks and lent the money in poor communities. But the process was not entirely altruistic; these organizations took in thousands of dollars in fees for every loan. Some of the loans even required recipients to become active in questionable community causes.
In 1994, the CRA was rewritten under the Clinton administration through his National Homeownership Strategy. The changes to CRA broadened the CRA in ways Congress never intended. Instead of putting the changes before Congress, Clinton ordered Robert Rubin to rewrite the rules in 1995. The rules in effect made it harder for a bank to get a satisfactory "rating" by CRA. If you did not loan enough money to diverse borrowers, your ability to expand or merge became more difficult. A favorable CRA rating is important in the banking industry. Banking is a highly regulated industry and virtually every major action requires the approval of some government entity.
Howard Husock, a scholar at the Manhattan Institute wrote, "Bank examiners would use federal home-loan data, broken down by neighborhood, income group and race, to rate banks on performance." Yet, those rules were not enough. President Clinton persuaded the Department of Housing and Urban Development (HUD) to double-team the issue. Andrew Cuomo, Clinton's HUD secretary made a series of changes to Fannie Mae and Freddie Mac that allowed them to get into the subprime loan market in a big way. Other rule changes allowed the quasi-government agencies to hold just 2.5% of their capital to back investments versus 10% for banks. This single change allowed the bad loan problem at Fannie and Freddie to get much bigger. Since Fannie and Freddie can borrow funds at much lower rates due to their government-sponsored status, banks poured billions of dollars into loans that required no money down and no verification of income. From 1994 to 2007 subprime lending surged from $35 billion to $1 trillion.
One of the regulators of Fannie Mae and Freddie Mac emerged in the 1992 Federal Housing Enterprise Financial Safety and Soundness Act. The Office of Federal Housing Enterprise Oversight (OFHEO) was an arm of HUD. From the very beginning OFHEO was essentially a toothless regulator because each year Congress had to pass its budget; a unique characteristic among financial regulators. It was relatively easy for Fannie and Freddie to keep OFHEO off their backs; they funneled $200 million to various political causes and community activists while donating to 354 political candidates of both parties.
There were warnings. In 1992, Republican Jim Leach of Iowa was on the floor of the house talking about the potential danger Fannie Mae and Freddie Mac posed to our economy. The Washington Post reported Leach warned that Fannie and Freddie were changing "from being agencies of the public at large to money machines for the stockholding few."
As the Clinton Administration came to a close, Treasury officials under the new Secretary, Lawrence Summers, became increasingly concerned with Fannie and Freddie. Undersecretary Gary Gensler in 2000 made a request to Congress to end their special status. Democrats were in an uproar and so were Fannie and Freddie, who at that time were headed by politically connected CEOs. "We manage our political risk with the same intensity that we manage our credit and interest rate risk," Fannie CEO Franklin Raines, reported to investors in 1999. Mr. Raines was forced out of Fannie Mae after it was found to have engaged in fraudulent accounting practices. He passed the incident off as mistakes by subordinates and paid $24.7 million to settle the case. The former aid to President Clinton was compensated to the tune of $91.1 million between 1998 and 2004 by Fannie Mae. Given the questionable management that led to its eventual failure, why would any politician want to have direct links with the previous CEO's, Franklin Raines and Jim Johnson, of Fannie Mae?
There are some that would like to pin the crisis on the GOP led 1999 Gramm-Leach-Biley Act which repealed the 1933 Glass-Steagall Act. The new law allowed commercial banks to participate in a much broader assortment of financial services essentially expanding their customer base. Many experts believe this actually helped lessen the current crisis. A quick review of events helps us understand why. Investment banks Bear Stearns, Lehman Brothers and Merrill Lynch all got into such deep trouble they were either merged with a commercial bank or filed for bankruptcy protection. Bank of American and JP Morgan Chase could not have come to the rescue if Gramm-Leach-Biley had not passed. It is fairly obvious that investment banks suffered more severe consequences as a result of the credit crisis and commercial banks like Bank of America, JP Morgan Chase, Wells Fargo and Citi Group that were able to hold up better due to their broader business base.
A study of the record of the Bush Administration shows a consistent effort to address the problems at Fannie and Freddie. In 2003 President Bush proposed what the NY Times called "the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago." His plan included a new regulator for Fannie and Freddie, one that would boost capital mandates and examine how they managed risks. Even after schemes at Fannie and Freddie to boost earnings were uncovered, Democrats killed the reform. "Fannie Mae and Freddie Mac are not facing any kind of financial crisis," stated Rep. Barney Frank, then-ranking Democrat on the Financial Service Committee. North Carolina Democrat Melvin Watt accused the White House of "weakening the bargaining power of poorer families and their ability to get affordable housing." According to the White House, President Bush tried no fewer than 17 times this year to raise the issue of Freddie-Fannie Reform. In 2005, a bill cleared the Senate Banking panel, but stalled due to Democratic and some Republican opposition. In September of this year, former Democratic President Bill Clinton weighed in saying Democrats have been, "resisting any effort by Republicans in the Congress or by me...to put some standards and tighten up a little on Fannie Mae and Freddie Mac."
Alan Greenspan in 2005 told Congress, "We are placing the total financial system of the future at substantial risk." That year, Sen. John McCain, one of three sponsors of a Fannie-Freddie reform bill, said "If Congress does not act American Taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system and the economy as a whole." Democratic Sen. Harry Reid, now the Majority Leader, accused the GOP of trying to "cripple the ability of Fannie Mae and Freddie Mac to carry out their mission of expanding home ownership." One determining factor in our elected official's fierce defense of Fannie and Freddie could be the huge sums of money donated for campaign funding. From 1989 through 2008, 384 politicians received funds from the two organizations. During that same period, the two government sponsored enterprises spent $200 million on lobbying and other political causes. In addition, their charitable foundations placed millions more with think tanks and questionable community groups. The two entities were also a favorite employer for out of work politicians. Regardless of what form (individual or corporate) taking large campaign contributions in recent years looks foolish for political candidates if they claim to have really knew the extent of the problems at Fannie and Freddie.
Throughout the crisis the media has been fairly successful in putting its own spin on the cause and effect of our current situation, often reporting what it wants us to hear rather than the facts we need to form our own opinion. I believe there is some corruption in both of our political parties. In the case of CRA, what started with good intentions ran amok by greed and objectives that were not realistic.