The Delinquent Twins of Financial Ruin
Paul Krugman and Elizabeth Warren are two of the most prominent progressive intellectuals of our era. Krugman is a Nobel Prize winner in economics who hails from the Economics Department of Princeton University and thinks he knows things that nobody else knows. Belief in poorly conceived economic theories does that. Warren is an undistinguished professor from Harvard Law School, albeit with a flair for righteous self-promotion. She is the Regulation Queen. She is informed less by the Constitution, and more by her muse, Lewis Carroll's Red Queen. As I watched her browbeat the hapless creatures sent before the Senate Banking Committee I half expected her to scream "Off with their heads!" The Red Queen believed in executions now and trials later. Warren was just so offended that the jails weren't bursting at the seams with mortgage bankers. Of course, she had no problem with Fannie and Freddie managers who bought the junk proffered by Wall Street. To be fair, Paul and Elizabeth didn't conceive Fannie and Freddie. They are just protecting their delinquent adopted progeny.
The entire left-wing propaganda machine is working overtime to blame evil profiteers in the private sector for the real estate bubble and ensuing financial unpleasantness. Conservatives blame the government chartered twins. Truthfully, blame is shared. The bankers were simply acting as crack dealers to the crack smokers, Fannie and Freddie. The crack in this case is a lawful commodity known as leverage. As with all drug economies, the buyers and sellers formed a symbiotic community. Neither group could have flourished without the other.
Recently, the leftist columnists and talking heads have been downplaying the roles of Fannie and Freddie. After all, they say, F&F didn't originate the bad loans. No, they just bought them from their co-conspirators in the investment banks.
Whether you are buying and selling loans or any other goods or services, you are creating demand for those loans or products. A deep and liquid market for a commodity tends to cause an increased supply. The originators of risky loans were just middlemen between the borrowers and the investors. Fannie and Freddie were the investors. The middlemen took handsome fees from the borrowers or "sellers," and then marked them up for the investors or "buyers." They were very good at their jobs, but the charge that they defrauded Fannie and Freddie is ridiculous.
Considering the incredibly high salaries and bonuses paid to the morons who managed F & F, you would think they could have found enough money in their multi-trillion dollar asset bases to hire somebody capable of doing the necessary math for due diligence. Gross negligence has never been grosser. They were not and are not widows and orphans deserving of protection from government nannies.
That math is easy enough to describe in a few words. No rocket scientists are needed here. The theory behind bundling risky loans is that the risk is diversified and thereby lowered. That works provided that the risk factors of the various loans are not highly correlated. The theory collapses if the component parts of the bundles share a major risk factor.
The worst thing that can happen to a collateralized loan is that the value of the collateral goes down a lot. The enemies of leverage are lower asset values. This is learned in finance kindergarten. Nobody passes Finance 101 without understanding it.
Since all low equity loans share the risk of a weak market for the underlying collateral, you must hope that fluctuations of individual asset values are statistically independent. But in this case the most important risk factor was a general decline in fundamental asset prices; namely, real estate values. Such declines have occurred frequently throughout history. By 2007, there were a few million too many homes on the market. Everyone in the industry knew or (a liberal favorite phrase) should have known the danger.
In the cynical and disingenuous words of Hillary Clinton, the dumbest smart woman ever to wield such power, who cares who fell down on the job or why? I leave it to others to explain the political pressure that caused the debacle. The fact is that by rewarding F&F executives for their temporary successes with huge nonrefundable bonuses and forgiving ultimate failures, the outcome was close to inevitable.
Barney Frank did have to endure a vicious tongue lashing from Bill O'Reilly. Poor befuddled Barney was so out of his depth as chairman of the House Banking Committee that he was as helpless as his namesake Barney Fife when his one bullet was misplaced or accidentally fired.
Modern finance appears hopelessly complex. But that is a lame excuse. Every derivative product is, at its core, just a vehicle for leverage. The politically connected leaders of Fannie and Freddie didn't bother getting a license to drive those vehicles. Maybe the written test and road test were just too hard. Or maybe they wouldn't even have passed the eye test.
As we barrel down the financial highway, now "protected" with "new" regulations written by clueless bureaucrats with a taste for the high life, it would be well to remember the warnings of our ancestors against excessive leverage. Unfortunately, the entire financial system of the world is based on fractional reserve banking -- a fancy phrase for leverage. The road runs through a minefield. Modern progressive economists like Paul Krugman and Elizabeth Warren think they know something more than the rest of us dolts. With Fannie and Freddie temporally discredited, who knows what new evil spawn will result from Paul's and Elizabeth's not so well-meaning efforts?