Being a political junkie I'm on a lot of mailing lists. A day hardly passes when my mailbox doesn't contain something "political" from one or more advocacy groups. A recent arrival provides a good example of how the right has a problem sorting out facts from fiction when it comes to factors that caused the current financial crisis.
I received the Spring 2009 issue of Cato's Letter published by the nonprofit organization bearing the same name. Of course, this is a "non-profit" that many "for-profit" capitalists like to support because of their unfettered advocacy of free-market economics, limited to no government intervention in the markets, and some civil liberty advocacy thrown in for window dressing.
The current issue of the newsletter contained an article titled "In Defense of Doing Nothing" by Jeffrey Miron. Jeffrey's Widipedia page tells us that he is an outspoken libertarian, former chairman of the Economics Department at Boston University, and currently a professor at Harvard. Quite impressive.
In his Cato Letter article Jeffrey claims that among many factors leading to the current banking and financial crisis, the primary cause was government programs to encourage new home ownership. Miron discusses what he calls "mild interventions" by government to create more first-time homeowners. Then he delivers the kicker. Here are his own words:
"Over time howerver, these mild interventions began to focus on increased home ownership for lower income households. In the 1990s the Department of Housing and Urban Development ramped up pressure on lenders to support affordable housing. In 2003, accounting scandals at Fannie and Freddie allowed key members of Congress to pressure these institutions into substantial risky mortgage lending.. By 2003-2004, therefore, federal policies were generating strong incentives to extend mortgages to borrowers with poor credit characteristics. Financial institutions responded and created huge quantities of assets based on risky mortgage debt."
This exact quote from Miron's article is a text book example of how the right wing invents a distorted reality and gives it credibility by using a non-profit think tank and the presumed expertise of a professor to make it the commentary of a "expert" in the field. If a Harvard professor said it, it must be true. Harvard professor or not, I think we need to look at some facts.
In his new book "The 86 Biggest Lies on Wall Street" author John Talbott described the 2003 versions of Fannie and Freddie as "over-extended and poorly managed." The worst part of the housing bubble, the part that was created by those "huge quantities of assets based on risky mortgage debt" occurred between 2003 and 2006. Fannie and Freddie were largely on the sidelines during this period. Think about that. During the period when most of the questionable loans were made, Fannie and Freddie were on the sidelines.
Further, those "newly created assets" were actually were pieces of paper known as Collateralized Debt Obligations (CDOs). This is a fancy name for a bundle of sub-prime and other loans packaged up and sold to hungry (some might say greedy) investors looking to rake in big profits. Here's the kicker. According to Talbott, loans backed by Fannie and Freddie were, by definition, not sub-prime because they were basically insured.
More importantly, CDOs where Wall Street's invention pure and simple. No government agency pushed the financial industry to create this tool for speculation. Further, no government institution pressued private bond rating agencies to blindly give their seal of approval to such investments. In this case, Wall Street did it to itself. Unfortunately, they were able to use their influence to send the taxpayers the bill for bailing them out.
When you realize this it becomes clear that Miron's whole thesis is claptrap. The big joke in all this is the notion that Fannie, Freddie and other government institutions were pushed by liberal politicians to make risky loans. In fact, almost the exact opposite was true. Both institutions engaged in heavy lobbying, and made over $150 million in campaign contributions to members of Congress to, as John Talbott suggests, get less, not more, regulation and oversight from the government. The government didn't push Fannie and Freddie to do anything. But the execs of these two private "for profit" companies did use their enormous financial power to keep regulators at bay.
This explains how myths and distortions work their way into daily discourse among pundits and politicians and then work they way down and often become part of the public's perception of "conventional wisdom." Even the term "sub-prime" is often viewed in the wrong context. The common perception is that a sub-prime borrower is someone who had lousy credit, lied on a credit application, or for some other reason was not worthy of a "real mortgage" so had to go the "sub-prime" route.
The truth is sub-prime borrower could be someone with decent credit who simply wanted a lower down-payment. In other words in return for making a loan with less money down, the lenders charge a higher rate of interest, usually three percent. The banks simply charge more for assuming more risk in the form of a lower down payment. Admittedly, this is one example. My point is that sub-prime doesn't signal a load made to appease some government agency.
To put it in focus. During the pre-recession real estate boom, the biggest part of the "bubble" that has now burst, occurred in prosperous communities where $250,000 homes skyrocketed to $300,00, $350,000 and above. Or in communities where $600,000 and $700,000 homes were suddenly selling for $900,000 and $1 million+.
Almost none of this had anything to do with government incentives to create first-time homeowners. It had a lot to do with government's failure to responsibly regulate key financial institutions and reign in speculative derivitives like CDOs that actually encouraged the real risky loans.