Systemic Colapse, Part 3

Congress accelerates meddling

The late 1970s were marked by double-digit interest rates, wage and price restrictions plus an OPEC oil embargo by the newly created Middle Eastern cartel. American business was at a standstill, unemployment skyrocketing. Congress devised a plan to encourage business.  This Pollyanna--or criminal--solution set the stage for our present meltdown.  Economist Thomas Sowell calls such short-sighted plans first stage thinking--creating a solution to a problem while refusing to understand how a plan will function in practice.
 
Modifications of Community Reinvestment Act (CRA) 

& Repeal of the Grass Steagall Act

The S&L meltdown ended up costing taxpayers over $1 trillion, according to some sources, the largest fraud in U.S. history. But we hadn’t seen anything yet.
By the early 1990s, while Congress half-heartedly sorted out the S&L scandal (translation: arranging for tax payers to foot the bill for the mess) Wall Street was busy inventing derivatives -- the bundling of good-and bad-loans together then marketing them as AAA investments to be sold on the world market.  Made possible by yup, more deregulation. 

During the 1990s congressional tinkered with the rules of CRA, further easing restrictions on minorities acquiring mortgages.  But it was the repeal of the 1933 Glass Steagall Act that unleashed Pandora’s Box.  That law separated banking for investments.  It's repeal by Clinton's Republican lead Congress allowed commercial and investment banks, securities firms and insurance companies to consolidate, forming conglomerates if they so chose.  Remember one of the reasons FDR passed the 1933 Glass Steagall Act: to prevent banks from investing its depositors money in riskier schemes.

Congress still guaranteed certain loans up to $100,000!  A startling aspect of congressional meddling was its collegial bipartisanship. Both parties voted for these insanely risky laws.  Congressman key to the Glass Steagall repeal were Republicans Phil Gramm and Jim Leach, plus Democrats Chuck Schumer and Chris Dodd.  Both Schumer and Dodd are still employed on the public's dime.

Congress drops home mortgages off a cliff

 Add to this toxic brew the most irresponsible legislation ever passed, affecting the home mortgage market: the 2003-American Dream Down Payment Initiative (ADDPI) in which lenders were encouraged not to press low income borrowers for full documentation for home loans.  The ADDPA authorized HUD to make home loan down payment grants to minority buyers while encouraging Fannie Mae and Freddie Mac to support the sub-prime market. 

This madcap legislation was passed in a Republican controlled Congress under President Bush. If banks didn’t comply regulatory agencies could prohibit those banks’ involvement in the really lucrative stuff, like bank mergers, overseas financing, etc. 

ADDPI created the market for sub-prime loans, tailor made for ADDPI-- people with spotty credit histories.  Applicants didn’t have to prove they had an income, or even a history of solvency.  They’d get the teaser low-interest mortgage rates for the first year or two then WHAM!  When the real interest rates kicked in the monthly mortgage payments could double. The coda to all this Congressional ‘banking’ legislation was the September 2008 worldwide sub prime mortgage collapse.

“I do not want Fannie and Freddie to be just another bank,” Senator Barney Frank said in 2003, “I do not want the same kind of focus on safety and soundness,” Frank emphasized, according to Roger Lowenstein in his 2010 book, The End of Wall Street.  Frank focused on the political expedient of thousands of new minority home buyers. 

A lingering recession/depression is the result of this congressional permission allowing Wall Street and Main Street freelance with American taxpayers signed up as the bailout go to if insolvency ensues.  Alas this has had devistating results for U.S. financial solvency and now world banks.  These legislative acts and deregulation have created a vast list of minority casualties who’renot only at risk of losing their dream homes but are saddled with toxic mortgages and destroyed credit.  It’s the opposite of Fannie Mae’s mission to engage working class home buyers in the market ecconomy.  These toxic loans are held by banks now labeled by big government as ‘too big to fail.’ 

On September 7, 2008, the Federal Housing Finance Agency (FHFA) announced a federal takeover of the financially rocked Fannie Mae and Freddie Mac, the most sweeping government interventions  in quasi-private financial markets in decades. Fannie Mae and Freddie Mac’s investment grade was lowered to Baa3, the lowest grade credit rating.

Conclusion

 When I first started researching the 2008 sub-prime mortgage meltdown I didn’t expect to find any government program that actually helped large swatches of the population--and was solvent. Early Fannie Mae was both. 

Unfortunately big government couldn’t leave well enough alone.  There are simple lessons to be learned from this--big government, like big banks, can't be trusted with something as complex as the world's largest (so far) economy. 

The Administration is now crafting legislation to reform banking with many of the same government and banking players who were in charge of the 2008 banking meltdown--Federal Reserve Chairman Bernanke, appointed in 2006, Treasury Secretary Geithner, Senator Dodd, chairman of the Senate banking committee and Representative Frank, chairman of the House financial services committee, a curious list of policemen.  If these men were in the private sector they'd probably be sharing a prison wing with Bernie Madoff.

Sources:

The Housing Boom and Bust by Thomas Sowell, 2009
The Ascent of Money by Niall Ferguson, 2008
A Patriot’s History of the United States by Larry Schweikart, 2004
End of Wall Street by Roger Lowenstein, 2010
A Colossal Failure of Common Sense: the Inside Story of the Collapse of Lehman Brothers by Lawrence G. McDonald, 2009