The FCIC (Financial Crisis Inquiry Commission), the Commission of which Representative Phil Angelides (D-CA) was chairman, reached nine main conclusions as to the cause of the near credit collapse in 2008, not one of which cited the role played by Congress, prior Administrations, or Fannie Mae (FNM) and Freddie Mac (FRE). The Commission was comprised of ten people, five Senators and five Representatives. Six were appointed by Democrats and four by Republicans. It was like having the fox investigate the stealing of chickens.
Certainly the causes cited by Mr. Angelides played a role. Regulatory supervision was lax, as were corporate governance and risk management assessments. Homeowners took on more debt than was prudent, and investors bought mortgage securities without paying adequate attention to the risks they entailed. There was little transparency and government was ill prepared for the crisis. There was a breakdown in business ethics (assuming they ever existed), as well as in mortgage-lending standards. Over-the-counter derivatives played a part, and credit rating agencies – with ratings paid for by the seller – were disingenuous. Buoyant markets and sunny days led to an aversion to skepticism.
The findings were endorsed by all six Democrats, with no Republican in agreement. The conclusions, which were announced four years ago this month and which included a 27-page dissent from three of the Republicans on the Commission and an abbreviation of the fourth Republican Peter Wallinson’s more pointed dissent, were published that year. The New York Review of Books practically glowed, calling it “the definitive history of this period,” a questionable assessment, at best. Mr. Wallinson, now with the American Enterprise Institute, just released his version in book form: Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why it Could Happen Again.
What the Commission’s conclusions ignored was the role played by government. For decades, politicians had been anxious to increase the percentage of households who were homeowners, which had been stuck at 64%. The Community Reinvestment Act of 1977 was designed to encourage (some might use a stronger word) commercial and savings banks to help meet the needs of all the constituents in their neighborhoods and communities – to reduce or eliminate the practice of discrimination, what was known as redlining. In other words, banks were asked to take on more risk, but without the ability to price it into their products. In 1992, Congress passed a law requiring GSEs (Government Sponsored Enterprises) to purchase 30% of mortgages granted to low and moderate income homebuyers. The Department of Housing and Urban Development (HUD) later adjusted the percentage up to 56 percent. Mr. Bush, as we all remember, touted the benefits of homeownership – certainly a worthy goal, but one that comes with risk, a factor ignored by those trying to influence both behavior and lending practices.
In retrospect, it was unsurprising that Congress decided to act before the Angelides Commission made its report. The 2000+ page Dodd-Frank Wall Street Reform and Consumer Protection Act, ironically named after its two proponents, Senator Christopher Dodd (D-CT) and Representative Barney Frank (D-MA) who had done more than most to encourage the GSEs to take on more risk, was passed in July 2010, pretty much along Party lines and six months before the Commission made its report. “A crisis is a terrible thing to waste,” had advised Presidential advisor Emanuel Rahm shortly after Mr. Obama took office. Certainly, Mr. Dodd and Mr. Frank did not want anyone looking too closely at their relationships with the managements of Fannie Mae and Freddie Mac while they were still in office. Deciding that discretion to be the better part of valor, both chose not to stay in Washington – Chris Dodd leaving in 2010 and Barney Frank in 2012.
Despite claims from Congress and the Administration that Dodd-Frank, and its off-shoot the Consumer Protection Bureau, has made the world safer, the problem of “banks too big to fail” has made the system riskier. According to Forbes, the five largest U.S. banks control 44% of the industry’s $15.3 trillion in assets, up from 40% in 2007, and less than 10% in 1990. Glass-Steagall, the Act that had separated commercial banks from investment banks in 1933, was repealed in 1999 under the Gramm-Leach-Bliley Act during the Clinton Administration. No effort was made by the FCIC to revive Glass-Steagall, which would have been resisted by banks to whom size matters, but which would have been a sensible means of reducing risk.
In September 2009 Edward DeMarco was named acting director of the Federal Housing Finance Agency (FHFA), which has oversight over FNM and FRE. Mr. DeMarco, a career bureaucrat, assumed his job would be to help reform housing policy. However, when Mr. DeMarco began reining in the two GSEs, which had been bailed out with $188 billion in taxpayer funds in 2008, he ran up against private-sector businesses with vested interests in keeping the agencies viable and with those who in Congress and the White House who believed government’s role in mortgage insurance should persist. Mr. DeMarco left a year ago, and was replaced with the more compliant Mel Watt, a former Democrat Representative from North Carolina. In a speech last November to the American Enterprise Institute, Mr. DeMarco (now a Senior Fellow at the Milken Institute) applauded government’s role in aspects of the mortgage market, but criticized the fact that FNM and FRE had “enriched shareholders and managers, distorted capital markets, inflated house prices and threatened taxpayers.” As he rhetorically asked Mary Kissel in an interview in the Wall Street Journal last July: “Is providing leverage or loosening the underwriting standards to provide credit to households with little down payments and poor track records of managing credit really helping that family, or is it setting that family up for increased risk of failure?”
With Mr. DeMarco’s departure, adult supervision left the FHFA. In December, Fannie Mae and Freddie Mac, instead of being unwound, allowing for private insurance companies to assume risks now borne by taxpayers, announced that they would again promote homeownership. With an implicit guaranty from the U.S. government, they will purchase mortgages even where the down payment is as low as 3%, suggesting a 4% decline in the value of the home will place the borrower underwater. They did set criteria, however: The loans must be fixed rate; the buyers must be first-time buyers, have a FICO score of 620 (which places them in the fourth quintile – a poor credit risk), and the buyer must purchase mortgage insurance.
There is little question that the lessons of 2008 have not been learned, and that is the reason why this episode reminds us of the wisdom of Yogi Berra: “It’s like déjà vu all over again.”
The AEC’s fundamental goal is to promote a free, responsible and prosperous society. Through education and improving public understanding of key economic questions, the AEC promotes the idea of a free market economy and the ideal of a free society.