Friday, December 23, 2011

The Big Lie Grows

The Right can't agree on much these days--witness the Boehner-McConnell miscue over payroll tax cuts--but conservatives are eagerly converging around the idea that their Sugar Daddy No. 1, Wall Street, was largely blameless in the biggest financial crash since the Depression. We're hearing a whole new iteration of a very tired claim: that government housing policies dating back to Bill Clinton and Fannie Mae and Freddie Mac, the quasi-governmental lenders, were Ground Zero of the crisis. Gov. Rick Perry, whose cluelessness only seems to grow the longer he spends on the trail, not only wants to "free up Wall Street" to save the economy, but in Iowa this week he labeled Fannie and Freddie a "modern day Bonnie and Clyde." Gingrich and Romney have joined in identifying Fan and Fred as Public Enemies No.1.


Now the GOP has a willing accomplice in that weakest of regulatory sisters: the SEC. Having proved inept at nailing Wall Street over the last three years despite the biggest financial fraud in history--what I once called the Too Big to Jail problem-- the SEC is going for the easy pickings, Fannie and Freddie. This has lent credibility to the loons of the Right, as Joe Nocera noted the other day. It is also exactly what we have long expected from the the seriously compromised SEC chairwoman, Mary Schapiro, who spent most of her career as a tool of the financial industry, and her Deutsche Bank-engendered enforcement chief, Robert Khuzami. As head of the Commodity Futures Trading Commission in the mid-90s, Schapiro failed to assert control over OTC derivatives trading, despite scams that were already so worrisome that one of her successors, Brooksley Born, called them “the hippopotamus under the rug.” Later, when Schapiro was running the Financial Industry Regulatory Authority (FINRA)--Wall Street's abysmally incompetent "self-regulatory" body--she also missed Bernie Madoff's Ponzi scheme. In both her jobs Schapiro followed a pattern: she tended to aggressively investigate relatively minor violations while failing to see the hippopotamus-size frauds in the room. As Bill Singer, a former attorney for the National Association of Securities Dealers who's become a leading critic of regulators, told me back in 2009:  "My ultimate concern with Mary Schapiro is, we cannot afford to have the new SEC chair come in with a bucket of whitewash and a bucket of plaster. We need a wrecking ball."

We never got one. We got Schapiro and her bucket of whitewash instead. Now Khuzami has gone the route of least resistance, suing six former Fannie/Freddie execs in civil court saying they misrepresented the extent of the exposure of these "government-sponsored entities" (GSEs) to subprime loans. The Fan/Fred conspiracists have erupted in celebration. "Fannie led private lenders into the subprime market," the Wall Street Journal edit page crowed on Dec. 22.

Were Fannie and Freddie corrupt? Of course. I wrote that more than three years ago, as did many others. But to argue that they were prime movers in this crisis is to argue that the moon is made of green cheese rather than rock and dust. It's not just that new Fed data makes clear how deep and extensive the infection of bad lending on Wall Street--and therefore culpability--became. What's more significant is the obvious evidence that while Fannie and Freddie got involved, they were very late to the game, and they were at best fellow travelers.

As Bloomberg BusinessWeek reported this week, at the peak of the mortgage mania in 2005-06, only 6 percent of all subprime loans involved lenders or borrowers governed by the law, under which Fannie and Freddie were required to operate, according to Federal Reserve data. The rest was shadow banking encouraged or sponsored by Wall Street. “The available evidence seems to run counter to the contention that the CRA [the Community Reinvestment Act encouraging loans to low-income borrowers] contributed in any substantive way to the current mortgage crisis,” Fed economists Neil Bhutta and Glenn Canner wrote in 2009.

But what really puts the kabosh on the Fannie/Freddie theory is that -- as I wrote a year ago and go into considerable detail in Capital Offense -- the seeds of the financial crash of 2008 were planted decades before the subprime securitization market took off. The notorious advent of "CDOs," or collateralized debt obligations, were not something new under the sun. They were only the latest generation of a long lineage of  deceptive Wall Street securitization practices that developed independent of Fannie or Freddie or government-sponsored loans or real estate. To the extent that government was complicit, it was mainly in its willingness to stop regulating Wall Street and ignore the system of institutionalized fraud that was emerging. 

Among other changes, the 2000 Commodity Futures Modernization Act created what may have been the world’s most laissez-faire market in over-the-counter derivatives; the Glass-Steagall repeal in 1999 erased the remaining firewalls between federally insured banks and the riskiest trading practices; and the Securities and Exchange Commission lowered limits on leverage whenever asked, creating a pyramid of debt. Increasingly complex products and practices regularly blew up—think of the 1994  bankruptcy of Orange County, Calif., and the 1998 collapse of Long Term Capital Management—but the result was only more deregulation.


The heart of the issue had to do with the burgeoning markets in over-the-counter derivatives, credit default swaps and brain-crushingly complex structured finance products. The key to these trades was as much deception back then as it later became during the CDO craze. “Quants” on the street -- many of them former physicists or other math geniuses -- were always finding complex new ways to repackage assets. The structured-finance schemes usually followed the same theme: The key was to take junk -- risky but very high-yielding bonds or securities denominated in pesos or Thai baht or Malaysian ringgits -- and disguise them well enough so that pension investors or insurance companies or others thought they were buying investment-grade stuff denominated in dollars. 

These practices were direct forerunners of what many of the same Wall Street firms later did during the subprime bubble. The approach was the same: disguise bad assets as better ones. This was achieved by euphemizing poor credit risks as “subprime borrowers” and lumping them together with better credit risks within vastly complex CDOs, then slicing and dicing the loans so that investors--indeed, even the CEOs of the Wall Street firms themselves--no longer understood what was safe and what wasn't. Need further proof? Consider: by 2006, 44.7 percent of all securitized subprime mortgages in the country were "stated income" or no-document loans of the kind the GSEs couldn't engage in, according to Patrick Madigan, an Iowa assistant attorney general. "There's only one reason for that high number, and that's fraud." Fraud of precisely the kind that a securitization-hungry Wall Street had been engaging in for a decade or more before the subprime bubble.  


After the mortgage-refinancing boom of 2003–04, demand from Wall Street for fresh subprime "product" for new CDOs grew so intense that lending standards nationwide disintegrated. To meet the Street's demand for a steady supply, lenders kept reaching lower and lower down the scale of quality in both property and borrowers. The investment banks were so desperate for more mortgage-backed securities to sell that some of them cut deals with the big nonbank lenders to deliver billions of dollars worth of loans a month, no questions asked. "The drug lord was Wall Street. This was money looking for people to exploit," Jim Rokakis, the treasurer of Ohio's Cuyahoga County, which was particularly hard hit, told me in 2008.

Yes, Fannie and Freddie got into the game at some point -- but it was a game that had been invented by Wall Street years earlier. QED.







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