David Reynolds: Why it happened

Column by David Reynolds

Greed. That’s OK for a one-word answer. But the editor allots me 800 words each week, so I should say a little more. I could say that before their sudden death, the investment banks were not subject to the same regulatory controls we place on commercial banks. But that is still not enough.

What we need to say has not been widely said. We need to peel the onion again and chase to the great con game – a game that has taken the air out of the credit markets. Remember, private con artists don’t give a hoot about public confidence. And confidence is what drives our credit based economy. And makes the U.S. dollar accepted around the globe.

So why did it happen? Here is my take: The Law of Unintended Results trumped The Laws of Finance. Good intentions to help a few unglued the bond of confidence that works so well for so many.

During the Clinton era there was considerable talk about how its racial and class affirmative-action policies could be extended into a new field – home ownership. In effect, the administration and its party asked if it was possible to reverse “red lining” – that despicable method whereby those in certain neighborhoods were denied credit simply because of where they sat, not because of their credit standing. For everyone knew that the majority who lived within those red lines were minorities.

Well, Clinton & Co. accomplished mission impossible. One company member was previously the president’s budget director, the head of the Office of Management and Budget, a once-proud agency where I spent a few years. His name: Franklin Raines. His next job: the head of Fannie Mae: His parachute: golden.

Raines and others ran such a successful sleuth operation of extending affirmative action to the housing sector that L.A. Times reporter Ron Brownstein hailed it as one of the “hidden success stories of the Clinton administration,” saying that “black and Latino home ownership has surged to the highest level ever recorded.”

Yet there were those in 1998 who saw 2008 coming. They said that whenever the housing cycle takes its normal downturn that no down payment mortgages could exceed a home’s selling price.

Sorry to say, their sensible voices were not heard. In 2001, the new president’s chief economist, Gregory Mankiw, warned of the “implicit subsidy” of Raines’ old agency, that providing loans to unqualified borrowers was creating a risk for the entire financial system. Rep. Barney Frank, now assigned to clean up a mess he denied would ever happen, told Mankiw that he had “no concern about housing.” And in 2005, congressional Republicans attempted to place Fannie and Freddie under some controls. Their bill died.

Nonetheless, the N.Y. Times seemed pleased. It reported that both Fannie and Freddie were “under heavy assault by the Republicans,” but these entities had “important political allies” with the Democrats.

If two of this nation’s leading newspapers think everything is coming up roses, why not go out and plant your own garden. No need for any investigative piece on affirmative action in housing. The Wall Street story is even more appealing than the Enron saga. The Wisconsin Avenue story, where Fan and Fred hang out in D.C., can wait.

OK, so how did they pull off their con game? Easy. Banks were told to consider nontraditional measures for creditworthiness. Two examples: Unemployment benefits and welfare payments. (I’m not making this up.) Then Housing Secretary Andrew Cuomo investigated Fannie Mae for racial discrimination. Nice ploy, Andy. HUD proposed that by 2001 (interesting date) half of all loans be to low- and moderate-income borrowers.

The L.A. Times reported, “The majority Democratic Congress has mandated that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers. Operating under that requirement, Fannie Mae, in particular, has been aggressive and creative in stimulating minority gains.”

Ah, creativity! That is what we teach our brightest at the best business schools. Ask my good friend Richard Corrington about how creative Wall Street has become. Or maybe not. Do we really want to know all the creative mischief that can be caused by high leverage con games? Do we wish to embarrass the Fed Chairman and the Treasury Secretary by asking them to itemize a $700 billion bailout package? That, of course, is plus or minus a few hundred billion. Don’t you love Washington’s affection for zeros. Rounding numbers is an inside the Beltway art form. And sometimes you almost get the feeling that they are talking about real money.

There you have it. Greed, denial, race, class warfare, and good intentions with bad results, Sorry for the interruption. Next week, back to the elections. Unless, of course, another juicy con game comes our way.


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