Monday, September 22, 2008

Blame for the financial crisis...what's not in the news

Okay, this post will be long but there is a lot of blame to go around for the recent financial meltdown. I have researched this a lot, from both sides of the political spectrum, and I present what I consider the key components to what got us here, trying to be as impartial as possible so that people can get the truth…something the mainstream media has had much difficulty reporting. My basic conclusion is simple: It all boils down to subprime mortgages. The how and where is up to you.

In 1977, Congress passed the Community Reinvestment Act, and in 1995 this Act was significantly strengthened by Clinton to allow for more enforcement and government involvement in private lending. In 1977, only one banker testified in support of the Act, all others were adamantly opposed. The CRA mandates that each banking institution be evaluated to determine if it has met the credit needs of its entire community. This is called a bank’s CRA score. That record is taken into account when the federal gov’t considers an institution's application for deposit facilities, including mergers and acquisitions. The main objective was to increase loans to small businesses and low-income families. Naturally, this poses a difficult situation.

The primary target of the act was the process of “redlining”. This is the practice of limiting mortgages in depressed neighborhoods. Banks did this to minimize their foreclosure risk, since such properties were likely to decrease in value. The government sought to stop redlining. Later, a similar effort was aimed at similar practices in the insurance industry.

Basically, if a bank does not make the right CRA score, through lending to low-income individuals and businesses, then its growth can be restricted by the government. The CRA also opened the door for community organizations to file complaints against individual banks that they felt were not meeting the needs of the community. One of these organizations was ACORN, known for its civil rights advocacy as well as voter fraud, upper level corruption and some controversial tactics against corporations. One of our presidential candidates has a history of working closely with ACORN and I encourage readers to further research this organization.

In 1991, ACORN fought against weakening the CRA by staging a 2 day takeover of the House Banking Committee. And under intense pressure from them, Allstate agreed to negotiate and signed an agreement in 1994 for a $10 million partnership with ACORN and NationsBank for below-market mortgages to low-income homebuyers. Finally, in 1995 Clinton strengthened the CRA to what it is today. As a result (in a simple example) a local bank would not be allowed to open its new branch across town until it demonstrated that it adequately and appropriately loaned money throughout the community, including the low-income households. If these households didn’t meet proper lending requirements, the banks had to find a way or else forget about that new branch.

The subprime mortgage was born. This substantially increased the number and aggregate amount of loans to small businesses and to low- and moderate-income borrowers for home loans. At the time, the CEO of Countrywide Financial went on the record stating that to get loans approved for low-income families, "lenders have had to stretch the rules a bit." The financial risk was too much for the smaller banks, so the practice of securitization was also born. Basically, smaller banks would pool mortgages and loans together and sell them to large financial institutions, who would repackage them and sell to investors. The first public securitization of CRA loans started in 1997 by Bear Stearns. The number of CRA mortgage loans increased by 39 percent between 1993 and 1998, while other loans increased by only 17 percent.

In 1999, Congress passed the Gramm Leach Bliley Act, which effectively terminated the Glass-Steagall Act. The GLBA opened up markets among banks, security agencies and insurance companies allowing banks to provide investment and insurance services. Supporters contended that consumers could one-stop shop with their bank and the competition would result in lower prices for these services. Opponents contended that the oversight was inadequate and these institutions should be limited in the services they provided, or else risk more corruption and fraud. However, prior to GLBA, there had already been many relaxations of Glass-Steagall. For example, a few years earlier, commercial Banks were allowed to get into investment banking, and before that banks were also allowed to get into stock and insurance brokerage. Insurance underwriting was the only main operation they weren't allowed to do, something rarely done by banks even after the passage of the Act.

Crucial to the passing of this Act was an amendment made to the GLBA, stating that no merger may go ahead if any of the financial holding institutions received a "less than satisfactory [sic] rating at its most recent CRA exam", essentially meaning that any merger may only go ahead with the strict approval of the regulatory bodies responsible for the CRA. This was an issue of hot contention, and Clinton stressed that he "would veto any legislation that would scale back minority-lending requirements." In other words, if the GOP didn’t make sure low-income housing was affordable, the law would never had become law. The law passed the Senate with a 90-8-1 vote, and the House with a 362-57-15 vote.

This was considered a GOP law and has been the recent focus of much criticism from the Left. Among those who voted in favor of the GLBA: Joe Biden, Harry Reid, Chris Dodd, Dianne Feinstein, Ted Kennedy, John Kerry, Joe Leiberman, Chuck Schumer, John Edwards, Charles Rangel and, yes, Nancy Pelosi. John McCain did not vote.

One of the outcomes of GLBA is the emergence of mega-financial corporations. It paved the way for mergers, most notably CitiGroup. Most recently, it allowed Bank of America to bail out Merrill Lynch. The downside is that these corporations became very big, which is a problem if they fit the “too big to fail” description, meaning their bankruptcy would lead to economic chaos worldwide. See AIG for an example.

In 2003, Bush sought to reform the government’s role in the mortgage industry after economic advisors voiced concern for poor business practice at Fannie Mae and Freddie Mac. These 2 companies controlled over half of the nation’s mortgage market and were the lending standard that most private banks went by. Bush wanted more oversight of them by establishing a new agency in the Treasury Dept to assume supervision of them. His efforts died in Congressional committee, and were strongly opposed by the National Association of Homebuilders.

In 2005, this effort was revitalized by several in the Senate, including John McCain. They voiced concern over a recent accounting scandal at Fannie Mae which showed earnings manipulation with a $175 million discrepancy. Top executives Franklin Raines and Jamie Gorelick were implicated in the scandal, and Fannie Mae was fined $400 million for SEC violations. Investor’s Business Daily said this, "Market failure? Hardly. Once again, this crisis has government fingerprints all over it." It should be noted that Raines and Jim Johnson (another former Fannie CEO) have been a part of Barack Obama’s presidential campaign. Johnson actually headed up Obama’s vice presidential search team.

McCain argued for reform on the Senate floor in 2006. He said that a report by the Office of Federal Housing Enterprise Oversight charged that “Fannie Mae employees deliberately and intentionally manipulated financial reports to hit earnings targets in order to trigger bonuses for senior executives…If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.”

Supporters of Senate Bill 109 demanded more oversight and regulation at the GSEs. It would require annual audits of Fan & Fred’s affordable housing programs; create an independent regulator to oversee the safety and soundness of the housing enterprises; give the regulator the authority to “wind down” a failing GSE and protect against a taxpayer bailout; give the new regulator greater discretion in raising capital standards to protect against insolvency. The bill died in Congressional committee.

Among those arguing against it was Barney Frank (D-Mass), who said: “These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis. The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.”

This would not be complete without mentioning Penny Pritzger. Why her? Because she is the finance chairman of Obama’s presidential campaign and was once president of Superior Bank. This bank collapsed in 2001, the largest failure in a decade.

In February, 2008, Asian Week analyzed Superior’s failure. "The [sub-prime] financial engineering that created the Wall Street meltdown was developed by the Pritzkers and Ernst and Young, working with Merrill Lynch to sell bonds securitized by sub-prime mortgages," according to Timothy J. Anderson, a whistle-blower on financial and bank fraud, and reported by Asian Week. "The sub-prime mortgages were provided to Merrill Lynch, by a nation-wide Pritzker origination system, using Superior as the cash cow, with many millions in FDIC insured deposits."

My concern in posting this is that I believe both political parties and branches of government share the blame for this financial mess, along with crooked lenders, brokers and irresponsible borrowers. But one party in particular, and one presidential candidate, seems to claim complete innocence and the media has let them get away with it. The record supports my contention. Of course, most news outlets won’t report things accurately so I encourage people to get the facts as I did. I see the government taking a much too active role in the financial world with the CRA. This is nothing other than social engineering and it was a major player in the corporate failures. When McCain argues against this he is accused of being a “deregulator”.

Yes, the corporate world sought expansion and, as a result, complied with CRA to issue bad loans. There is a very fine line between entrepreneurship and greed. Bottom line: government policy – championed by groups like ACORN - encouraged irresponsible lending in the name of more diverse home ownership. There is no other way to put it.

Yes, the GLBA allowed for financial giants to become “too big to fail” and thus the need for government bailouts. But I have yet to see how GLBA caused this crisis and no one has made that argument. Had GLBA died, there still would have been a subprime market, driven by Fannie & Freddie. Instead of a few giant banks failing, we would have had many small banks failing. That’s what happened in the Great Depression.

The point is that, yes, we need more reform and more oversight and transparency, but I’m not convinced how helpful this will be if we continue with the mandates as laid out in the CRA. The free market works, but is destined to fail if the government becomes overly involved with social engineering. Now, we face a situation where the government must get more involved in order to prevent a global financial disaster. Our leaders must ensure the gov’t gets out of this business as soon as possible, or outright socialism draws just that much closer.


Mike said...

John, I worked for/as a mortgage broker for about 5 years earlier in this decade. You are spot-on with your assessment. I find it amazing (though entirely predictable) that the media have not even touched on the reason why lenders started making sub-prime loans in the first place, namely that the government told them that they had to.

I would also point out that the loosely regulated broker system is at least partly to blame as well. It takes more education to get licensed to cut hair for a living than to open a mortgage brokerage, peddling other people's money for a small cut off the top. As a broker, it didn't really matter to us whether the borrower would pay it back or not. We got our 2-5% up front, sold the loan to the "big" bank, and then went on our way.

Anonymous said...


The GLBA allowed for the wholesale securitization of subprime loans and this caused the avalanche.

Meanwhile, I commend you on your analysis, although I disagree w/ some of it.

I am compelled to ask, however, is this your own independent analysis or someone else's?


John Washburn said...

The opinions are mine unless otherwise noted, the facts come from many sources including wikipedia. I've read several different columns alluding to the legislation mentioned, but didn't form a definite opinion on the matter until researching it on my own.

Loop, securitization played a role but the root cause was the bad loans. After all, securitization of good loans wouldn't have caused this issue. And if there was no GLBA allowing for securitization then there would still be this mass of bad loans dragging down a lot of small banks, still causing a huge financial problem.

Anonymous said...


I don't think so. Even w/ the policy to forbid redlining which itself was a discriminatory practice the bad loans were made by brokers who had no stake in whether the loans were paid.

It's one thing for the government to step in and say, "You can't just have a policy of not making any loans to people living w/in redlined zones b/c if you do, you have condemned that zone to eternal decay."

It's quite another to say, "I will lend money to anyone regardless of their ability to pay it back."

As you say, the problem would have been localized w/o the GLBA and much, much smaller. In my opinion, small to the extent of being of little or no consequence.

Consider that small banks were, for other marketplace reasons, already on the way out as viable business models.



Fannie Mae & Freddie Mac had friends in high rep
Barney Frank, House Banking Chair,
and Senator Chris Dodd, Senate Banking's Head Dude, and Barack Obama too; and they should All be asked to give back the money! reb

John Washburn said...

Discriminatory practice? That's a bold statement. It's hard for me to call sound business practice discriminatory.

If I went to Sears and tried to buy a $20 hammer with a five dollar bill, I would hardly claim discrimination when they refused to sell it to me.

If you are upset about decaying property values in the inner city, then why not speak out against crime, drug trade, gang-violence and illegitimacy? Blaming the banks for not wanting to invest in the area is hardly fair.

I guess we're at a fundamental disagreement. You seem to blame securitization, while I blame subprime mortgages aided in much part by the CRA.

I would at least like to hear our US media markets putting both arguments out there. It's concerning that most Americans aren't getting the whole story and are thus denied the right to form an informed opinion.

Anonymous said...


What I mean by discrimination is that he process of redlining precludes investment and it is stupid. When property values rise, we have both seen the positive effect of gentrification on formerly distressed neighborhoods. Relining is a policy that precluded that process.

You have put together a nice little theory. How many of the afflicted loans were mandated by the CRA?

The fact is--and I know this b/c I work in a building in which there were a lot of mortgage brokers and my employee and members of her immediate family allowed themselves to victimized by one of them--the brokers who made loans to people who could repay them, either b/c of their income or the terms of the loan, are the essential villains of the piece. The GLBA allowed the disease to spread like the Spanish flu.