Commentary Magazine


Who’s To Blame?

Barack Obama would have us believe that lax regulation and deregulation in the form of the Glass-Steagall Act are at the root of the problem. He’s wrong on both counts.

First, as detailed by two AEI gurus, the answer is closer to home–or to the House and Senate, to be exact. The nub of the problem they argue in convincing fashion were Freddie Mac and Fannie Mae which jumped into the sub-prime mortgage market with abandon:

It is important to understand that, as GSEs [G0vernment-Sponsored Enterprises], Fannie and Freddie were viewed in the capital markets as government-backed buyers (a belief that has now been reduced to fact). Thus they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities. Their buying patterns and interests were followed closely in the markets. If Fannie and Freddie wanted subprime or Alt-A loans, the mortgage markets would produce them. By late 2004, Fannie and Freddie very much wanted subprime and Alt-A loans. Their accounting had just been revealed as fraudulent, and they were under pressure from Congress to demonstrate that they deserved their considerable privileges. Among other problems, economists at the Federal Reserve and Congressional Budget Office had begun to study them in detail, and found that — despite their subsidized borrowing rates — they did not significantly reduce mortgage interest rates. In the wake of Freddie’s 2003 accounting scandal, Fed Chairman Alan Greenspan became a powerful opponent, and began to call for stricter regulation of the GSEs and limitations on the growth of their highly profitable, but risky, retained portfolios.

If they were not making mortgages cheaper and were creating risks for the taxpayers and the economy, what value were they providing? The answer was their affordable-housing mission. So it was that, beginning in 2004, their portfolios of subprime and Alt-A loans and securities began to grow. Subprime and Alt-A originations in the U.S. rose from less than 8% of all mortgages in 2003 to over 20% in 2006. During this period the quality of subprime loans also declined, going from fixed rate, long-term amortizing loans to loans with low down payments and low (but adjustable) initial rates, indicating that originators were scraping the bottom of the barrel to find product for buyers like the GSEs.

When some Senators tried to rein in the GSEs, their Demcoratic patrons blocked the way:

In 2005, the Senate Banking Committee, then under Republican control, adopted a strong reform bill, introduced by Republican Sens. Elizabeth Dole, John Sununu and Chuck Hagel, and supported by then chairman Richard Shelby. The bill prohibited the GSEs from holding portfolios, and gave their regulator prudential authority (such as setting capital requirements) roughly equivalent to a bank regulator. In light of the current financial crisis, this bill was probably the most important piece of financial regulation before Congress in 2005 and 2006. All the Republicans on the Committee supported the bill, and all the Democrats voted against it. Mr. McCain endorsed the legislation in a speech on the Senate floor. Mr. Obama, like all other Democrats, remained silent.

Well, what about “banking deregulation”? That sounds ominous. Actually that’s the good part of the story–banks operated across state lines, offered new products and improved as financial institutions. You will note that, with the conversion of the last two investment banking firms, Morgan Stanley and Goldman Sachs, to bank holding companies, banks are once again king.

And don’t take my word for it. From the Washington Post:

Obama said McCain “has fought time and time again against the common-sense rules of the road that could’ve prevented this crisis,” neglecting to mention that his new brain trust on the crisis includes two Clinton administration Treasury secretaries, Robert E. Rubin and Lawrence H. Summers, who helped negotiate the deregulation of the financial services industries in 1999. In an interview on Friday, Rubin said the law, named after its now-retired congressional sponsors — Phil Gramm (Tex.), a top McCain economic adviser; Jim Leach (Iowa), who heads Republicans for Obama; and Thomas J. Bliley Jr. (Va.) — “had no impact, zero,” on the current crisis.

There is plenty to debate about going forward–the shape and very existence of the bailout plan–but voters should at least be clear about how we got into the present mess.