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  • Morning Bell: A Vicious Cycle of Their Own Making

    In what some observers are calling a reshaping of Wall Street, two of the world’s largest investment banks, Merrill Lynch and Lehman Brothers, are set to disappear. Lehman has announced it will file for Chapter 11 bankruptcy protection, and Merrill Lynch was bought by Bank of America. For all the complicated financial instruments and relationships involved in the current financial turmoil, the underlying cause is still relatively simple: the bursting of the housing bubble.

    One market strategist told The New York Times: “We are in the grip of a vicious circle and the only thing that to me will break that is for home prices to stop going down.” The most dangerous thing we can do right now is to assume that massive government intervention is needed to shore up home prices. After all, massive government intervention is what caused the housing bubble in the first place.

    Fannie Mae and Freddie Mac were created by Presidents Franklin D. Roosevelt and Lyndon B. Johnson to make homes more affordable for Americans. They accomplish this by buying, repackaging and then selling home loans that other institutions make, thus freeing institutions to offer more loans. Contrary to what some defenders of big government assert, Fannie and Freddie were also key players in the subprime mortgage market. In 2004 alone, they bought 44% of all subprime securities. Every dollar that Fannie and Freddie gave to companies like Countrywide Financial for bundled subprime mortgages was another dollar Countrywide gave out in new subprime mortgages.

    When President Bill Clinton took office, Fannie and Freddie were viewed as “key” to Clinton’s plans to expand home ownership. The Washington Post reports: “The result was a period of unrestrained growth for the companies. … The companies increasingly were seen as the engine of the housing boom.” As the companies grew, conservatives repeatedly warned that their size posed a systemic risk to the financial system. As Sarah Palin put it, thanks to the implicit federal guarantee of their debt, Fannie and Freddie had become too big and too expensive to the taxpayers.

    But Fannie and Freddie pushed back hard, turning to friends on the left for protection. Former Walter Mondale and Barack Obama campaign adviser James Johnson led a fierce lobbying campaign to fight reform of Freddie and Fannie. Clinton administration OMB director Franklin Raines told investors when he was Fannie Mae CEO in 1999: “We manage our political risk with the same intensity that we manage our credit and interest rate risks.” Fannie and Freddie’s lobbying power over the left continues to be strong to this day. According to the Center for Responsive Politics, the top three recipients of campaign donations from Freddie and Fannie’s PACs and employees are all Democrats. From 1989 through today, Sen. Chris Dodd received $165,400, Barack Obama $126,349, and John Kerry $111,000. The Washington Post concludes: “Blessed with the advantages of a government agency and a private company at the same time, Fannie Mae and Freddie Mac used their windfall profits to co-opt the politicians who were supposed to control them.”

    Nobody wants to see anybody lose their home. The current Wall Street turbulence will not settle until home prices do. But before we move to some new massive government spending effort to prop up home prices at some artificial level, we should also remember what the historical record teaches us about the unintended consequences of well-meaning market interventions.

    Quick Hits:

    Posted in Ongoing Priorities [slideshow_deploy]

    26 Responses to Morning Bell: A Vicious Cycle of Their Own Making

    1. Slava, San Francisco says:

      It's not democrats that are on the verge of decriminalizing prostitution in San Francisco, but sex workers, their advocates, Wobblies, and other union activists.

    2. Frank Lowell Rice, P says:

      Good work keep them coming so we all can be informed properly,

      Thank you and please add my address to your subscription list.

      Frank Lowell Rice, Ph.D.

    3. Brutus Centinel - Al says:

      The drift toward a fully socialized society must be stopped now. You are precisely correct in your views. The invisible hand of the market can be harsh on those who become greedy, wouldn't you agree.

      If appropriate, I commented on this same situation at http://rightopposition.com/blog

      Thank you Heritage for your work!

    4. Michael J O'Bri says:

      Having 30 years experience in banking I watched in awe and bewilderment as banks and lending institutions made bad loans and then passed off these bad loans to Freddie and Fannie. Banks receive a fee for the origination of these mortgages, and then a fee for the on going service of the loan. Lending risks was transferred to Fannie and Freddie who gladly took on more and more risks as the housing market became saturated with sub prime loans. It was believed that the implicit guarantee would kick in as it did should capital issues arise with the GSEs. Loans are mathematical in nature, and work with the 5 Cs of credit; credit worthiness, character, capacity, collateral, and sometimes conditions. These principles have been guiding credit lending for centuries and under a democratic congress and President, [Bill Clinton], they decided to have government rewrite the credit book. A bad loan is a bad loan, and from experience it takes approximately 3 – 4 years for a loan to mature and go bad. Even with the sale of Merrill Lynch and the demise of Lehman Brothers this crisis is far from over. Additionally the word sub prime should be changed to bad lending since that is what it really is. One final little known fact is that the SEC in 2004 changed the lending ratio from 15:1 to 30:1 as the investment banks stated unequivocally that they understood and could control risks. These are the same people who have given the Obama – Biden campaign nearly $44 million in campaign contributions this election cycle. Other than a very painful period in our financial service industry and economy there is not that much that can be done as a quick fix. Like a bad cold it must take its course and with housing bills that are ineffective yet make us feel a little better, no magic pill can make the cold go away. One way to begin resolving the crisis is to vote out of office anyone who had anything to do with this mess, especially Schumer and Dodd, and let's not forget Obama and Biden. The XYZ investment bankers will be looking for new jobs and have more time to campaign for Obama. Let's hope they find jobs, but outside the Financial Service industry.

    5. Fred Haynes, Alexand says:

      Regarding the Wall Street Issues – You have done an excellent job in describing what has happened! However, what is missing is your deliniation of credible courses of action that need to be taken now to prevent more of the same.For example, the policies of forcing Freddi & Fanny to make unwise investments suggest a systemic Federal Policy of not looking after the Taxpayers funds. As a result of this policy there are other Federal Institutions operating under the same Policies and they have similar exposures — where is the oversight?? Who is accountable??

      Keep up the good work. But with your good reporting turn some of your incredable intellectual resources to identifying some actions "we" can take to fix the real problem — not just the symptoms. Regards, Fred

    6. Paul Rabin, Pawling, says:

      Yes, it is all Clinton's fault.

      Let me ask you, what does crack taste like?

    7. Sam, New York says:

      "Nobody wants to see anybody lose their home." But then why attack the institutions that have made it possible for millions of Americans to own homes in the first place? Also, why, if they were created by FDR, are they only having trouble now? Isn't it because the government took their hands off the wheel, deregulating securities markets and lending rules for banks? I'm willing to buy that the Dems are responsible, but it ain't the New Deal side of their party, it's the side that's in bed with Wall Street.

    8. Pingback: ZEITGEIST

    9. Pingback: Defenders of Big Government Spawned Mortgage Crisis | OpenMarket.org

    10. Luddhunter, Hermosa says:

      The bad idea at the core of this miserable tyrannical episode is egalitarianism. In the name of fairness and compassion, both Republican and Democratic presidents and congressmen (Dems have more culpability) instituted via Fannie/Freddie a de facto second set of welfare teats to feed the runt piggies who still hungered for more "fair" housing over and above the explicit welfare teats of public housing, AFDC, food stamps, etc.

      It is not unlike the massive nationalizations of the USSR in the 30's and China in the 60's…demagogues get elected by fomenting class warfare, then centralize economic decision-making by regulation and force the private sector into transactions they would never do in a free market, then when systemic failure begins, rush in and pretend to be the hero by taking control.

      We must change the regulations to provide just enough oversight to make sure there is not overt discrimination in housing, but we must also let the runt piggies fail by objective, verifiable, race-independent criteria to get loans they should not qualify for. The teats of Mother Government should be reserved for true physical emergencies, fire, crime, injury, disease, and natural disasters. Any more than that is policy that leads to socialism, and massive governmental and oligarchical corruption. Only the Libertarians have a credible plan for reversing this quickening tyrannical trend we are on. Vote for Bob Barr to signal the next generation of congressmen to take liberty seriously.

    11. Pingback: Michelle Malkin » Black Monday update: AIG tries to borrow its way out of debt

    12. willis says:

      "I’m willing to buy that the Dems are responsible, but it ain’t the New Deal side of their party, it’s the side that’s in bed with Wall Street."

      You should be proud of Wall Street Sam, after all they are one of the institutions that made it possible for millions of Americans to own their own home.

    13. Pingback: Fausta’s Blog » Blog Archive » “A Vicious Cycle of Their Own Making”

    14. Pingback: Republican solution to financial crisis: blame the Democrats « Mercury Rising ??

    15. Pingback: Corruption You Can Believe In: Failed Sub Primes and Mortgage Fraud Lendors Funneled Money to Dodd & Obama the Most. Fannie & Freddie Gave $200 Million to Partisans-Most Went to Democrats! Dodd, Obama Among Top Recievers. Republicans Attempted to

    16. Pingback: A Housing Bubble Whodunnit…. « The Swine Line

    17. Pingback: We Swear » Blog Archive » Credit “Crisis” - figuratively. literally. irregardlessly.

    18. Pingback: Ravalli County News » Blog Archive » Managing “Political Risk” at Fannie

    19. Arthur White says:

      The "Vicious Cycle…." is good as far as it goes, but the root of the fiasco is in the

      Community Reinvestment Act of 1977, sponsored by Senator Proxmire, D-Wisconsin. It required evaluating lending institutions (banks) on their extending the "American Dream" of home ownership to what were marginally qualified applicants. Agents then were pressured to make more loans and too many succumbed by falsifying credit worthiness information. Clinton pushed it hard in the '90's. Mortgages were bundled and sold on up to Freddie Mac and Fannie Mae as something they weren't. FM and FM went along with it.

      The house of cards collapsed in August 2007 resulting in the current crisis. The economy

      is suffering because of it. Senator Kyl, Arizona, on the floor of the Senate several months ago, said that the blame 'belonged in this body right here'(or words to that effect).

      No Bush administration policy is to blame for this bad affect on the economy.

    20. Pingback: The real culprits of the Fannie Mae/Feddie Mac Failure.. - A Grym View

    21. Charles Hill says:

      According to the New York Times, Democrats blocked Bush’s Fannie Mae and Freddie Mac reforms so low income people with bad credit could buy houses.

      ''These two entities -Fannie Mae and Freddie Mac – are not facing any kind of financial crisis. The more people exaggerate these problems, the more pressure there is on these companies, and the less we will see in terms of affordable housing.'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee.

    22. Joanne Conrad, Genes says:

      I would like to know to what you are referring in stating "what the historical record teaches us about the unintended consequences of well-meaning market interventions."

      Perhaps you are referring to the politicians' activities on Fannie Mae and Freddie Mac, that are now, apparently, backfiring. This financial crisis is seeming to be traced all back to their malfeasances. No?

    23. Charles says:

      Democrats created the Fannie Mae and Freddie Mac problems years ago. They stopped ALL eforts at reform until it was too late. Now they are trying to blame Bush, McCain and Republicans, everyone but themselves. That's the Gods truth and here is the proof:

    24. topcat says:

      Is this site interested in a dissenting viewpoint?

      What I see most on display here is what I call Lawyerthink. By that, I mean, the desired answer is known at the outset, so great effort is put into working BACKWARDS from the desired conclusion for logic in support of it. In this case, the desired answer is "proof" that this most recent of marketplace trainwrecks is not a marketplace failure. In such cases, when all evidence seems to indicate otherwise, great leaps in logic are required to put the blame elsewhere -in this case on the government.

      Here, citations are made of a 'study' by the Heritage Foundation that concludes that government subsidies 'forced' market players into this problem. As if the Heritage Foundation could ever conclude otherwise and still sustain its funding.

      Such logic requires that we conclude all the marketplace players were essentially 'duped' into booking, selling, securitizing, rating, and insuring these loans despite what their own risk assessment methods should have told them about the quality of the loans. To me, that is a remarkably asinine conclusion. To believe this, a person has to believe that market players concluded a 'bailout' would occur early on, not at the stage that it has occurred. AIG's stock was at $2 by the time Paulson said he would bail them out. So what market player puts into his calculations that all is good so long as the government refunds him for the last nickel of his dollar investment?

      That makes no sense at all, and neither does the idea that the dot.com market bubble, and all its attendant fraud was also a product of governmental intervention. Kenny Lay, Bernie Ebbers, et al, acted of their own accord in defrauding investors, and this latest round of fraud follows on the heels of that round of speculation and fraud.

      This idea that such problems are a product of government intervention just don't hold water. Real truth seekers should instead ask what it is about our markets that have produced successive cycles of destabilizing, fraudulent, and irrational marketplace behavior. For those that think that markets are fundamentally rational and self-correcting, it's time to ask how come, over and over again, they never seem to fix themselves.

    25. Charles Hill says:

      Democrats in Congress and Bill Clinton relaxed lending stardards years ago so low income people with bad credit could buy houses with no downpayment, poor credit and no proof that there income was enough to afford the house.

      Just Google old newspaper articles or the Congressional Record.

      "A brief history of the Fannie Mae and Freddie Mac mess is in order. Back in the days when a Bank or Savings and Loan approved a home loan, they did so with lending standards that had historically led to only safe loans. They had to because they kept the loan and were responsible if it failed. These standards included 3 major parts.

      First, the mortgage payments could be no greater that a set percentage of your income, usually about 40 percent.

      Second, a down payment was required of about 10 percent or above so the new owner would immediately have some equity in the home.

      Third, A good credit rating was required to prove you had a history of paying your bills.

      Some adjustments could be made, for example people that had poor credit could get a loan with a larger down payment so if the loan failed, the bank could still resell the house and cover the loan."


    26. Pingback: Laigle’s Forum » Blog Archive » Plenty of shame to go around

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