Saturday, October 4, 2008

Where is the defense of free markets?!

I am increasingly becoming frustrated with the absence of either McCain or Palin saying a single word in favor of free markets, especially during the first Presidential debate and Thursday's Vice-Presidential debate.

Barack Obama runs around saying the financial crisis has rendered the "final verdict" on the economic philosophy of the Bush Administration, a philosophy that McCain shares, that says that regulation is always bad and the free market should always be left alone. Bush & McCain said they wanted the market to run free, but instead they let it run wild.

This is utter nonsense!

The biggest single factor in the current financial crisis is the mess at Fannie Mae and Freddie Mac. These two Government Sponsored Enterprises (GSE's) hold over half the mortgages in the US.

The Bush Administration, John McCain, and other Republicans have tried to reign them in over the last 6 years and have been stopped at every turn mostly by Democrats.

The roots of the current crisis go back to the Community Reinvestment Act (CRA) in 1977. Back then, liberals were complaining about low rates of home ownership in minority neighborhoods. Because low-income neighborhoods can have a very distinct geographic area, you could sometimes draw a "red line" around entire neighborhoods where no one owned the home they lived in. Instead of assuming that this was because the people that lived in these neighborhoods did not have a sufficient income to put a required 10-20% down payment on a house, the Democrats blamed local mortgage lenders of "redlining."

The CRA required lenders to make sure they met "the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods." Despite the law's good intentions, the law's effect was to force lenders to make riskier loans, probably raising interest rates some in the process. But the main point here is that the CRA was the start of the move to lower lending standards in the name of "affordable housing."

In the late 80's and early 90's a series of minor changes gradually made CRA ratings more public and housing advocacy groups more power in demanding strict enforcment of the CRA. In 1995, the Clinton administration revamped the regulations regarding the CRA to give it, and housing advocacy groups, more teeth.

Fannie Mae and Freddie Mac were both created by Congress to help provide a secondary market for the mortgage industry. Local mortgage brokers and companies originate mortgage loans, and then sell a good portion of them to Fannie and Freddie. Fan and Fred then re-sell the loans to investors. In 1992, Congress passed a law that required Fannie Mae and Freddie Mac to "devote a portion of their lending to support affordable housing." Because these loans were more risky, Fan and Fred started bundling some solid loans with some risky ones into securities.

As early as 2002, even while President Bush was moving forward on an affordable housing initiative to increase minority home ownership through help with down payments and buyer education, the Bush administration began attempting to increase regulations on Fan and Fred. The two GSE's were getting so large and so leveraged that a failure of either one of them could cause major damage to the economy. Treasury Secretary John Snow was calling in 2003 for a "world-class regulator" for Fan and Fred. They were blocked by leading Democrats on the Banking committees in the House and Senate: Barney Frank, Chris Dodd, and Chuck Schumer.

Both Fan and Fred are shareholder owned and thus had incentive to grow like any publicly-owned company. But they were also chartered by Congress and therefore seen as having implicit government backing. With this special status they were able to obtain cheaper credit and use this advantage to dominate the secondary mortgage market.

Fannie Mae and Freddie Mac moved further and further into the sub-prime mortage market in the late 90's and early 2000's. In a series of House hearings in 2004 after an accounting scandal at Freddie Mac larger than Enron, Democrats continually defended Fannnie and Freddie, applauded their efforts toward affordable housing, and even threatened the regulator that they should be investigating him.

In 2005, the Senate Banking committee passed a bill on a party line vote -- all Republicans for and all Democrats against -- that would have set up a strong regulator for the GSE's. Later John McCain co-sponsored a bill to do the same, though it never got to a Senate floor vote over oppostion from almost all Democrats and a few Republicans. McCain said at the time:

"For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac–known as Government-sponsored entities or GSEs–and the sheer magnitude of these companies and the role they play in the housing market. OFHEO’s report this week does nothing to ease these concerns. In fact, the report does quite the contrary. OFHEO’s report solidifies my view that the GSEs need to be reformed without delay.

"I join as a cosponsor of the Federal Housing Enterprise Regulatory Reform Act of 2005, S. 190, to underscore my support for quick passage of GSE regulatory reform legislation. If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole."
Barack Obama didn't make a peep at the time.

By 2005 and 2006, a significant portion of the loans that the GSE's were buying were subprime loans. With the GSE's willing to take subprime loans off of any lenders hands, mortgage brokers had every incentive to make as much commission off of as many loans as possible. Fannie and Freddie were fueling the housing bubble.

When the bubble started to burst in 2007, forclosure rates started going up. Even with only 2% of the homes in the US in forclosure, Fannie and Freddie were both over-leveraged enough that they could not stay solvent. The government had to bail them out with $300 billion.

Worse yet, the entire financial system was poisoned with the GSE's mortgage-backed securites and MBS derivatives that started losing value and no one really knows how much they are all worth. The market dived on these MBS's and many financial firms, who in hindsight were also over-leveraged could not take the losses on these and went under.

Pretty soon the banks weren't sure what was on other banks' balance sheets and how much value they had, or who was going to go under next. Banks stopped overnight lending to each other, and voila, we have a crisis.

Now explain to me how the free market had anything to do with this crisis. The main players were the GSE's and goverment meddling with the market by demanding more affordable housing. Without the government screwing up the market, it is hard to see how a truly free market could have possibly led to the severity of a crisis we have right now.

I just wish McCain or Palin would stand up and say, "The current crisis is not a failure of free market principles or caused by deregulation. It was caused by the government's overzealous push for affordable housing through the Government Sponsered Enterprises of Fannie Mae and Freddie Mac. Democrats like Barney Frank and Chris Dodd have been at the heart of the problem. I am on record over 2 years ago in favor of tighter regulations on the GSE's. Barack Obama, as usual, just 'voted present.'"

How hard would that be to say?

No comments: