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How the Democrats Created the Financial Crisis: Kevin Hassett

How the Democrats Created the Financial Crisis: Kevin Hassett

Commentary by Kevin Hassett

Sept. 22 (Bloomberg) -- The financial crisis of the past year has provided a number of surprising twists and turns, and from Bear Stearns Cos. to American International Group Inc., ambiguity has been a big part of the story.

Why did Bear Stearns fail, and how does that relate to AIG? It all seems so complex.

But really, it isn't. Enough cards on this table have been turned over that the story is now clear. The economic history books will describe this episode in simple and understandable terms: Fannie Mae and Freddie Mac exploded, and many bystanders were injured in the blast, some fatally.

Fannie and Freddie did this by becoming a key enabler of the mortgage crisis. They fueled Wall Street's efforts to securitize subprime loans by becoming the primary customer of all AAA-rated subprime-mortgage pools. In addition, they held an enormous portfolio of mortgages themselves.

In the times that Fannie and Freddie couldn't make the market, they became the market. Over the years, it added up to an enormous obligation. As of last June, Fannie alone owned or guaranteed more than $388 billion in high-risk mortgage investments. Their large presence created an environment within which even mortgage-backed securities assembled by others could find a ready home.

The problem was that the trillions of dollars in play were only low-risk investments if real estate prices continued to rise. Once they began to fall, the entire house of cards came down with them.

Turning Point

Take away Fannie and Freddie, or regulate them more wisely, and it's hard to imagine how these highly liquid markets would ever have emerged. This whole mess would never have happened.

It is easy to identify the historical turning point that marked the beginning of the end.

Back in 2005, Fannie and Freddie were, after years of dominating Washington, on the ropes. They were enmeshed in accounting scandals that led to turnover at the top. At one telling moment in late 2004, captured in an article by my American Enterprise Institute colleague Peter Wallison, the Securities and Exchange Comiission's chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's position on the relevant accounting issue was not even ``on the page'' of allowable interpretations.

Then legislative momentum emerged for an attempt to create a "world-class regulator'' that would oversee the pair more like banks, imposing strict requirements on their ability to take excessive risks. Politicians who previously had associated themselves proudly with the two accounting miscreants were less eager to be associated with them. The time was ripe.

Greenspan's Warning

The clear gravity of the situation pushed the legislation forward. Some might say the current mess couldn't be foreseen, yet in 2005 Alan Greenspan [AND JOHN MCCAIN] told Congress how urgent it was for it to act in the clearest possible terms: If Fannie and Freddie "continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road,'' he said. "We are placing the total financial system of the future at a substantial risk.''

What happened next was extraordinary. For the first time in history, a serious Fannie and Freddie reform bill [McCain's bill!] was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.

Different World

If that bill had become law, then the world today would be different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest and most venerable institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed.

But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.

That such a reckless political stand could have been taken by the Democrats was obscene even then. Wallison wrote at the time: "It is a classic case of socializing the risk while privatizing the profit. The Democrats and the few Republicans who oppose portfolio limitations could not possibly do so if their constituents understood what they were doing.''

Mounds of Materials

Now that the collapse has occurred, the roadblock built by Senate Democrats in 2005 is unforgivable. Many who opposed the bill doubtlessly did so for honorable reasons. Fannie and Freddie provided mounds of materials defending their practices. Perhaps some found their propaganda convincing.

But we now know that many of the senators who protected Fannie and Freddie, including Barack Obama, Hillary Clinton and Christopher Dodd, have received mind-boggling levels of financial support from them over the years.

Throughout his political career, Obama has gotten more than $125,000 in campaign contributions from employees and political action committees of Fannie Mae and Freddie Mac, second only to Dodd, the Senate Banking Committee chairman, who received more than $165,000.

Clinton, the 12th-ranked recipient of Fannie and Freddie PAC and employee contributions, has received more than $75,000 from the two enterprises and their employees. The private profit found its way back to the senators who killed the fix.

There has been a lot of talk about who is to blame for this crisis. A look back at the story of 2005 makes the answer pretty clear.

Oh, and there is one little footnote to the story that's worth keeping in mind while Democrats point fingers between now and Nov. 4: Senator John McCain was one of the three cosponsors of S.190, the bill that would have averted this mess.

(Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist. He is an adviser to Republican Senator John McCain of Arizona in the 2008 presidential election. The opinions expressed are his own.)

To contact the writer of this column: Kevin Hassett at


Last Updated: September 22, 2008 00:04 EDT

skb9850 skb9850 7 years 34 weeks
I agree Dave, it's much easier to believe in Republican greed.
UnDave35 UnDave35 7 years 34 weeks
I would say this needs to be published in every liberal blog site we can find, but no one would really believe it. Believing it would mean that their best two Presidents put legislation in place which is the cause of this, and not Republican greed.
Shopaholichunny Shopaholichunny 7 years 34 weeks
:jawdrop: Thanks for the info ladies. People are so misinformed. I agree RCL.
RCLdesigngirl RCLdesigngirl 7 years 34 weeks
Laine, thank you for sharing that! If I had known the government was just handing out houses left and right, I would have upsized a long time ago! Hell, I would have supersized! This is just ridiculous! A country cannot sustain on two factions of belief. One being that hard work will take you wherever you want to go, and the other being that hard work is irrelevant because you can just mooch off of the people who work hard. It is very tempting to start to request that my paycheck be made to me in CASH which will go in my sock drawer.
Cassandra57 Cassandra57 7 years 34 weeks
This is a great article! I've had a sense that much of the current furor might be due to just a few underlying factors, but I haven't had the time to investigate. (Personally, I think that's how Congress gets away with all they do--the citizens are too busy to watchdog them!) A co-worker on Friday said that she knew someone who had been involved in writing mortgages (and is now unemployed). The woman would flat-out lie on the mortgage documents, and apparently there was no real verification process. Hence all the paper written based on undocumented income, etc. Here's one angle I'm looking at: The FHA. "Unlike conventional loans that adhere to strict underwriting guidelines, FHA-insured loans require very little cash investment to close a loan. There is more flexibility in calculating household income and payment ratios."
girlbassist girlbassist 7 years 34 weeks
Sadly, the general public probably won't see articles like these.
RCLdesigngirl RCLdesigngirl 7 years 34 weeks
God, that makes me sick.
samantha999 samantha999 7 years 34 weeks
a little somehting I was reading this morning: "This crisis was caused by political correctness being forced on the mortgage lending industry in the Clinton era. Before the Democrats' affirmative action lending policies became an embarrassment, the Los Angeles Times reported that, starting in 1992, a majority-Democratic Congress "mandated that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers. Operating under that requirement, Fannie Mae, in particular, has been aggressive and creative in stimulating minority gains." Under Clinton, the entire federal government put massive pressure on banks to grant more mortgages to the poor and minorities. Clinton's secretary of Housing and Urban Development, Andrew Cuomo, investigated Fannie Mae for racial discrimination and proposed that 50 percent of Fannie Mae's and Freddie Mac's portfolio be made up of loans to low- to moderate-income borrowers by the year 2001. Instead of looking at "outdated criteria," such as the mortgage applicant's credit history and ability to make a down payment, banks were encouraged to consider nontraditional measures of credit-worthiness, such as having a good jump shot or having a missing child named "Caylee." Threatening lawsuits, Clinton's Federal Reserve demanded that banks treat welfare payments and unemployment benefits as valid income sources to qualify for a mortgage. That isn't a joke — it's a fact." *************** "Glory belongs to the act of being constant to something greater than yourself, to a cause, to your principles, to the people on whom you rely, and who rely on you in return. No misfortune, no injury, no humiliation can destroy it."
Shopaholichunny Shopaholichunny 7 years 34 weeks
I agree RCL! Maybe upper-middle class. ;) hehe
RCLdesigngirl RCLdesigngirl 7 years 34 weeks
And also that the American Dream doesn't stop at being middle class!! Hillary made that point at the DNC, which cracked me up! The beauty of the American Dream is that there is no stopping point. Dream it, do it, achieve it...whatever it is! I don't know of very many people whose dream it is to be middle class.
Shopaholichunny Shopaholichunny 7 years 34 weeks
:jawdrop: Good point Sam. That's soooo TRUE. Part of the American Dream is also working HARD for what you want and learning how to live within your means.
samantha999 samantha999 7 years 34 weeks
This mess started with the Carter administration wanting the "poor & minorities" to own homes. Clinton furthered that with his bill. They felt it was the American dream to own a home in debt instead of the American dream being working hard and earning what you have without tremendous debt. Schumer (D-NY) was responsible for the bank collapse this year. He wrote letter upon letter that were made public and caused a run on the bank. Most banks can hold their own with bad debt as long as the consumer does not pull their cash. Causing the run caused the first major bank collapse in CA. this year. If the democrats were living up to the "transparent" gov't they preach, then maybe just maybe this could have been stopped before the damn broke. *************** "Glory belongs to the act of being constant to something greater than yourself, to a cause, to your principles, to the people on whom you rely, and who rely on you in return. No misfortune, no injury, no humiliation can destroy it."
Shopaholichunny Shopaholichunny 7 years 34 weeks
Thanks soooo much RCL! GREAT article. People need to WAKE up.