William Hamilton – Financial turmoil: This too shall pass
September 23, 2008
Encouraging home ownership is good government policy. Homeowners view themselves as stakeholders in the greater community and are less likely to want to overthrow the government whose chief function is (or, ought to be) to keep them safe in their persons and their property.
So, in 1977, with the best of intentions, the Carter Administration decided to force lending institutions to accept more risk when deciding who would be approved for home loans. President Carter, with the support of a Democrat majority in Congress, created the Community Reinvestment Act. The purpose of the Act was to provide credit, including home ownership opportunities, to minority populations and to make commercial loans to small businesses. The Act ordered lending institutions to make loans throughout their entire market area and prohibited them from cherry-picking the upscale end of their markets.
After President Clinton strengthened the enforcement provisions of the Act, lenders felt Uncle Sam pressuring them to ask for less and less in down payments, to ask for less and less collateral or even none at all. Lenders who compiled were rewarded with lower cash-reserve requirements and access to funds at lower rates than lenders trying to adhere to more prudent lending requirements. In other words, Political
Correctness was substituted for prudent lending decisions. Thats the first reason for the current mortgage mess.
The second reason belongs to President Johnson who re-created Fanny Mae and created Freddie Mac as government-sponsored-entities (GSEs), affording both GSEs a low-cost, line-of-credit from the U.S. Treasury, exemption from taxes and zero oversight by the Securities and Exchange Commission (SEC).
The third reason for the mortgage mess is the 1999 repeal of the Glass-Steagall Act of 1933. Glass-Steagall prohibited commercial banks (that make home-mortgage loans) from doing business with stock brokers and/or investment banks. The repeal was passed by a Republican majority in Congress and signed by Democrat President Bill Clinton. As a result, those shaky home mortgages began to be used by go-go stock brokers and investment bankers to collateralize exotic investment instruments that they sold to investors around the world.
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Naturally eager to earn more commissions and fees, some of the lenders sold shaky loans upstream to brokers and investment banks that bundle loans and then sell them higher up the line to even larger bundlers. Realizing that they were holding a lot of risky loans, the larger bundlers turned to large insurance companies, like AIG, to underwrite some of their risk. But no matter how sophisticated or exotic the investment-banking instruments, they ultimately rest on borrowers making their monthly mortgage payments.
In the short run, the government achieved its noble social goal of putting a lot of folks into home ownership. But, in the long run, too many of those folks did not have the income and/or money-management discipline to make their monthly payments.
Others experienced bad luck, health problems or divorce, and could not make their payments.
Despite their obvious mismanagement of Fannie Mae, former Fannie Mae CEOs, James A. Johnson and Franklin Raines each bailed out with golden parachutes of $21 million and $25 million, respectively. In recent years, the two largest recipients of Fannie Mae and Freddie Mac campaign contributions have been Senate Banking Committee Chairman, Chris Dodd (D) and Senator Barak Obama (D).
Johnson, who delivered over $200,000 as an official campaign-contribution “bundler” for Senator Obama, was named to head Obama’s vice-presidential search committee. But, after he was implicated in the Countrywide Financial scandal, Johnson resigned.
In the weeks ahead, we will probably see a new version of the Resolution Trust Corporation (RTC). It will sell off the physical assets (homes and office buildings) that underlie the non-performing mortgages. As was the case with the RTC, the U.S. government will eventually net a big profit. The turmoil will pass. And, once again, the second mouse will get the cheese.
William Hamilton, a syndicated columnist and a featured commentator for USA Today, worked 24 years ago as the principal assistant to the head of Lehman Brothers Public Finance.
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