Never Let a Serious Crisis Go to Waste
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One of the main arguments for the ultimate irrelevance of the market designers was that it was not so much “the market” that mattered when it came to the actual valuation of the wonky assets—it was rather a concerted political push to change the accounting rules, so that banks could proceed to assert that the values of the assets were whatever they wanted them to be. Under pressure from the White House, the Treasury, and the banking lobbyists, the Financial Accounting Standards Board was induced to change rule FASB 157-e in April 2009, against the explicit disapproval of the American Institute of Certified Public Accountants and the Center for Audit Quality.147 Mortgage-backed assets could now be listed as enjoying elevated values in bank and SIV balance sheets, without all that muss and fuss of the excessive complexity of boutique auctions.
B) Fannie Mae and Freddie Mac Did It
You have to give them credit: it didn’t take too many all-nighters for the Neoliberal Thought Collective to come up with what would become the single most popular story on the right in America, wrapping the entire crisis up in a neat tidy package. In this meme, the crisis was first and foremost a housing bubble, which, when it burst, had some other unpleasant side effects; loans were extended to a bunch of deadbeats who should never been given a shot at home ownership in the first place; the reason that happened was the ill-conceived Community Reinvestment Act passed by the Democrats in 1977; and then the mortgage loans to the deadbeats were enabled by the Government Sponsored Entities (GSEs) Fannie Mae (actually: Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). Hence, on both the demand and supply sides, the government had polluted the mortgage market, first causing the housing bubble, and then the subsequent collapse. It was all the fault of the government. Full stop.
It is indisputable that Fannie and Freddie had become untenable as vague “public-private” financial entities in the early phases of the crash as the prices and collateral value of mortgage-backed securities tanked, and as such were nationalized in September 6, 2008, by the Bush administration. Their previous status as purely governmental entities was therefore dubious, a minor glitch in the neoliberal demonization of the government. What is a bit more stunning is that the story that Fannie and Freddie had caused the crisis was first put forth a little more than a month later by the neoliberal collective members Charles Calomiris (Hoover, Cato) and Peter Wallison (American Enterprise Institute [AEI]) in the Wall Street Journal.148 As a trial balloon, it initially appeared rather unpromising, both to those with ringside seats at the subsequent collapse of Wall Street giants like ninepins and to various pundits on both sides of the political divide in 2008. For instance, in testimony at the October 23, 2008, session of the House Committee on Oversight and Government Reform, Alan Greenspan explicitly ruled out the hypothesis that Fannie and Freddie were the “primary cause” of the financial crisis, as did Christopher Cox, then chair of the SEC. Paul Krugman, smelling a rat, came out fairly early against the whole idea:
Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S&L fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble. Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Freddie and Fannie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t.149
Here is where considerations of agnotology kicked in. The NTC does not abandon a delicious hypothesis simply because it appears to come a cropper on a few facts and encounters strenuous opposition. Instead, they are flush and primed to send up multiple trial balloons, observe which way the prevailing winds are blowing, and then invest in further inflation for those that appear to take flight and festoon their political allies. The Fannie/Freddie meme was not the only causal narrative explored by the collective, but it sure looked good in crisis-aftermath America, especially after the Tea Party movement was itself commandeered by various Koch-funded front organizations. The Cato Institute seconded the analysis with alacrity. The AEI then threw its weight behind the Freddie/Fannie story, with Wallison as point man, and the trusty echo chamber was revved up. Professional economists were recruited to bolster the narrative. The public-choice crowd was quick to chip in. Mark Calabria from Cato was brought in to fluff up the numbers. Dependable fellow travelers such as David Brooks, George Will, and Tyler Cowen chimed in in the columns and blogs. Douglas Holtz-Eakin signed on, in a way to soon become important in the Financial Crisis Inquiry Commission. Edward Pinto at AEI was brought on board to crunch some numbers. Raghuram Rajan promoted a more fuzzy-tinged and humanized version of the story in his Fault Lines. But the real agnotological breakthrough came when a respected journalist seemingly positioned outside of the Russian doll (indeed, hailing from within that brimstoned Mordor for the right, the New York Times) was somehow induced to write a book also casting Fannie and Freddie as the evil twins behind everything that went wrong in the crisis: Gretchen Morgenson and Josh Rosner’s Reckless Endangerment. This sparsely sourced and footnote-free book clearly depended heavily on Pinto for the few vague numbers it cited; it was much more expansive when it pursued searing indictments of political figures such as Barney Frank, Robert Zoellick, and Andrew Cuomo. A few obscure economists at the Fed came in for especially vituperative comment. At this juncture the NTC had hit a home run: Michael Bloomberg was caught repeating the meme in his hissy fits provoked by the Occupy Wall Street movement. Persistence and repetition and emoluments had paid off—the Fannie/Freddie “explanation” had become embedded in the blogosphere and the cultural landscape, spread far and wide by the Republican presidential candidates and beyond. When the SEC brought charges against six former Fannie and Freddie executives in December 2011, Wallison was accorded column inches in the Wall Street Journal to crow that he and his comrades had been vindicated.150
It was this sequence of events that prompted Joe Nocera, also of the Times, to bemoan the spread of the Big Lie:
Thus has Peter Wallison, a resident scholar at the American Enterprise Institute, and a former member of the Financial Crisis Inquiry Commission, almost single-handedly created the myth that Fannie Mae and Freddie Mac caused the financial crisis. His partner in crime is another A.E.I. scholar, Edward Pinto, who a very long time ago was Fannie’s chief credit officer. Pinto claims that as of June 2008, 27 million “risky” mortgages had been issued—“and a lion’s share was on Fannie and Freddie’s books,” as Wallison wrote recently. Never mind that his definition of “risky” is so all-encompassing that it includes mortgages with extremely low default rates as well as those with default rates nearing 30 percent. These latter mortgages were the ones created by the unholy alliance between subprime lenders and Wall Street. Pinto’s numbers are the Big Lie’s primary data point.151
The literature attempting to refute this meme was even more prodigious than the usual crisis lit standards; it nearly defies cogent summary.152 The vulnerability of those skeptical of the GSE meme was the fact that attack on the neoliberal Freddie/Fannie story was often confused with defense of the behavior and structure of Fannie and Freddie, something no politically saavy person of almost any stripe would countenance. Even its supposedly spineless regulator accused Fannie of accounting fraud in 2005.153 At the end of the day, Fannie and Freddie had made money through heavily promoted ambiguity concerning whether or not as a privatized entity it had enjoyed a government guarantee of its debt; of course the government takeover settled that question, but only at the expense of debilitating the rest of the banking sector. The fact that it was a cesspit of party political slush funds, machine cronyism, and cooked books did not dispel the undeniable stench of corruption, something Morgenson and Rosner made much of. The other drawback in refuting the neoliberal meme was that almost no one wanted to get bogged down in the minutiae of the extended history of the GSEs, nor in endles
s picky fights over the numbers, and other subtleties that often eluded the journalists and bloggers. For instance, it was demonstrably the case that Fannie and Freddie were the initial loci of the invention of securitization of mortgages decades ago; but that hardly saddled them with responsibility for every baroque development of securitization thereafter, many of which it avoided. A crisis story that could fit on a three-by-five card, yet revealed multiple layers of slippery ramification just below the surface, was the holy grail for the Neoliberal Thought Collective. Yet, in the end, their three-by-five slogan was a ruse.
There are two pincers of the attack on the Freddie/Fannie meme: the first, concerning the Community Reinvestment Act (CRA), and the second, the weaknesses in the proposition that Fannie and Freddie somehow caused or motivated the housing bubble and subsequent crisis. With regard to the CRA, the largest players in the subprime market were private-sector firms that were not subject to CRA stipulated rules and regulations. Therefore, for the story to work, the bulk of the subprime action had to happen in the GSEs, but as we shall see, it did not. Furthermore, in institutions subject to the CRA, not all loans fell under the CRA guidelines; so the proportion of loans affected were quite small. Then the timing seems a little off, since the CRA came into effect in 1977, but the housing boom dates from much later. It has become commonplace to point out that housing bubbles happened in many countries in the first decade of the millennium; but none of those other countries had any legislation similar to the CRA. And finally, Democrats and Republicans alike basked in the warmth of CRA-style hosannas to the “ownership society,” at least until the whole shebang went south. Thus it is not clear that the CRA was much more than background static in the great pell-mell rush to push mortgages off onto all manner of persons ill-equipped to maintain and service them. Some politicians were avid cheerleaders for what had happened; but they did not actually create the elaborate set of mechanisms and legal puffery that constituted the housing bubble.
The primary riposte to the Fannie/Freddie meme is that Fannie and Freddie lost market share in the subprime market to private-sector firms from 2002 until late 2006; and the reason that happened was that it was the private-label “originate and securitize” machine that was the main driver behind subprime mortgages and the housing boom in the last decade. Here is where the real pitched battles were fought between the neoliberal think tanks and their opponents.
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Figure 5.1: Proportions of U.S. Mortgages Originated by Various Financial entities, 1953–2007
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The evidence on the face of it seems unequivocal: Figure 5.1 (proportions of mortgages originated by various financial institutions) shows the exit from mortgage finance of savings and loans after 1975; the rise of securitizations by government sponsored entities from 1972 onward; the loss of market share by Fannie and Freddie beginning in 2002; and the twofold rise of private mortgage-backed securities and finance companies in the early 1990s and the acceleration in 2002. Most analysts by 2006 had been noticing that Fannie and Freddie had been losing market share because they had been avoiding the dicier “subprime” side of the mortgage market, in part due to their own government guidelines, avoiding nonconforming loans. Indeed, Ben Bernanke before the crisis was arguing that the CRA had been ineffectual precisely because less than 30 percent of Fannie and Freddie’s portfolio consisted of mortgages that could be generously asserted to be based upon “affordable” or low-income properties.154 As Moody’s reported in 2006, just as the bubble was about to burst:
Freddie Mac has long played a central role (shared with Fannie Mae) in the secondary mortgage finance market. In recent years, both housing GSEs have been losing share within the overall market due to the shifting nature of consumer preferences towards adjustable-rate loans and other hybrid products. For the first half of 2006, Fannie Mae and Freddie Mac captured about 44% of total origination volume—up from a 41% share in 2005, but down from 59% in 2003. Moody’s would be concerned if Freddie Mac’s market share (i.e., mortgage portfolio plus securities as a percentage of conforming and non-conforming origination), which ranged between 18% and 23% from 1999 through the first half of 2006, declined below 15%. To buttress its market share, Freddie Mac has increased its purchases of private label securities.155
The GSEs had been getting prodded by members of Congress to purchase more subprime; but mostly, the “advice” came too close to the pricking of the housing bubble. There has been substantial dispute over just how much subprime and Alt-A loans Fannie and Freddie hoovered up in this narrow window; but a major riposte to the neoliberal story “The Democrats Made Them Do It” is that neither GSE touted a change in policy, but if anything, tended to underreport these activities. This is one primary reason most outside analysts trace the housing bubble to the private sector, and in particular, specialized subprime originators such as Countrywide and Ameriquest and the banking firms that repackaged them into baroque securities; it even corrupted profitable subsidiaries of “industrial firms” such as GMAC and GE Capital; consequently, “the biggest factor contributing to the subprime boom was securitization.”156 Another argument against the neoliberal story is that there was in parallel a bubble in commercial real estate, which had nothing whatsoever to do with the GSEs.157 This trend dovetailed with another trend in the big banks, a transition from deriving much of their profit from loans to deriving it from fees for packaging mortgages (and other loans, such as credit card, auto loan, and student debt) into asset backed securities (ABS), selling ABSs and MBSs, creating dummy Structured Investment Vehicles (SIVs) to further reprocess MBSs into CDOs, and so forth. One estimate suggests that income from fee-related activities at commercial banks increased from 24 percent of total revenue in 1980 to 31 percent in 1990 to 48 percent in 2003.158 Combined with stunning increases in concentration in the mortgage origination market, such that the top 25 mortgage originators controlled 90 percent of the market in 2007, the consensus interpretation of events was that the mortgage boom was an adjunct to bigger changes in the private financial sector, and not prompted by some outbreak of rabid mendacity amongst the newly conniving population of home purchasers.
For the neoliberal meme “Fannie and Freddie Did It” to work, it would be necessary to refute and reject this emergent consensus narrative. One major arena in which this happened was the Congress-mandated Financial Crisis Inquiry Commission.
C) Financial Crisis Inquiry Commission
The function of the Financial Crisis Inquiry Commission in the United States was purportedly to do for our Great Crisis what Ferdinand Pecora’s investigation did for the Great Depression: provide trenchant research and a communal teaching experience concerning the causes of the crisis. On a public stage, our best and brightest would bring all the possibilities to the table, so that America might come to grips with its tragedy. Or at least that’s the way it was sold to the public when it was included in the Fraud Enforcement and Recovery Act of 2009. But after a year and a half of hearings, many of which were made available online,159 including questioning of more than eight hundred witnesses and expenditure of $6 million on staff, the whole pretence of a definitive archive of explanations broke down even before the report was formally issued in January 2011. The four Republican members of the supposedly bipartisan ten-person panel issued a preemptive-strike “Report” in December 2010, which sought to torpedo the main event (even before the final version had come up for a vote). That sketchy counterstory was more or less included as one of two “dissenting reports” appended to the final published report, the first under the names of Keith Hennessy, Douglas Holtz-Eakin, and Bill Thomas; the latter under the name of Peter Wallison. Wallison’s appendix made the case for the neoliberal “Fannie/Freddie did it” line summarized above.
What one would derive from reading the document was the concurrent posit of A and not-A as causes of the crisis. The six-person endorsed body of the report pinned the crisis on “failure to effectively rein in excesses in the mor
tgage and financial markets,” which then got parsed as a laundry list of usual suspects: credit-rating agencies, failures of regulators, OTC derivatives, crappy mortgages repackaged as sweets, Greenspan, executive compensation, Bernanke, shadow banking, etc. However, the majority went out of their way to reject one cause: “we examined the role of the GSEs . . . We conclude these two entities contributed to the crisis, but were not a primary cause . . . The GSEs participated in the expansion of subprime and other risky mortgages, but they followed rather than led Wall Street.” In other words, it went out of the way to insist everything contained in the Wallison appendix was false. The other minority appendix endorsed the Wallison line in passing, but seemed more concerned to absolve Wall Street of any culpability, proclaiming, “derivatives did not in any meaningful way cause or contribute to the crisis,” and denying that “shadow banking” was even a coherent concept.160 Consequently, it was exceedingly vague about what did cause the crisis, although it did coquette with the notion that it was all China’s fault. The first Republican dissent did not even bother with much in the way of evidence.