In October, 1992, researchers for the Federal Reserve Bank of Boston produced a report meant to settle the question of whether banks were refusing to write mortgages for residents of minority neighborhoods merely because of their race. A few years earlier newspapers, beginning with the Atlanta Journal-Constitution, had started publishing sensationalistic stories based on studies which argued that banks were redlining, or avoiding minority neighborhoods for racial reasons, but many experts questioned the research behind these stories. The Boston Fed study, while critical of the earlier reports, nonetheless argued that some measure of redlining was, indeed, occurring. This blockbuster news led the Boston Fed to issue new suggestions for mortgage underwriting that significantly watered down lending standards for minority borrowers.
In their new book about the housing bubble and the 2008 financial crisis (Reckless Endangerment: How Outsized Ambition, Greed and Corruption Led to Economic Armageddon), New York Times reporter Gretchen Morgenson and financial analyst Joshua Rosner interview the lead author of the Boston Fed study, economist Alicia Munnell, who now says, incredibly, that she never meant the study to be used to dilute lending standards for minority borrowers. In fact, she intended the exact opposite, that is, to warn that bankers were “doing nice things for white people” like themselves that were unwarranted. Needless to say, reading her remarks after all these years, I couldnt help thinking to myself, “Now she tells us.”
Morgenson and Rosner interviewed Munnell because the authors place enormous importance on government-led efforts to change mortgage lending standards, an effort the giant government-sponsored entities which buy up mortgages, Fannie Mae and Freddie Mac, were responsible for driving. Their book, which repeats what others have said but which fills in many of the details of the years leading up to the mortgage meltdown, is likely to restart the debate about just how much of a role the government and its policies figured in the financial crisis.
Earlier this year, the Financial Crisis Inquiry Commissions report sparked controversy when it said that government affordable housing policy, embodied by Fannie and Freddie, didnt play a crucial role in the crisis but that the Fannie and Freddie merely “followed rather than led Wall Street and other lenders” over the financial cliff.
Morgenson and Rosner have a different story to tell. It was Fannie Mae, they argue, which led the way in relaxing loan underwriting standards in the industry, and Fannie Mae whose lobbying tactics, using affordable housing as a cudgel to expand its portfolio with risky lending, was “watched closely and subsequently imitated by others in the private sector.” It was Fannie Mae who showed those on Wall Street how it was possible to eliminate the traditional due diligence conducted by lenders, which “soon became the playbook for financial executives across the country,” and executives at Fannie Mae who, when all else failed, viciously and personally attacked those who questioned its practices, in the process destroying a few careers. As a congressional aide said of Fannie Mae, although it had a grandmotherly image, “theyll castrate you, decapitate you, tie up and throw you in the Potomac.” No wonder Congress barely blinked when, in 1994, Fannie Mae announced a $1 trillion commitment to affordable housing, including money lent under inferior underwriting standards.
Reckless Endangerment locates the origins of the crisis in the ironically named Federal Housing Enterprises Financial Safety and Soundness Act of 1992, which was supposed to protect taxpayers from big losses by Fannie and Freddie. That law pushed the institutions into affordable housing lending and prompted Fannie in particular to adopt a strategy to disarm critics by continually arguing that efforts to rein in the companys operations, such as requiring it to back its mortgage purchases with more capital, would only hurt the goal of expanding home ownership. “You should rejoice in Fannie Mae and Freddie Mac rather than fight them,” Fannies chief executive, James Johnson, told the New York Times.
In the wake of the 1992 legislation, Fannie Mae created the Housing Impact Advisory Council, an assembly consisting of low-income housing advocacy groups and mortgage lenders. Fannie Mae also began supplying grants to the housing groups, like ACORN, which a few years earlier had criticized the GSEs in the press as “strictly by-the-book” interpreters of underwriting standards whose young underwriters, “are not sensitized to the existence of redlining, be it racial or geographic.” Now Fannie was singing a different, more cooperative tune, and its new council, Morgenson and Rosner write, evolved into “the centerpiece” of President Clintons 1994 National Partners in Homeownership program, a “disastrous homeownership policy” that played a crucial role in inflating the housing bubble.
Fannie Mae became an especially intense advocate of affordable housing ventures, ferociously attacking anyone who questioned its mission or its methods. One of the more compelling sections of Reckless Endangerment recounts a particularly dramatic Congressional hearing in June of 1996, when members of Congress, armed with questions supplied by Fannie Mae, lay in wait for June ONeill, the inimitable former head of the Congressional Budget Office, who presented to Congress one of the first studies casting doubts on Fannie Maes value to the housing market and pointing out its risks to taxpayers. Fannie Maes executives had already attacked the study in newspapers, calling it the work of “economic pencil brains” and “digit heads” who would have more important jobs in government if they could “figure out a better way of delivering credit to millions of families.” Needless to say, though ONeill artfully parried the criticism and made a compelling case for caution, most members of Congress largely ignored the report and its warnings.
Morgenson has a reputation for take no prisoners reporting style, and thats reflected in the book. In an appendix, the authors group the characters from this long drama into a list of “friends” of Fannie Mae and doubters who pushed back, subprime “enablers” and “feckless regulators.” That last category is led by Treasury Secretary Timothy Geithner, president of the New York Fed from 2003 through 2008, and includes current New York Governor Andrew Cuomo, HUD secretary from 1997 through 2001. Both also appear on a long list in the books epilogue of those involved in the crisis who are still in positions of power.
Over the years encompassed by the book, Fannie spent roughly $100 million on lobbying and political contributions, so there are plenty of enablers. But Massachusetts Congressman Barney Frank stands out, particularly. Reckless Endangerment broke the news that Frank recommend his then-companion for a job at Fannie, where he worked for seven years. The book also recounts Franks defenses of the GSEs, many offered in a brusque, peremptory manner that suggested the powerful congressman would brook no criticism of the affordable housing monsters.
Reckless Endangerment has plenty to say about the role private financial institutions played in the mortgage mess, too, how in particular these players took the cues offered by the federal government and over time created progressively more toxic mortgages based on the outlines of lower lending standards first promulgated by Fannie and Freddie. And how as the mortgage market swelled under the expanding home ownership push Wall Street firms eventually cast themselves into intense competition against the GSEs for the securitization market, packaging increasingly more sophisticated private mortgage-backed securities whose risks no one, not even their creators, sufficiently understood.
Still, its the long, sad tale of how executives at Fannie Mae artfully used federal housing policy as a vehicle to expand their own power, raise their salaries, and bolster their stock price while helping inflate the housing bubble that stands out the most in Reckless Endangerment.
Original Source: http://www.realclearmarkets.com/articles/2011/06/29/housing_and_reckless_disregard_for_risk_99102.html