In late January the author spoke briefly at a Nassau Institute meeting in the Bahamas honoring the work of the late Milton Friedman, the monetarist and Nobel Laureate. Those comments –
- Summarized Friedman’s monumental work from the late 1940s to the 1980s on the relationship between accelerated monetary growth and inflation and
- Highlighted his warning…in 1981 at the beginning of a long period of growth in U.S. debt and the money supply…that accelerated monetary growth could produce “nasty consequences”. 1
Three decades later the U.S. is dealing with the nasty consequences. A federally sponsored speculative “Housing Bubble” created a self-generating boom, a prosperity that seemingly benefited all. But then housing prices fell, mortgage foreclosures skyrocketed and the Great Recession began.
This memo takes the reader from the promise of affordable housing to a disaster and a not too promising future.
Fannie and Freddie
It will not deal with the most significant financial reform legislation since 1929, the Dodd-Frank Wall Street Reform and Consumer Protection Act. It was approved in principle by President Obama in June 2009, passed by Congress and signed by him in July 2010.
It will deal with the issues raised in the Final Report of the National Commission on the Causes of the Financial and Economic Crisis that contained a 410 page Report and a 120 page Dissent.
The Report and the Dissent fully agree that the crisis was “man made”; and one could reasonably conclude that it was caused by the failure of the Federal Reserve.
In the book Bernanke’s Test J. V. Overtveldt argues that “the derivatives’ explosion, extreme leverage of regulated and shadow banks and excesses of mortgage lending were all flagrant abuses that both Alan Greenspan and Ben Bernanke, Chairmen of the Fed, could have said ‘no’ to. But they did not. As a result, a complex and unstable system veered dangerously out of control.” 2
BUT that story line is much too simple.
The Report focused on the “villains”…
- Bank presidents who didn’t understand their own lending risks,
- Unscrupulous mortgage bankers who shamelessly induced homeowners to take unreasonable risks,
- Enterprising investment bankers who created new exotic mortgages, packaged them, and sold them to “needy” investors world-wide,
- Rating agencies who willingly gave the securities favorable ratings and
- Insurance companies eager to insure the lending risks.
The Dissent argued that the Commission of Inquiry and its Report “erred in assuming that it knew the causes of the financial crisis, namely deregulation…greed and recklessness on Wall Street, predatory lending in the mortgage market, unregulated derivatives and a financial system addicted to excessive risk-taking.” It “did not seriously investigate any other cause”; and, in fact, the majority of the Commission ignored the Dissent. 3
For example, in March 2010, the Dissenters provided the Commission staff with —
- A 70-page, fully sourced memorandum stating that there were 27 million sub-prime and other high risk mortgages (Non-Traditional Mortgages) outstanding out of a total of 55 million. As the financial crisis began, half of all U.S. mortgages were of inferior quality and liable to default when housing prices were no longer rising.
- A paper documenting a two-decade effort of the Department of Housing and Urban Development (HUD) to increase home ownership by reducing mortgage underwriting standards…through the Clinton and Bush administrations.
These papers were never made available to all the members of the National Commission, or even to the commissioners who were members of the subcommittee charged with considering the role of housing policy in the financial crisis.
The Report did examine the role of “Fannie Mae” and “Freddie Mac”, a.k.a. the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. The Report recognized that these federally sponsored mortgage companies had “a deeply flawed business model”, a $5 trillion mortgage exposure and…they even “ramped up” their purchases and guarantees of risky mortgages as the housing market was peaking. In the end they needed $151 billion from the U.S. Treasury to stay afloat. 4
AND…the Dissent reported that for many years prior to the financial crisis Fannie bought loans that should have been classified as sub-prime but were not. “This lack of disclosure on their part appears to have been a factor in the failure of many market observers to foresee the potential severity of the mortgage defaults when the housing bubble deflated in 2007.”
The Report falsely concluded that “Fannie and Freddie followed rather than led Wall Street and other lenders in the rush for fool’s gold”; it failed to identify the Government itself as the “critical player”. 5
Government Sponsored Recklessness
The Report contended that both the Clinton and George W. Bush Administrations sought to increase home ownership through an intensive effort to reduce mortgage underwriting standards.
- The Department of Housing and Urban Development imposed its affordable housing requirements on Freddie, Fannie and the Federal Housing Administration. And its “Best Practices Initiative” encouraged greater sub-prime and other high risk lending by sub-prime lenders and mortgage banks.
- The Federal Deposit Insurance Corporation responding to the Community Reinvestment Act of 1977 (and its subsequent Congressional modifications) examined all banks under its jurisdiction to determine if they did “offer credit in a manner consistent with safe and sound operation” and with the objective to reduce discrimination in housing in lower-income and minority neighborhoods.
Ultimately, all lenders were compelled to compete for mortgage borrowers who were at or below the median income level causing underwriting standards to decline…thus increasing the numbers of weak and high risk loans far beyond what the market would normally produce. In the end one could get a NINJA loan with “No Income, No Job, No Assets”.
- In Economic Theory, if one can buy a thing of value at zero cost, then the demand for that thing becomes infinite.
- In fact, by the middle of 2007, there were approximately 27 million risky Non-Traditional Mortgages in the U.S. financial system—half of all mortgages outstanding—with an aggregate value of over $4.5 trillion. These were unprecedented numbers, far higher than at any time in the past, and the losses associated with the delinquency and default of these mortgages fully account for the financial crisis. 6
In the pursuit of an “affordable” housing goal, Government mandated reckless and ill-advised financial behavior that led directly to that crisis.
The New Left
This author contends that the Government acted as it did because of the political weight of the “New Left” in American politics.
David Horowitz in Left Illusions describes how in 1956, when Nikita Khrushchev leaked the story of Stalin’s crimes, some Communists simply left the party disillusioned. In contrast, others were re-energized…no longer did they need to defend the indefensible but could freely embrace the socialist project. 7 And that they did.
Saul Alinsky was a Marxist, who just before his death in 1972, defined this “new movement” in Rules for Radicals.
- The objective is still revolution; but a revolution of radicals “within a popular democracy who want “Change” and use “certain concepts that operate regardless of the scene or the time.“ 8
- “Mankind has been and is divided into three-parts: the Haves, the Have-Nots, and the Have-a-Little, Want More.” 9
- Change is led by community organizers who have the skills to relate to the “hierarchy of values of a person or bloc of people”, to communicate and to lead.
- “Before men can act an issue must be polarized. Men will act when they are convinced that their cause is 100 per cent on the side of the angels and that the opposition are 100 percent on the side of the devil. He knows that there can be no action until issues are polarized to this degree.” 10
In our popular democracy Alinsky’s “legacy lives on as a staple of the leftist method, a veritable blueprint for a revolution euphemistically called CHANGE. Two of his most notable modern-day disciples are Hillary Clinton and Barack Obama.” 11
Some may contend that this is just another conspiracy theory or a juxtaposition of unrelated events. Nevertheless –
Affordable housing was one of the New Left’s policy objectives that was pursued in a reckless manner to a disastrous end. “Why?” and “How?” are relevant questions.
The above “affordable housing” story is a clear example of where the U.S. stands today. It has lived beyond its means for decades…piling up debt to stratospheric levels; and it cannot now borrow as easily as it once did.
In addition to financing the deficit, it did two large “quantitative easings” (a.k.a. printing money) to stimulate the economy, $300 billion in December 2009 and $600 billion in August 2010. Without matching real growth, these actions will simply raise prices.
The cause for additional concern is that President Obama recently announced his financial plan for the next budget year that included some revenue enhancing measures and more spending initiatives. Ben Bernanke simultaneously announced that the Fed would keep interest rates low, a Federal Funds between 0 and 1/4%, through 2014 ; and he expected Consumer Price inflation to continue to be moderate.
It appears that the present Government may be over-looking the evidence of a possible second “dip” as then Chairmen Greenspan and Bernanke did in 2005. And…
We still have that Fed management and a President who manages from the “Left”, a disciple of Saul Alinsky and not Milton Friedman.
1. Milton Friedman, Money Mischief: Episodes in Monetary History, Harcourt Brace, 1994, pages xi & xii.
2. Stephen Roach, Chairman of Morgan Stanley Asia quoted in Johan Van Overtveldt’s Bernanke’s Test,
Agate, 2009, page 252.
3. The Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report, United States of America, pursuant to Public Law 111-21, page 443
4. Ibid, page xxvi
5. Ibid, page 454
6. Ibid, page 451
7. David Horowitz, Left Illusions, Spence, 2003, page xix.
8. Saul A Alinsky, Rules for Radicals, A Pragmatic Primer for Realistic Radicals, 1971, Vintage Books, 1989 Edition page xviii
9. Ibid, page 18.
10. Ibid, page 78.
John Perazzo in April 2008, Saul Alinsky, Communist Party USA member,