May 28, 2010
Has the SEC Charged the Right People with Securities Fraud?
As Fannie Mae and Freddie Mac ask for an additional $8.4 billion of U.S. taxpayer dollars to cover their rising mortgage losses, their cumulative total debt to the American public comes to $145 billion. The citizenry hardly notices, and the government quietly writes a check to the two failing institutions. This strategy is in keeping with the American political system's management of the populace's collective attention, with the understanding that if an administration can ride out a scandal for six months, then all will be forgotten.
The uncurious press moves on to other events, and the limited public memory replaces old facts with new. This myopic historical memory is exactly what the political class is using to hide its culpability in the national mortgage crisis. Therefore, a quick history lesson is in order.
The 1970s brought the Community Reinvestment Act, followed by the Equal Credit Opportunity Act and the Home Mortgage Disclosure Act. These laws were then used by socio-political activists to pressure banking and lending institutions into making bad loans, which these institutions probably would not have made without the new laws in place. In the name of social justice, the FDIC was further empowered to audit lenders for redlining practices and pressured regulated private lending institutions to make marginal and bad loans. From within Fannie and Freddie, two quasi-political, uninsured, and unregulated government institutions, these bad loans were bought and packaged or securitized as collateralized mortgage obligations (CMO). The bad loans were packaged with a collection of good loans into multi-year tranches so that the entire loan package could receive an investment-grade bond rating. With rating institutions giving good ratings to these volatile, risky CMOs, an artificial, government-created market was born.
The original lending institutions were happy to sell these notes, as they wanted the high-risk loans off their books. As a result of progressive government intervention and regulation, the multi-layered CMOs grew into a massive and lucrative financial instrument. This artificial sub-prime CMO market flourished only because of forced government regulation through bureaucratic agencies and law.
After the Glass-Steagall Act was officially repealed in 1999, every mortgage originator got into the business and legally underwrote marginal loans. This all occurred while the fundamentally unsound practice was being championed by Democrats such as past President Carter, Senators Dodd and Obama, and Congressmen Frank and Rangel, as well as ACORN, the Urban League, and virtually every other progressive political organization in the country.
Fannie and Freddie expanded the CMO market through the 1990s and early 2000s as investment banks realized the trade was lucrative and was not illegal. Such highly rated CMOs began replacing much safer U.S. Treasury notes in the banks' investment portfolios. Institutions such as Goldman Sachs, Lehman Brothers, and Merrill Lynch did the same, all the while originating, packaging, and selling the sub-prime loans along with a few good loans to keep the CMO highly rated. Again, these practices were all legal and supported by an artificial, government-created and -regulated market.
Countrywide Financial and other mortgage companies were happy to play in this new market of government-mandated social justice. The government had made the risks very low with cheap money, and Fannie and Freddie absorbed the toxic loans by purchasing them from the banks. As a result, housing prices exploded (and lest we forget, even Senator Chris Dodd earned a favorable low-interest loan from Countrywide). Insurer AIG was guaranteeing these securitized loans with the implicit backing of the government, gambling that the Feds would possess the deep pockets of last resort in the event that this social justice experiment failed.
With the rapid rise in energy costs in the middle part of the decade, consumers had to decide whether to buy gas or pay an outrageously high monthly mortgage payment that they couldn't afford in the first place. Consumers made their choice, and the CMO market tanked as home mortgages increasingly defaulted. So, with the absolute failure of their artificial and unsustainable government-mandated market singlehandedly collapsing the U.S. economy, the government began fulfilling its traditional role -- throwing good taxpayer money after bad, casting the net of blame widely, and all the while tactfully avoiding any blame for itself. Even when challenged by a learned student from Harvard Law, Congressman Barney Frank too loudly protested, expressing anger over the very implication that he, his committee, or the government was culpable for the mortgage disaster. As Frank protested, the audience recognized that his guilt spoke for itself. [Editor's note: The learned student was AT contributor Joel Pollak, currently running for Congress.]
The bottom line: There never would have been a mortgage crisis if it had not been for the government's creation of the laws and regulations that allowed for the CMO market to be born. But accusations are being hurled at anyone; Goldman Sachs has now become the blooded lamb, and President Bush has become the Judas, despite his warnings to Congress throughout his terms to stop unsustainable housing practices.
President Obama intends to correct this mess through more regulation and become the avenging angel of the progressive party. All that will come from his intentions is more intrusive and dysfunctional government regulation. As the government continues to force mortgage modifications, support the sub-prime market, and use taxpayers' money to bail out failed institutions, we are led farther into economic problems.
If the government had left the markets alone in the first place, this system-wide failure would never have happened, because banks and other financial institutions would never have made high-risk sub-prime loans. Now the U.S. taxpayer and all future entrepreneurs will pay the price in taxation and over-regulation.
It appears that the age of soft tyranny has ended, so be ready for more taxpayer-funded bailouts due to government-designed economic bubbles, based on unsound economic policy, and justified through social justice -- all of which will be followed by major economic collapses.