With the clarity of time we can look back at the brink of the collapse that hit us just prior to the last national election.  In the midst of the collapse we were stunned and angry, and tended to blame the party in power. Although the Democrats had controlled both houses of Congress since 2006, the disaster took its bigger toll on the Republicans.

While the roots of this collapse extend back through many administrations of both parties, it is important to know what did not cause this as well.

Some blamed the deficits, others blamed deregulation, but many just saw the main cause as unbridled greed.  I contend that while there were deficits, and there was greed, none of these played a critical role in fomenting this crisis.

As Thomas Sowell noted, blaming this crisis on greed is like blaming an airplane crash on gravity.  It is true but it doesn’t really explain anything. Worse if we just blame the undeniable then there is no need to examine human error, design flaws, or study ways to keep it from happening again.

Greed has been with us since the dawn of man. Why did it decide to show its ugly face in September of 2008? Greed is encumbered by the limits of a rational society and in a capitalist system it is encumbered by competition.  I may want to charge $2,000 a ton for steel, but competition keeps me from charging what I want, and even forces me to keep my payroll and expenses in line.

Our government tries to contain the fear of greed with regulations. If we are to blame greed we must face the failure of our regulations, or we may even need to face the possibility that our regulations fostered greedy behavior.  The second most common blame was the laissez faire attitude that had fostered deregulation of the financial markets.   Usually this is directed at the repeal of the Glass Steagal Act which separated lenders from investment banks. This law was repealed under The Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act of 1999, which was signed by President Clinton.

But other nations, notably Canada, also repealed similar legislation and they did not experience the financial crisis we did. But Canada also did not suspend prudent lending standards to force the spread of home ownership beyond its natural market.

Nor was deregulation the norm under George W Bush. In fact just the opposite was true.

Elliot Spitzer noted that we did not suffer from the lack of regulators or regulations. There were plenty to do the job, but they seem to lack the courage and the will to do the job.  We needed better regulations, not more of them.  In many cases the regulated industries such as Fannie Mae  (exempt from SEC and FDIC regulation) spent enormously on lobbyists and campaign contributions to thwart efforts to regulate them.  It was successful for them.

The biggest recipient of campaign contributions from AIG was Barak Obama. The biggest recipient of the PAC assembled by the largest mortgage lender for Fannie Mae, Country Wide Finance,  was Barak Obama. The largest recipient of campaign funds from Fannie Mae was ….. yes, Barak Obama. The second largest recipient in these three cases was Chris Dodd, Chairman of the Senate Banking Committee.

The deficits which seemed so irresponsible at the time now look like pocket change.  Deficits do matter but it depends how long they last, how large they are relative to GDP, prevailing interest rates, and what the deficits are spent on.  Personal debt spent on a house or investment equipment may seem prudent, the same debt spent on a boat or jewelry would not.

While the debt incurred under George Bush was arguably bad, it was not a critical factor in causing the meltdown.  We incurred controversial debts under Ronal Reagan and incurred little repercussion from the financial industry.

Bubbles are nothing new and may just be a part of the pricing mechanism. The Federal Reserve was created to bring stability to our financial system. It first test was the Great Depression of 1929, and it failed miserably.  Nearly 80 years later with the value of the dollar down 95% and in the middle of the worst financial crisis in our adult lives, we should ask if it is part of the problem.

Eliminating commonly perceived causes should help us focus on solutions that will work. If we delude ourselves into blaming greed, deficits, and individual demonas we risk designing solutions that not only will not work, but will like make the problem worse

“Fannie and Freddie played the political game even more fiercely than their opponents, spending millions of dollars on armies of lobbyists on Capitol Hill. Each company was a revolving door for the powerful in Washington- both Republican and Democrat. Newt Gingrich and Ralph Reed, among others, worked as consultants for Fannie or Freddie; Rahm Emanuel was a board member of Freddie.”

“By the 1990’s, Fannie’s chief executive could boast, without much exaggeration, that “we are the equivalent of a Federal Reserve system for housing.”  At their pinnacle the two mortgage giants- neither of them and originator of loans- owned or guaranteed some 55 percent of the $11 trillion U.S. mortgage market.  Beginning in the 1980’s, the two companies also became important conduits for the business of mortgage- backed securities.  Wall Street loved the fees it collected from securitizing all kinds of debt, from car loans to credit card receivables, and Fannie’s and Freddie’s portfolio of mortgages were the biggest honeypot around.”

“But in 1999, under pressure from the Clinton administration, Fannie and Freddie began underwriting subprime mortgages. The move was presented in the press as a way to put  homes within the reach of countless Americans, but providing loans to people who wouldn’t ordinarily qualify for them was an inherently risky business.”

From Too Big To Fail by Andrew Ross Sorkin

“In moving, even tentatively, into this new area of lending (subprime) Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government -subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s”  (New York Times in 1999)

“The success of the two companies (Fannie and Freddie) in both the financial and political arena inevitably fostered a culture of arrogance. “We always won, we took no prisoners and we faced little organized political opposition,” Daniel Mudd, then president of Fannie Mae, wrote in a 2004 memo to his boss. That overconfidence led both companies eventually to move into derivatives and to employ aggressive accounting measures. They were later found by regulators to have manipulated their earnings, and both were forced to restate years of results.  The CEOs of both companies were ousted.”

From Too Big To Fail by Andrew Ross Sorkin

Wall Street’s financial leaders have been paraded before Congress to explain their efforts to restore stability to our financial system. Obama has turned on the populist spigot to demonize Wall Street to justify bigger taxes and fees and hip shot regulation.

Wall Street deserves the scrutiny and reform is needed.  Yet this fiasco was as much a government failure.  Fannie Mae was exempt from regulation by the SEC, FDIC and the Fed.  When Congress was solidly warned about excessive risks taken by the Fannies,they rejected calls to increase oversight, largely along party lines. Little protest is heard from the halls of Congress over some of the huge bonuses paid to Frank Raines and others at Fannie Mae while the system was imploding.

Some recent regulations such as the mark to market rules made this crisis much worse than it would have otherwise been.  Other regulations such as control  of derivatives  by the Commodities Futures Trading Commissions were removed (under Clinton) at a pivotal time. The Fed ’s monetary policy was also a factor.

A hearing to truly understand what happens and what needs to be done would have our Congressmen on the other side of the microphone.

While banks are returning TARP money, some having taken it under duress, Fannie Mae continues to lose money and receive more bailout. In return for such dismal performance executives are getting pay raises and bonuses.

It is a growing contention that Fannie played a disproportionately large role in a once in a century compilation of bad policies, hubris and incompetence.  Fannie Mae was exempt from SEC, FDIC, and FED scrutiny, and was subject to Congressional oversight that refused to acknowledge their systemic role on the financial catastrophe.

The Wall Street Journal noted  in “The Biggest Losers” that while other banks are turning around Fannie Mae and Team Obama is just digging a much deeper hole.

Excerpts:

All of which would seem to make the CEOs of Fannie and Freddie the world’s most overpaid bureaucrats. A release from the Federal Housing Finance Agency that also fell in the Christmas Eve forest reports that, after presiding over a combined $24 billion in losses last quarter, Fannie CEO Michael Williams and Freddie boss Ed Haldeman are getting substantial raises. Each is now eligible for up to $6 million annually.

Freddie also has one of the world’s highest-paid human resources executives. Paul George’s total compensation can run up to $2.7 million. It must require a rare set of skills to spot executives capable of losing billions of dollars.

Where is Treasury’s pay czar when we actually need him? You guessed it, Fannie and Freddie are exempt from the rules applied to the TARP banks. The government gave away the game that these firms are no longer in the business of making profits when it announced that the CEOs will be paid entirely in cash, though it is discouraging that practice at other big banks. Who would want stock in the Department of Housing and Urban Development?

Meanwhile, these biggest of Beltway losers continue to be missing from the debate over financial reform. The Treasury still hasn’t offered its long-promised proposals even as it presses reform on banks that played a far smaller role in the financial mania and panic.

There are those who see our financial problem as a moral failure. In one sense it is, but not in the sense those who wish to frame it in moral tones believe.

To blame greed for the meltdown is simplistic and irrelevant. Greed has been with us forever. Why would it appear in its ugliness now?

I would say that our economic collapse was the fault of a moral supremacy that ignored sound economic principles and common sense.  In an effort to encourage home ownership for the poor, the government demanded that prudent lending standards be forced out of the system. To assure a market the government through Fannie Mae guaranteed mortgages and ridiculous financial instruments to feed the market.

When alarms were being sounded the regulators and legislators were being hounded with political pressure from lobbyists for the very firms they were regulating. Chris Dodd, Hillary Clinton and Barak Obama were among the largest recipients of campaign funds from Fannie Mae.  Barney Frank and many others loudly protested those who warned of a problem, insisting that these programs providing housing for the lower income were somewhat sacrosanct.

It was the unwillingness to understand the limits of government to fulfill our moral wishes that fed this mania.  It was our pursuit of moral justice through government force that led taxpayer funded ACORN to pressure banks to make high risk loans to those who otherwise would not have qualified.

It was not greed or the absence of morality that caused this disaster; it was the ignorance of basic economic principles and the belief that the government can create wealth by making promises it can’t fulfill and that it can erase risk by ignoring it.  In its malfeasance it made the poor worse off and destroyed equity value for millions of the middle class.

If there is a moral failure it is that the government refused to accept its limitations, and that the voters wanted a government that will promise them everything.

The greed of those who wanted a modest house they could not afford caused us more damage than the titans on Wall Street who found a way to get rich delivering the voters their delusion.

The quasi-governmental institutions Fannie Mae and Freddie Mac guaranteed  mortgages, which Wall Street happily securitized once the credit rating agencies- which had been given a legally protected oligopoly by the government-declared them to be safe investments.  Government owned banks and municipalities across the world bought mortgage- backed securities like never before.

The central position of Fannie Mae and Freddie Mac reinforced confidence that the government would intervene if the housing market ran into trouble. The Fed’s safety net and the FDIC made banks dare to take big risks because they could privatize any gains but socialize any losses.

When home prices began to fall and the market no longer wanted mortgage-backed securities, the financial authorities stepped in and decreed that the banks had to write down the value of such securities radically, giving rise to several waves of panic selling. And when nobody wanted to finance the special companies anymore, the banks had to take them over, which put such a burden on their balance sheets that regulations forced them to pile up capital rather than make loans.  President Bush and other leading policy makers whipped up a panic to push through the laws they wanted. And just as the financial markets were more worried than ever because they did not know where the big risks were, the authorities banned shorting, thus depriving the markets of liquidity and information when they needed it most.

If this is laissez faire, then I would like to know what government intervention looks like.

If politicians, central bankers, and bureaucrats had intentionally tried to create a crisis, they would have been hard put to find more effective actions.  At each stage, the government inflated the bubble at least as eagerly as the most enthusiastic of Wall Street traders. The only difference was that the government’s pump was so much bigger.

From “Financial Fiasco” by Johan Norberg

HKO comments- yet the media has thoroughly convinced the ignorant and the gullible that this was a failure of capitalism.

In several past postings reviewing the recent financial meltdown, I have noted the pivotal role played by Fannie Mae.

A toxic mix of arrogance and incompetence infected Wall Street.  Bad political, monetary, and tax policy inflated the housing market bubble.  But without the assurances of Fannie Mae, the ratings agencies and market makers would not have  been able to give the mortgage backed securities at the center of the crisis the ratings they clearly did not deserve.

Fannie Mae was exempt from regulation by the FDIC, the SEC and SIPC.  It’ s sole overseer was Congress.  When Congress was presented with evidence that Fannie Mae was taking excessive risks and needed restraint in 2005 and 2006, the bearers of caution were beat down by Barney Frank and many others  and the proposal was unable to even make it out of committee. On almost straight party lines the Democrats refused to restrain the agency. Fannie Mae, with a monopoly granted by the government lobbied hard to prevent any interference by the Congress.

The largest recipients of Fannie Mae campaign funds was Hillary Clinton, Christopher Dodd (Senate Banking Committee Chairman) and Barak Obama.

While understandable outrage was leveled at the Wall Street Firms and AIG for the bailouts the real outrage was the bailout of Fannie Mae.  Now President Obama has pledged unlimited support for the agency.

When private enterprise fails capital exits the enterprise; when a government enterprise fails it attracts additional capital.  Private mistakes go bankrupt, government mistakes get institutionalized.

Are lobbyists that bad?

If the government was about to make sheet-rock illegal because of bad or misguided information and you were in the sheet-rock or home-building business, wouldn’t you seek to persuade the lawmakers than their efforts were wrong? Wouldn’t you seek to give them better information or explain how that law will dramatically increase the costs of homes?

Every business or service sold has unique characteristics that few in Congress understand; they depend on lobbyists to fill in the blanks.  And Congress is not always driven by the highest of motives. They are frequently duped by industries that appear to be fighting to protect the public, but really are just trying to use the law to make life harder for their competitors.

Do we want a health care bill with no inputs from doctors, pharmaceutical companies, or health insurance administrators?  Do we want a trade bill with no input from the producers and consumers who will be harmed? Do we want an energy bill with no input from those who actually produce and distribute …. energy?

Obama and most others have criticized the input of lobbyists and the influence they have yielded. Yet the biggest recipient of campaign funds from the controversial insurance giant AIG, the PAC assembled by  Countrywide Financial, and from Fannie Mae was Barak Obama.  If he was so opposed to lobbyists’ influence why didn’t he reject their campaign contributions?

While critical of the influence of lobbyists, the president’s dramatic growth of government will only increase the activity and influence of lobbyists.  Lobbyists are caused by excess government regulation; a growth in regulation is guaranteed to cause an increase in lobbying activity.

In spite of the rhetoric to the contrary you can expect to see more lobbyists under this president, not less.

“It is a matter of record that many of the leading decision makers of the New Deal administration in the 1930s were advocates of government intervention in the economy and of a fundamental restructuring of the economy-a New Deal- years before the stock market crash of 1929 and the Great Depression that followed, which put them in a position to carry out ideas to which they were dedicated long before there was any economic crisis to deal with. The New Deal  succeeded in using a transient crisis to create enduring institutions, including among others the Federal National Mortgage Association or “, Fannie Mae,” which FDR created in 1938, and which has been at the heart of the housing boom and bust that led to today’s financial crises.”

Thomas Sowell in The Housing Boom and Bust

HKO Comments-  “A crisis is the rallying cry of the tyrant.”  Reagan successfully resisted a call to intervene after the 25% drop in the Dow Jones in 1987. Few remember but many wondered if such a large one day drop was not a precursor to another Depression.  He let the market repair itself and it rose 10,000 points in the ensuring decade. Not every short term crisis requires a long term solution