The Financial Mess: How We Got Here

"How can you vote Republican when they so messed up the economy?" a liberal friend screams at me with such vehemence that I had to put the phone a full arms length from my ear.  Of course, my friend never heard of the Community Reinvestment Act.  He is one of those mindless liberals who thinks that George Bush and the Republicans are responsible for everything from Global Warming to Hurricane Katrina to the attempted genocide of the entire black population of New Orleans. 

He claims to be informed but he doesn't remember those dire warnings going back nine years ago that the Community Reinvestment Act would eventually cause a major financial and banking crisis in this country.   

The Community Reinvestment Act was pushed hard by Bill Clinton, although it originated under Jimmy Carter.  Asked about it the other day on one of the morning TV talk shows, Clinton said times back then were different. Fannie and Freddie had lots of money and he (in his infinite wisdom) decided that the money should not go to share holders or to executive compensation, but should be used to put the poor into homes. 

As you can imagine, wonderful things happen when the government strong arms corporations as to how they should spend their money and, better yet, how they should assess the qualifications of home buyers.  So the country's biggest buyers of mortgages were pressured into lowering the qualifications of applicants, in order to increase the percentage of poor that got mortgages.  By 2006, 30% of all mortgages went to people who in any other circumstances wouldn't qualify.

Now the political left would like you to know that the CRA-controlled institutions did not lend the largest percentage of sub-prime mortgages. But that's information by deception, because the mortgage business is a competitive business.  If the government strong arms one part of the business, the other part will respond.  And strong arm was what the Clinton administration did, even using the Office of the Comptroller of the Currency to pressure banks to lend more money to the disadvantaged. Caught in the act, a spokesman for the office noted that its abuse of power was "for the best of intentions:" the same inclination used to pave the road to hell.

In the short run, all sorts of money was to be made by lowering standards and processing sub-prime loans for the poor. The Wall Street Journal raised concerns about Fannie's and Freddie's capital requirements.  Senator Phil Gramm  (R, TX) raised issues about community pressure groups, such as Barack Obama's ACORN, extorting money from banks by holding their feet to the CRA fire, and threatening to militate against mergers and acquisitions unless the banks entered into preferential agreements with community groups.

The Gramm-Leach-Bliley Act cut down on CRA reporting requirements and upped the ante for groups such as ACORN, forcing them to disclose their relationships with local banks.

Fannie and Freddie became big contributors to the Democratic Party.  The sub-prime business paid off-at least while the bubble was growing. And the Kerry, Hillary and Obama campaigns have numbered among the leading recipients of the largess of the two mortgage lenders.

Franklin Raines, the Fannie Mae C.E.O. from 1999 to 2004, had been budget director in the Clinton administration.  The left would not like you to be reminded that Raines has been a consultant to the Obama campaign, according to the Washington Post, and that Freddie and Fannie number among the top 5 contributors to Obama's run for the presidency.  Raines is being sued for the recovery of 50 million in compensation acquired by the alleged manipulation of Fannie's books. Now, that's not change we can believe in.  That's Washington as we have come to know and "love" it. 

The Bush administration in 2003 tried to change the system, to no avail. Congressman Barney Frank, (D, MA ) was in the forefront of stopping the Bush proposal to take control out of Fannie and Freddie and put it into a third overseeing organization.  Frank too has emerged in the current crisis as one of the major critics of the administration. 

Former Federal Reserve Chairman Alan Greenspan continued to raise the alarm over Fannie's and Freddie's weak capitalization.  His concerns were ignored.

Former Congressman Michael Oxley (R,OH), then chairman of the House Financial Services Committee and  co-author of the Sarbanes-Oxley Act, introduced a bill in 2005 in response to the growing problem, but Fannie and Freddie put their lobbyists to work and the bill died.

Democratic Senator Chris Dodd, who is now Chairman of the Banking Committee and who appears along side  Majority Leader Harry Reid on television to discuss the current bailout negotiations,  has had harsh words for the Bush administration for its alleged role in the crisis.

But the rest of us should have some harsh words for Senator Dodd.  After all, the Bush administration in 2003 and Senator Phil Gramm even earlier, in 1999, had been working to change the system.  Dodd, like Obama, has been a big recipient of campaign funds from  Fannie and Freddie, organizations that Dodd oversees.  Dodd has apparently been more consumed with campaign contributions from the mortgage giants than the responsibilities of oversight.

When I point out the long trail of  Obama's  corruption stretching back to his days in the Illinois legislature, my liberal friends invoke moral equivalence, "They're all corrupt." 

There is no shame among the left.  When they think Bush is responsible for the collapse of the banking system, they scream at you.  When you point out that the Community Reinvestment Act created a pattern of abuse that now threatens the entire financial system, without hesitation liberals say, "They're all corrupt."

The Federal Deposit Insurance Corporation even has a web site so you could see how well your bank is meeting its obligations under the CRA.  Those of you who had  money in Washington Mutual, which just went belly up, will be happy to know that WaMu, over the five individual reporting periods, had almost exemplary ratings on its commitment to CRA. That should give WaMu depositors great joy, to compensate for the financial mess they may be in.  If WaMu had been less responsive to the CRA and more responsive to the market, maybe it wouldn't be insolvent.         

I am not suggesting that the CRA by itself led to the current crisis, but the CRA was the first and most important part of the food chain.   The CRA caused the expansion in the number of questionable loans that lending institutions made, but Wall Street and insurance underwriters were all to willing to package these loans, enhance their ratings through convenient exercises in fantasy, sell them, and insure them with reserves that were more inadequate than the incomes of the people who got the loans in the first place..

The best thing that can emerge from the current financial crisis is the realization that the government needs to stop directing economic decision making.  In a sense, the government is putting out a fire it started when it both created the CRA and assessed lending institutions by how well they were doing in response to the program. When Clinton decided, in his usual arrogance, that he knew better than the market how banks should lend money, the seeds were sown for the current financial disaster.

If you want to blame Bush for the current crisis, it might make you feel good, reinforce your sense of how the world works, enable you to find a meeting of the minds when you next engage your liberal friends over wine and quiche, but like so many things you believe and which make you feel good, it has no correspondence to reality.  

Abraham H. Miller is emeritus professor of political science, University of Cincinnati.
If you experience technical problems, please write to