NY Times blames Clinton for crisis

[Silver Bullet]

New York Times blamed Clinton for what would be the upcoming mortgage crisis back in 1999

http://johnrlott.tripod.com/op-eds/FoxNewsBailoutDeb092208.html

The mortgage crisis has produced a massive case of political amnesia. That happens when one is trying to redirect blame for something that could cost up to $700 billion. Some who now claim that the mortgage crisis is the result of too little regulation saw things more clearly when so much wasn’t at stake.

The New York Times editorialized on Saturday that “This crisis is the result of a willful and systematic failure by the government to regulate and monitor the activities of bankers, lenders, hedge funds, insurers and other market players.” If you believe the Times or the Obama campaign, everything but government regulation is to blame for the crisis.
Yet, it is not just economists who were predicting these problems. For example, a September 30, 1999, article in the New York Times predicted exactly what has happened:

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people . . . ''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.'' . . .
Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.'' . . .

Indeed, during the late 1990s, the Clinton administration and Fannie Mae bragged about how they had lowered the standards required to borrow money for homes to increase borrowing by groups that otherwise wouldn’t qualify. Their goal of increasing minority ownership was surely a laudable one, but making others pay for the voters’ altruism has real costs.
As even the New York Times understood in 1999, as long as housing prices kept on going up there was no problem with this system. If someone couldn’t pay their mortgages, they could sell their property. There was no threat of default. However, a lack of down payments meant that people defaulted on their mortgages.

Unfortunately, these insights don’t fit the current political template. With just 43 days to the election, the New York Times and others want to be in sync with the Obama campaign’s attack on the Bush administration not having enough regulation. It particularly doesn’t fit the fact that McCain was criticizing Fannie Mae and Freddie Mac for years along the lines of the New York Times 1999 article. Ironically, in other articles, the New York Times described the Democrats as “important political allies” of these two government-sponsored enterprises.
The New York Times is right that “Taxpayers have every right to be alarmed and angry.” But they should read their old news articles to see whom they should get angry at.

Is the proposed bailout bill the answer?

$700 billion for the bailout is a lot of money. The costs so far of the Iraq war are probably even a couple hundred billion dollars less than that. But if the $700 billion wasn’t bad enough, it is on top of the giant bailout just announced a couple of weeks ago for Fannie Mae and Freddie Mac. The costs are likely to grow further when Democrats add on their demands to subsidize homeowners.
The argument is that something has to be done now. We're in a panic, and mortgages supposedly can’t be sold for what they are really worth. The fear is that with the value of assets so low, financial institutions will try to sell off their mortgage-backed securities, driving down the price of those assets and making financial institutions insolvent that would otherwise be financially viable.
What the government proposes to do is buy these assets when they are low, when people are panicking, and resell them later once confidence has been restored. Supposedly, the government could actually make money.

There are some real problems with this argument. First, even if most people are behaving irrationally and don’t understand the true long-run value of these mortgages, just like the government is proposing to do, others can make money by buying these assets at fire sale prices and reselling themselves once the crisis is past. In fact, if this panic explanation is true, there is a strong reason to believe that this desire to make money, to see the chance to buy low and sell high, would actually keep the price from falling very much.

McCain’s proposal on Friday to provide bridge loans would let the companies themselves decide whether this panic explanation is true.
If the government’s argument is right, one first has to assume that all those smart people in government are a lot smarter than people in the finance industries. Ironically, the government will be hiring private evaluators to determine how much the government should pay for these assets. Given that government regulation -- forcing mortgage companies to make loans that they didn’t want to make -- created this problem, it is not obvious why government officials should be so wise right now.

Increased stock prices after the bailout’s announcement isn’t necessarily evidence that the bailout is needed. Stock prices might also be rising simply because the government is promising to pay a lot for some worthless assets. If so, that is nice for stockholders of affected companies, but not so nice or necessary for the rest of us.

But for the sake of argument, let’s assume that only the government’s offer to purchase these mortgages can prevent panicked sellers from sending prices down. It still isn’t clear that you want to subsidize these companies. As the 1999 New York Times article noted and McCain has continued to point out, such subsidies create incentives for companies to take unjustified risks in the future. Imagine how your gambling behavior would change if the government promised to cover your losses and let you keep your winnings.

The government may also end up managing or owning these companies. Political considerations, not efficiency, will end up being the goal. A simple demand might be what company managers can be paid. But private shareholders have a lot better incentive deciding the costs and benefits of motivating managers than political constituencies who have little at stake in whether the company makes the right decisions.
Some parts of the proposed legislation released over the weekend are also worrisome. For example, at least in the first draft, the proposed power given to the Secretary of the Treasury would be unlimited and unchecked.

“Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”

It emphasizes the possible problems that can arise from drafting legislation too quickly.

Conclusion

Why do people put so much faith in government correctly solving this problem when the debate can’t even honestly discuss what caused it? With all the pressure to get things done quickly, it seems unlikely that things will be properly sorted out. With $700 billion at stake, let’s make sure that we really have a very good reason for spending the money.

*John Lott is the author of Freedomnomics and a senior research scientist at the University of Maryland.

This is one of the few times I’ve seen the Times say anything intelligent.  Congratulations, Times !

[Monkeyleg]

That wasn't the NY Times being intelligent, it was John Lott.

[MicroBalrog]

That wasn't the NY Times being intelligent, it was John Lott.

Or maybe Mary Rosh?

[Silver Bullet]

That wasn't the NY Times being intelligent, it was John Lott.

You are correct.  I was thinking of this text from the NY Times

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people .

where they identified the Clinton Administration as a cause of the risky mortgages to the poorer folks.

However, I also hear now that the problem with the bad loans is more about risky loans to the middle and upper class who defaulted than by the lower economic classes.  I need a little more confirmation on that point.  If true, that somewhat guts the point I was trying to make, linking Clinton's loans to the lower classes as the cause of the mortgage catastrophe. 

On the other hand, if the loans to the poorer folks are the primary cause of the mortgage crisis, then my original point is correct.

[MechAg94]

I think that is partly true.  There were people who were buying 2nd homes or real estate as an investment taking advantage of the easy loans and intending to turn over the property for more money.  Just because people have money, doesn't make them smart or mean they have any class.  :)

[lone_gunman]

So if what the Democrats and Clinton did was wrong, why didn't Bush and the Republicans fix it when they had the chance?

[Silver Bullet]

Why don't you ask them ?

[Zardozimo Oprah Bannedalas]

Indeed, during the late 1990s, the Clinton administration and Fannie Mae bragged about how they had lowered the standards required to borrow money for homes to increase borrowing by groups that otherwise wouldn’t qualify.

I seem to recall that those standards were lowered through Congressional action. The party in control of congress at that time... I think they had some kinda elephant for a symbol?

[Don't care]

Seriously now folks, what would be said if the President and the Congress made it plausible for the poor to buy a home get out of the projects or any other run-down rental property, and then took it away?

Talk about political suicide by those who would support such a thing.

[Silver Bullet]

I seem to recall that those standards were lowered through Congressional action. The party in control of congress at that time... I think they had some kinda elephant for a symbol?

That doesn't mean that more Rs voted for it than did Ds.

[MicroBalrog]

The problem is not limited to a given party.

[MGshaggy]

That doesn't mean that more Rs voted for it than did Ds.

Sorry, but Gramm-Leach -Bailey (which repealed major parts of the Glass-Steagall Act) was passed on almost straight party lines (53 Reps and one Dem for; 44 Dems against).  Clinton signed it, but with the provison included that banks/IBs/insurance companies wishing to consolidate under the GLBA could be denied if they didn't comply with the CRA.

Certainly the CRA and many of the questionable loans made under it were a part of the problem leading to the current crisis, but it wasn't the main factor and there were many other factors.  For example, had the aggregated and securitized debt of these loans been properly rated, investors would (or could) have avoided them or taken only the more protected senior tranches of the revenue stream.  Had the default swaps backing some of these CDO/CLO/ABS products been properly rated and the financial health of the issuer fully investigated, far less would be in circulation and putting banks in jeopardy of failing.

[Silver Bullet]

Interesting post, MGshaggy.  I'll have to look up the alphabet soup terms, though.   

You really nailed me with the vote count.  Maybe I can find out why Clinton signed it if it was almost totally a Republican item.

[MGshaggy]

Interesting post, MGshaggy.  I'll have to look up the alphabet soup terms, though

Sorry SilverBullet, here's a few...

GLBA = Gramm Leach Bailey act
CRA = community re-investment act
CDO = collateralized debt obligation
CLO = collateralized loan obligation
ABS = asset backed security
CDS = credit default swap/default swap
IB = investment bank/investment banking
MBIA, AMBAC = companies that provide insurance on bonds

A huge part of the problem as I see it was the deregulation that came as part of the GLBA.  Glass-Steagall was enacted in response to the great depression and created the FDIC.  It also created seperations between banks, IBs, and insurance companies to keep them from getting too involved in each other's business.  As I understand it, the reasoning for the seperation was to protect retail banks (and the FDIC insured deposits they held) from losses generated in another division of a financial services conglomerate.  Banks have to meet reserve requirements set by the Fed, while other parts of the financial services industry do not.  Thus under Glass-Steagall the FDIC insured deposits would be somewhat more protected from huge losses in another part of a company like Citi or Wachovia, such as their IB division.

Take AIG for example.  Their primary line of business is as an insurance company.  The$100bn+ losses they've sustained have all come from a small division in Endland writing credit default swaps (CDS).  While a CDS looks a little like an insurance product against a default on a financial instrument such as a CDO, its not pure bond insurance like a company such as MBIA or AMBAC would issue.  Additionally, one can get a CDS against a bond not even owned by the CDS holder making it far more speculative like an investment.  Now if AIG had also been into retail banking, the losses from their CDS plays would be placing strain on their capital reserves and their ability to meet their reserve requirements and depositor demands for their money.  If the company couldn't meet those demands, the FDIC is then put at risk.  As it turned out AIG's losses still put the FDIC in jeopardy because AIG had a huge book of CDS, many of which were held by banks.  Had AIG been allowed to fail, the losses would have spilled over to many banks which would have sunk quite a few (so FDIC would have had to come to their rescue).

What I think many people take for granted and forget about in this mess is the importance of FDIC.  When people talk about ridiculous things like giving the $700bn to every taxpayer as a stimulus check, they don't seem to realize that if the bank thats holding their money fails and FDIC is depleted, not only is that stimulus money not worth the paper its printed on, but their existing savings/deposits could be wiped out.  Further, if the FDIC fails and the government can't satisfy depositor demands, it will be seen by the international community as a sign the US is a credit risk.  That will lead to far less investment in US treasuries by foreign investment such as sovereign wealth funds, and that in turn, will have an enormous impact on the ability of the US government to function and remain a superpower (think Russia in the 1980's).

[MicroBalrog]

Adding to what MGShaggy said:

In the modern economy, the government functions as the sole issuer of money and a lender of last resort. This does not mean that there are no alternatives to this – economists have come up with a variety of alternatives to the system, most of them theoretical. But in the current monetary system, variants on which are played in every modern economy with the exception of Scotland, the government is expected to be able to come in and spend money to prevent the economy from crashing.

However, the downside to this is as follows:

When money inflates (and all of those steps are inflationary), it does not inflate across the board all at once. When a bail-out is given, the people who get it directly usually are able to spend the money at a higher value than what it eventually inflates to, and therefore they benefit from the inflation. Then the benefit is passed along like a bump on a carpet, but it eventually peters out. You can keep this effect (known as an inflationary boom) by passing out more and more money, but obviously you cannot do so forever. This is why many economists think we should only do it in emergencies.

However, as many people warned, the problem is that once you create a political culture where it is acceptable to give out X billion in loans or grants to 'save' the economy, it becomes acceptable for those people who will get the loans first to come out and claim their company is key and the market will fall if it's not bailed out. That is not a good thing because you, the average person, get taxed to pay for it, either directly or through the dollar inflating.