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Posts Tagged ‘Fannie Mae’

Let’s assume you didn’t understand how a garbage disposal worked and, for whatever reason, you decided to stick your arm in one and turn it on. You would do some serious injury to your hand.

The rest of us would wonder what motivated you to stick your arm down the drain in the first place, but we would feel sympathy because you didn’t realize bad things would happen.

But if you then told us that you were planning to do the same thing tomorrow, we would think you were crazy. Didn’t you learn anything, we would ask?

Seems like a preposterous scenario, but something very similar is now happening in Washington. The Obama Administration is proposing to once again put the economy at risk by subsidizing banks to give mortgages to people with poor credit.

“Let’s party like it’s 2006!”

Even though we’re still dealing with the economic and fiscal damage caused by the last episode of government housing subsidies!

Here are some of the unbelievable details from a report in the Washington Post.

The Obama administration is engaged in a broad push to make more home loans available to people with weaker credit…officials say they are working to get banks to lend to a wider range of borrowers by taking advantage of taxpayer-backed programs — including those offered by the Federal Housing Administration — that insure home loans against default. Housing officials are urging the Justice Department to provide assurances to banks, which have become increasingly cautious, that they will not face legal or financial recriminations if they make loans to riskier borrowers who meet government standards but later default.

Brings to mind the famous saying from George Santayana that, “Those who cannot remember the past are condemned to repeat it.”

But what’s especially amazing – and distressing – about this latest scheme is that “the past” was only a couple of years ago. Or, to recall my odd analogy, one of our hands is still mangled and bleeding and we’re thinking about putting our other hand in the disposal.

Some people understand this is a nutty idea.

…critics say encouraging banks to lend as broadly as the administration hopes will sow the seeds of another housing disaster and endanger taxpayer dollars. “If that were to come to pass, that would open the floodgates to highly excessive risk and would send us right back on the same path we were just trying to recover from,” said Ed Pinto, a resident fellow at the American Enterprise Institute.

What’s also discouraging is that the government already is deeply involved in the housing market – even though this is an area where there is no legitimate role for the federal intervention.

Deciding which borrowers get loans might seem like something that should be left up to the private market. But since the financial crisis in 2008, the government has shaped most of the housing market, insuring between 80 percent and 90 percent of all new loans, according to the industry publication Inside Mortgage Finance. It has done so primarily through the Federal Housing Administration, which is part of the executive branch, and taxpayer-backed mortgage giants Fannie Mae and Freddie Mac, run by an independent regulator.

So I guess the goal is to have taxpayers on the hook for 100 percent of loans.

“Don’t worry, it’s not our money”

Anybody want to guess whether this will end well?

By the way, this is bad policy even if we somehow avoid a new bubble and big taxpayer losses. Even in a”best case” scenario, the federal government will be distorting the allocation of capital by discouraging business investment and subsidizing residential real estate.

And as shown in this powerful chart, that will have adverse consequences for wages and living standards.

The part of the article that most nauseated me was a quote from the head bureaucrat at the Federal Housing Administration.

“My view is that there are lots of creditworthy borrowers that are below 720 or 700 — all the way down the credit-score spectrum,” Galante said. “It’s important you look at the totality of that borrower’s ability to pay.”

Gee, isn’t that nice that Ms. Galante thinks there are lots of borrowers with good “totality” measures? But here’s an interesting concept. Why doesn’t she put her money at risk instead of making me the involuntary guarantor on these dodgy loans?

I’ve already said on TV that we should dump Fannie Mae and Freddie Mac in the Potomac River. And I’ve  argued that the entire Department of Housing and Urban Development should be razed to the ground.

But perhaps this cartoon best shows the consequences of the Obama Administration’s new subsidy scheme.

P.S. We also should get rid of housing preference in the tax code. Our economy should cater to the underlying preferences of consumers, not the electoral interests of politicians.

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Writing for the New York Times, Paul Krugman has a new column promoting more government spending and additional government regulation. That’s a dog-bites-man revelation and hardly noteworthy, of course, but in this case he takes a swipe at the Cato Institute.

The financial crisis of 2008 and its painful aftermath…were a huge slap in the face for free-market fundamentalists. …analysts at right-wing think tanks like…the Cato Institute…insisted that deregulated financial markets were doing just fine, and dismissed warnings about a housing bubble as liberal whining. Then the nonexistent bubble burst, and the financial system proved dangerously fragile; only huge government bailouts prevented a total collapse.

Upon reading this, my first reaction was a perverse form of admiration. After all, Krugman explicitly advocated for a housing bubble back in 2002, so it takes a lot of chutzpah to attack other people for the consequences of that bubble.

He likes cats, so he’s not all bad

But let’s set that aside and examine the accusation that folks at Cato had a Pollyanna view of monetary and regulatory policy. In other words, did Cato think that “deregulated markets were doing just fine”?

Hardly. If Krugman had bothered to spend even five minutes perusing the Cato website, he would have found hundreds of items by scholars such as Steve Hanke, Gerald O’Driscoll, Bert Ely, and others about misguided government regulatory and monetary policy. He could have perused the remarks of speakers at Cato’s annual monetary conferences. He could have looked at issues of the Cato Journal. Or our biennial Handbooks on Policy.

The tiniest bit of due diligence would have revealed that Cato was not a fan of Federal Reserve policy and we did not think that financial markets were deregulated. Indeed, Cato scholars last decade were relentlessly critical of monetary policy, Fannie Mae, Freddie Mac, Community Reinvestment Act, and other forms of government intervention.

Heck, I imagine that Krugman would have accused Cato of relentless and foolish pessimism had he reviewed our work  in 2006 or 2007.

I will confess that Cato people didn’t predict when the bubble would peak and when it would burst. If we had that type of knowledge, we’d all be billionaires. But since Krugman is still generating income by writing columns and doing appearances, I think it’s safe to assume that he didn’t have any special ability to time the market either.

Krugman also implies that Cato is guilty of historical revisionism.

…many on the right have chosen to rewrite history. Back then, they thought things were great, and their only complaint was that the government was getting in the way of even more mortgage lending; now they claim that government policies, somehow dictated by liberals even though the G.O.P. controlled both Congress and the White House, were promoting excessive borrowing and causing all the problems.

I’ve already pointed out that Cato was critical of government intervention before and during the bubble, so we obviously did not want government tilting the playing field in favor of home mortgages.

It’s also worth nothing that Cato has been dogmatically in favor of tax reform that would eliminate preferences for owner-occupied housing. That was our position 20 years ago. That was our position 10 years ago. And it’s our position today.

I also can’t help but comment on Krugman’s assertion that GOP control of government last decade somehow was inconsistent with statist government policy. One obvious example would be the 2004 Bush Administration regulations that dramatically boosted the affordable lending requirements for Fannie Mae and Freddie Mac, which surely played a role in driving the orgy of subprime lending.

And that’s just the tip of the iceberg. The burden of government spending almost doubled during the Bush years, the federal government accumulated more power, and the regulatory state expanded. No wonder economic freedom contracted under Bush after expanding under Clinton.

But I’m digressing. Let’s return to Krugman’s screed. He doesn’t single out Cato, but presumably he has us in mind when he criticizes those who reject Keynesian stimulus theory.

…right-wing economic analysts insisted that deficit spending would destroy jobs, because government borrowing would divert funds that would otherwise have gone into business investment, and also insisted that this borrowing would send interest rates soaring. The right thing, they claimed, was to balance the budget, even in a depressed economy.

Actually, I hope he’s not thinking about us. We argue for a smaller burden of government spending, not a balanced budget. And we haven’t made any assertions about higher interest rates. We instead point out that excessive government spending undermines growth by undermining incentives for productive behavior and misallocating labor and capital.

But we are critics of Keynesianism for reasons I explain in this video. And if you look at current economic performance, it’s certainly difficult to make the argument that Obama’s so-called stimulus was a success.

ZombieBut Krugman will argue that the government should have squandered even more money. Heck, he even asserted that the 9-11 attacks were a form of stimulus and has argued that it would be pro-growth if we faced the threat of an alien invasion.

In closing, I will agree with Krugman that there’s too much “zombie” economics in Washington. But I’ll let readers decide who’s guilty of mindlessly staggering in the wrong direction.

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I think it’s a mistake to bail out profligate governments, and I have the same skeptical attitude about bailouts for mismanaged banks and inefficient car companies.

Simply stated, bailouts reward past bad behavior and make future bad behavior more likely (what economists call moral hazard).

But some folks think government was right to put taxpayers on the hook for the sloppy decisions of private companies. Here’s the key passage in USA Today’s editorial on bailouts.

Put simply, the bailouts worked. True, in some cases the government did not do a very good job with the details, and taxpayers are out $142 billion in connection with the non-TARP takeovers of housing giants Fannie Mae and Freddie Mac. But it’s time for the economic purists and the Washington cynics to admit that government can occasionally do something positive, at least when faced with a terrifying crisis.

Well, I guess I’m one of those “economic purists” and “Washington cynics,” so I’m still holding firm to the position that the bailouts were a mistake. In my “opposing view” column, I argue that the auto bailout sets a very bad precedent.

Unfortunately, the bailout craze in the United States is a worrisome sign cronyism is taking root. In the GM/Chrysler bailout, Washington intervened in the bankruptcy process and arbitrarily tilted the playing field to help politically powerful creditors at the expense of others. …This precedent makes it more difficult to feel confident that the rule of law will be respected in the future when companies get in trouble. It also means investors will be less willing to put money into weak firms. That’s not good for workers, and not good for the economy.

If I had more space (the limit was about 350 words), I also would have dismissed the silly assertion that the auto bailout was a success. Yes, GM and Chrysler are still in business, but the worst business in the world can be kept alive with sufficiently large transfusions of taxpayer funds.

And we’re not talking small amounts. The direct cost to taxpayers presently is about $25 billion, though I noted as a postscript in this otherwise humorous post that experts like John Ransom have shown the total cost is far higher.

And here’s what I wrote about the financial sector bailouts.

The pro-bailout crowd argues that lawmakers had no choice. We had to recapitalize the financial system, they argued, to avoid another Great Depression. This is nonsense. The federal government could have used what’s known as “FDIC resolution” to take over insolvent institutions while protecting retail customers. Yes, taxpayer money still would have been involved, but shareholders, bondholders and top executives would have taken bigger losses. These relatively rich groups of people are precisely the ones who should burn their fingers when they touch hot stoves. Capitalism without bankruptcy, after all, is like religion without hell. And that’s what we got with TARP. Private profits and socialized losses are no way to operate a prosperous economy.

The part about “FDIC resolution” is critical. I’ve explained, both in a post criticizing Dick Cheney and in another post praising Paul Volcker, that policymakers didn’t face a choice of TARP vs nothing. They could have chosen the quick and simple option of giving the Federal Deposit Insurance Corporation additional authority to put insolvent banks into something akin to receivership.

Indeed, I explained in an online debate for U.S. News & World Report that the FDIC did handle the bankruptcies of both IndyMac and WaMu. And they could have used the same process for every other poorly run financial institution.

But the politicians didn’t want that approach because their rich contributors would have lost money.

I have nothing against rich people, of course, but I want them to earn money honestly.

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I’ve explained on many occasions how the financial crisis was largely the result of government-imposed mistakes, and I’ve paid considerable attention to the role of easy money by the Federal Reserve and the perverse subsidies provided by Fannie Mae and Freddie Mac.

But I’ve only once touched on the role of the Basel regulations on capital standards.

So I’m delighted that the invaluable Peter Wallison just authored a column in the Wall Street Journal, in which he explains how regulators created systemic risk by replacing market forces with bureaucratic edicts.

Europe’s banks, like those in the U.S. and other developed countries, function under a global regulatory regime known as the Basel bank capital standards. …Among other things, the rules define how capital should be calculated and how much capital internationally active banks are required to hold. First decreed in 1988 and refined several times since then, the Basel rules require commercial banks to hold a specified amount of capital against certain kinds of assets. …Under these rules, banks and investment banks were required to hold 8% capital against corporate loans, 4% against mortgages and 1.6% against mortgage-backed securities. …financial institutions subject to the rules had substantially lower capital requirements for holding mortgage-backed securities than for holding corporate debt, even though we now know that the risks of MBS were greater, in some cases, than loans to companies. In other words, the U.S. financial crisis was made substantially worse because banks and other financial institutions were encouraged by the Basel rules to hold the very assets—mortgage-backed securities—that collapsed in value when the U.S. housing bubble deflated in 2007.

What’s amazing (or perhaps frustrating is a better word) is that the regulators didn’t learn from the financial crisis. They should have disbanded in shame, but instead they continued to impose bad rules on the world.

And now we find their fingerprints all over the sovereign debt crisis. Here’s more of Peter’s column.

Today’s European crisis illustrates the problem even more dramatically. Under the Basel rules, sovereign debt—even the debt of countries with weak economies such as Greece and Italy—is accorded a zero risk-weight. Holding sovereign debt provides banks with interest-earning investments that do not require them to raise any additional capital. Accordingly, when banks in Europe and elsewhere were pressured by supervisors to raise their capital positions, many chose to sell other assets and increase their commitments to sovereign debt, especially the debt of weak governments offering high yields. …In the U.S. and Europe, governments and bank supervisors are reluctant to acknowledge that their political decisions—such as mandating a zero risk-weight for all sovereign debt, or favoring mortgages and mortgage-backed securities over corporate debt—have created the conditions for common shocks.

This is not to excuse the reckless behavior of national politicians. It is their destructive spending policies that are leading both the United States and Europe in a race to fiscal collapse.

But banks wouldn’t be quite as likely to finance that wasteful spending if regulators didn’t put their thumbs on the scale.

It’s almost enough to make you think that regulation is a costly burden that hurts the economy.

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Remember my post from a week ago when I said I was not a Republican even though Ronald Reagan and Calvin Coolidge are two of my heroes?

Well, now I have another reason to despise the GOP. Those reprehensible statists just voted to expand federal housing subsidies.

Here are some excerpts from an excellent National Review column by Andrew McCarthy.

Almost two weeks ago, when they figured no one was watching, the Republican-dominated House of Representatives, by an overwhelming 292–121 margin, voted to increase funding for the Federal Housing Administration. Just as government debt hit $15 trillion, edging closer to 100 percent of GDP, these self-proclaimed scourges of spending decided Uncle Sam should continue subsidizing mini-mansion mortgage loans — up to nearly three-quarters of a million dollars.  Given the straits that the mortgage crisis has left us in, to say nothing of the government’s central role in getting us there, one might think Republicans would be asking whether the government should be in the housing business at all. …the Republican House — installed by the Tea Party in a sea-change election to be the antidote to Obamanomics — decided the taxpayers should guarantee FHA loans up to $729,750. Had they not acted, the public obligation would have been reduced to “only” $625,500 per FHA loan — couldn’t have that, right? …thanks to GOP leadership’s good offices, this government mortgage guarantor now sports expanding portfolios, capital reserves acknowledged only in the breach, and the potential for hundreds of billions of dollars in losses. …If Republicans really thought the growth of government was unsustainable, they’d stop growing it.

I complained last month when 8 Republican senators voted to expand housing subsidies via Fannie and Freddie. Well, 17 GOP senators voted for destructive FHA subsidies, along with 133 Republican representatives.

So let’s recap. Everyone knows that government intervention caused the housing crisis, which is why Republicans should be voting to shut down the Department of Housing and Urban Development and enacting legislation to get government out of the housing sector.

But they decided instead that campaign loot from the corrupt housing lobbies was more important than doing the right thing.

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I have no idea whether George Santayana was a good philosopher, but he certainly was right when he wrote, “Those who do not learn from history are doomed to repeat it.”

Consider the fools in the U.S. Senate. They just voted to expand Fannie Mae and Freddie Mac subsidies, apparently thinking that re-inflating the housing bubble would be a good idea when every sensible person thinks we should abolish these government-created entities.

Here are some blurbs from the Business Week story.

The U.S. Senate adopted a measure that would raise the maximum size of a home loan backed by mortgage companies Fannie Mae, Freddie Mac and the Federal Housing Administration to $729,750. Senator Robert Menendez, a New Jersey Democrat, offered the increase as an amendment to a spending bill today. The measure was approved less than a month after the limit on so-called conforming loans was automatically reduced to $625,500. …The Senate adopted the amendment 60-31. The amendment required 60 votes for approval and was offered during the chamber’s consideration of a package of spending measures. If the Senate passes the underlying bill, the House would then have to vote for it to become law. …The limits, which vary by locale, apply to loans backed by the FHA and government-controlled mortgage companies Fannie Mae and Freddie Mac, which together buy or guarantee about 90 percent of all residential home loans.

For what it’s worth, every Democrat voted for the measure, as well as these Republicans.

Blunt – Missouri

Brown – Massachusetts

Chambliss – Georgia

Graham – South Carolina

Heller – Nevada

Isakson – Georgia

Murkowski – Alaska

Snowe – Maine

Maybe these feckless and irresponsible jokers should spend a bit of time reading Peter Wallison’s work. And here’s a George Will column if they can’t comprehend anything longer than 800 words.

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Here’s a recent interview with Neil Cavuto about bailouts for Fannie Mae, one of the government-created entities used by Barney Frank, et al, to subsidize housing (and line the pockets of well-connected political insiders).

My main concern is not the bailouts, which surely are odious, but whether we can at least limit future damage by getting the government out of the business of misallocating capital and distorting markets.

When in a hole, put down the %*#(& shovel and stop digging!

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Welcome Instapundit readers. Here’s a related link if you want to get even more depressed about politicians digging the debt hole deeper.

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If you want to understand how government intervention screws up markets and damages an economy, there are two new publications worth reading. First, pick up a copy of Reckless Endangerment, a new book by Gretchen Morgenson of the New York Times, and Joshua Rosner, an expert on housing finance.

I’ll confess I haven’t read the book, but it’s on my list based on two columns. Here’s some of what George Will wrote after giving it a read.

The book’s subtitle could be: “Cry ‘Compassion’ and Let Slip the Dogs of Cupidity.” Or: “How James Johnson and Others (Mostly Democrats) Made the Great Recession.” The book is another cautionary tale about government’s terrifying self-confidence. It is, the authors say, “a story of what happens when Washington decides, in its infinite wisdom, that every living, breathing citizen should own a home.” …“Reckless Endangerment” is a study of contemporary Washington, where showing “compassion” with other people’s money pays off in the currency of political power, and currency. Although Johnson left Fannie Mae years before his handiwork helped produce the 2008 bonfire of wealth, he may be more responsible for the debacle and its still-mounting devastations — of families, endowments, etc. — than any other individual. If so, he may be more culpable for the peacetime destruction of more wealth than any individual in history.

And here is some of what David Brooks wrote, in a column that focused on the sleazy insider corruption exposed by the book.

The Fannie Mae scandal has gotten relatively little media attention because many of the participants are still powerful, admired and well connected. But Gretchen Morgenson, a Times colleague, and the financial analyst Joshua Rosner have rectified that, writing “Reckless Endangerment,” a brave book that exposes the affair in clear and gripping form. The story centers around James Johnson, a Democratic sage with a raft of prestigious connections. …Morgenson and Rosner write with barely suppressed rage, as if great crimes are being committed. But there are no crimes. This is how Washington works. Only two of the characters in this tale come off as egregiously immoral. Johnson made $100 million while supposedly helping the poor. Representative Barney Frank, whose partner at the time worked for Fannie, was arrogantly dismissive when anybody raised doubts about the stability of the whole arrangement. …Johnson roped in some of the most respected establishment names: Bill Daley, Tom Donilan, Joseph Stiglitz, Dianne Feinstein, Kit Bond, Franklin Raines, Larry Summers, Robert Zoellick, Ken Starr and so on. Of course, it all came undone. Underneath, Fannie was a cancer that helped spread risky behavior and low standards across the housing industry. We all know what happened next. The scandal has sent the message that the leadership class is fundamentally self-dealing. Leaders on the center-right and center-left are always trying to create public-private partnerships to spark socially productive activity. But the biggest public-private partnership to date led to shameless self-enrichment and disastrous results.

Not surprisingly, politicians have not addressed the problem, even with the benefit of hindsight. The Dodd-Frank bailout bill, which was supposed to address the problems of the housing crisis/financial crisis, left Fannie and Freddie untouched. The two government-created entities are on life support after their bailouts (speaking of which, here’s a funny cartoon), so this would have been the right moment to drive a stake through their hearts. One can only wonder what damage they will do in the future.

But government intervention in housing is not limited to Fannie Mae and Freddie Mac. A new report from Pew looks at the panoply of tax preferences for the industry, and analyzes the impact on overall economic performance. There are parts of the report I don’t like, such as the term “subsidies,” which implies that tax distortions are a form of government spending, but I fully agree that tax preferences harm the economy by causing capital to be misallocated.

Investment in owner-occupied housing faces an effective marginal tax rate of just 3.5 percent. In contrast, investment in the business sector faces an effective tax rate of 25.5 percent. This leads to a tax-induced bias for capital to flow into housing-related uses rather than other types of projects. As a result, businesses are less likely to purchase new equipment and less likely to incorporate new technologies than otherwise might be the case. Less business investment results in lower worker productivity and ultimately lower real wages and living standards. While the housing sector provides employment and has other positive effects on the overall economy and on society, the resources employed in the housing sector displace investment that would otherwise occur in the business sector were it not for the favored tax treatment of housing. The resulting distortion in the allocation of capital likely lowers overall output, because resources are allocated based on tax considerations rather than economic merit. In effect, the United States has chosen as a society to live in larger, debt-financed homes while accepting a lower standard of living in other regards.

The moral of the story is that if more government is the answer, someone has asked a very stupid question.

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Here are two superb articles on the financial crisis.

First, from Peter Wallison at the American Enterprise Institute, we have a piece on the role of government housing subsidies. Since he warned, in advance, that Fannie Mae and Freddie Mac were ticking time bombs, Peter has great credibility on these issues. Here is his key argument, but read the article to see how bad government policy lured people into making dumb choices.

…the financial crisis would not have occurred if government housing policies had not fostered the creation of an unprecedented number of subprime and otherwise risky loans immediately before the financial crisis began.

Second, there’s an article from Roger Lowenstein at Bloomberg that examines why so few Wall Street bigwigs were prosecuted. Here’s his basic premise, but read the entire article to learn how Wall Street executives may have been greedy SOBs, but that’s true when they make money or lose money. What matters, from a legal perspective, is whether someone committed fraud, theft, or some other crime.

…these sentiments imply that the financial crisis was caused by fraud; that people who take big risks should be subject to a criminal investigation; that executives of large financial firms should be criminal suspects after a crash; that public revulsion indicates likely culpability; that it is inconceivable (to Madoff, anyway) that people could lose so much money absent a conspiracy; and that Wall Street bears collective guilt for which a large part of it should be incarcerated. These assumptions do violence to our system of justice and hinder our understanding of the crisis. The claim that it was “caused by financial fraud” is debatable, but the weight of the evidence is strongly against it.

The only thing I will add is that failure is an integral part of a free market system. When critics say that the financial crisis proves that markets don’t work, they obviously don’t understand that capitalism is a process that continuously provides feedback in the form of profits and losses.

So the fact the people and businesses sometimes lose money is to be expected (indeed, capitalism without bankruptcy is like religion without hell). From a public policy perspective, though, it’s important that people are not encouraged to make dumb decisions with government subsidies – or shielded from the consequences of those poor choices with bailouts.

And that’s why government intervention deserves the overwhelming share of the blame for the financial crisis.

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This cartoon is not new, but it succinctly captures what happened with that part of the TARP bailout. The only thing missing is some way of showing the government officials and political insiders who received undeserved wealth while the Fannie-Freddie scam was operating.

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In the “Five Things About Me” section of the blog, I included this blurb:

A left-wing newspaper in the U.K. wrote that I’m “a high priest of light tax, small state libertarianism.” I assume they meant it as an insult, but it’s the nicest thing anyone’s ever said about me.

I now have something new to add to that list. In their new book, Give Us Liberty, Dick Armey and Matt Kibbe noted that I was one of the few people in Washington who was against TARP from the beginning. I’m proud that I never wavered in my support for small government and free markets, and I’m proud to work at the Cato Institute, where there is never pressure to do the wrong thing merely to appease Republicans. So this passage from their book partially offsets the horror of yesterday’s football game.  

The day after Paulson released his sweeping plan, FreedomWorks quickly connected with other free market groups to assess their willingness to fight. It was a surprisingly small group. But a principled few stepped up, notably Andrew Moylan of the National Taxpayers Union. The Club for Growth and the Competitive Enterprise Institute also weighed in, and Dan Mitchell at Cato and the folks at Reason.com offered much needed policy support. The groups joined forces with a few free market Capitol Hill staffers who were also feeling remarkably isolated in their efforts to stop the massive government bailout.

For those who are not familiar with the debate, the TARP bailout was a failure, both in terms of what it did and what it didn’t do. Regarding the former, TARP gave blank-check authority to the Treasury Department, resulting in an unsavory combination of sordid special-interest handouts and economically-destructive misallocation of capital. The politicians and Wall Street moochers said TARP was necessary to recapitalize the financial system, but that easily could have been accomplished by doing something similar to what happened during the S&L crisis 20 years ago – shutting down insolvent firms and compensating (if necessary) creditors, depositors, and other retail customers. The real tragedy, however, is that politicians failed to fix the policies that caused the crisis – the corrupt system of housing subsidies from Fannie Mae and Freddie Mac and the reckless easy-money policy of the Federal Reserve. The lesson we should learn is that government intervention and subsidies have very high costs.

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Considering they could have sat on their hands and relied on unhappy voters to give them big gains in November, I’m not too unhappy about the House GOP’s “Pledge to America.” Yes, it’s mostly filled with inoffensive motherhood-and-apple-pie language, but at least there’s some rhetoric about reining in excessive government. After eight years of fiscal profligacy under Bush, maybe this is a small sign that Republicans won’t screw up again if they wind up back in power. That being said, I was a bit disappointed that the GOP couldn’t even muster the courage to shut down Fannie Mae and Freddie Mac, the two corrupt government-created entities that bear so much responsibility for the housing mess and subsequent financial crisis. The best the GOP could do was to say “Since taking over Fannie Mae and Freddie Mac, the mortgage companies that triggered the financial meltdown by giving too many high risk loans to people who couldn’t afford them, taxpayers were billed more than $145 billion to save the two companies. We will reform Fannie Mae and Freddie Mac by ending their government takeover, shrinking their portfolios, and establishing minimum capital standards.” Is it really asking too much for Republicans to simply say “The federal government has no role in housing and Fannie Mae, Freddie Mac, and the Department of Housing and Urban Development should be eliminated.” Heck, the GOP’s Pledge doesn’t even mention a penny’s worth of budget cuts for HUD. Here’s an excerpt from Peter Wallison’s Bloomberg column, which explains why Fannie and Freddie should be decapitated.

In a year when angry voters are demanding a reduced government role in the economy, it is remarkable that most of the ideas for supplanting Fannie Mae and Freddie Mac are just imaginative ways of keeping government in the business of housing finance. …This is pretty astonishing. One would think that something might have been learned from the recent past, when two New Deal ideas for government housing support–the savings and loan industry and the government sponsored enterprises, Fannie Mae and Freddie Mac–failed spectacularly. It cost taxpayers $150 billion to clean up the first and may cost more than $400 billion to resolve the second. …government policy that deliberately degrades loan quality or creates moral hazard will eventually cause devastation in the housing market. …Government involvement in housing finance is an invitation to disaster. As illustrated by the S&Ls and GSEs, no matter how such a system is structured, government support will hide the real risks.

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George Melloan’s column in the Wall Street Journal discusses the new Basel capital standards and correctly observes that 22 years of global banking regulations have not generated good results. This is not because requiring reserves is a bad thing, but rather because such policies do nothing to fix the real problem. In the case of the United States, easy money policy by the Fed and a corrupt system of Fannie Mae/Freddie Mac subsidies caused the housing bubble and resulting financial crisis. Yet these problems have not been addressed, either in the Dodd-Frank bailout bill or the new Basel rules. Indeed, Melloan points out that Fannie and Freddie were exempted from the Dood-Frank legislation.

There’s something to be said for holding banks to higher capital standards, even at the cost of more constrained lending and slower economic growth. But the much-bruited idea that Basel rules will make the world freer of financial crises is highly doubtful, given current political circumstances. The 2008 financial meltdown was not primarily the result of lax regulation but of co-option and abuse of the U.S. financial system by the political class in Washington. The federal government’s “affordable housing” endeavors, beginning in the 1990s, allowed and even forced banks to make highly risky mortgage loans. Those loans were folded into mortgage-backed securities (MBS) sold in vast numbers throughout the world, most promiscuously by two government-sponsored enterprises, Fannie Mae and Freddie Mac. The Federal Reserve contributed a credit bubble that caused house prices to soar, a classic asset inflation. When the bubble began to deflate in 2007, the bad loans in mortgage securities became poisonous. The MBS market seized up, and financial institutions holding them became illiquid and began to crash. The Lehman Brothers collapse was the biggest shock. The only way Basel standards might have helped prevent this would have been if they had been applied to Fannie and Freddie as well as to banks. They weren’t. President Bill Clinton exempted the two giants from Basel capitalization rules because they were the primary instruments of a federal policy aimed at helping more lower-income people become homeowners. This was a laudable goal that ultimately wrecked the housing and banking industries. Washington has learned nothing from this debacle, which is why the next financial crisis is likely to have federal policy origins and may come sooner than we think. Fannie and Freddie—now fully controlled by Uncle Sam and exempt from the Dodd-Frank financial “reform” legislation—are still going strong, guaranteeing and restructuring loans while they continue to rack up huge losses for taxpayers. …The record since the Basel process began 22 years ago doesn’t generate faith in banking regulation either. Basel rules didn’t prevent the collapse of Japanese banking in 1990, they didn’t prevent the 2008 meltdown, and they are not preventing the banking failures that plague the financial system even today.

P.S. The bureaucrats and regulators who put together the Basel capital standards were the ones who decided that mortgage-backed securities were very safe assets and required less capital. That was a common assumption at the time, so the point is not that the Basel folks are particularly incompetent, but rather that regulation is a very poor substitute for market discipline. Letting financial firms go bankrupt instead of bailing them out would be a far better way of encouraging prudence.

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For those who favor truth in labeling, the housing meltdown and related financial crisis and economic downturn should be brightly stamped with the phrase, “Made in Washington.” Here are two good pieces of evidence. First, this paper from the American Enterprise Institute is one of the best big-picture analyses on the issue. It identifies how “affordable lending” policies are at the heart of the problem. Here’s an excerpt from the abstract.

Government policies forced a systematic industry-wide loosening of underwriting standards in an effort to promote affordable housing. This paper documents how policies over a period of decades were responsible for causing a material increase in homeowner leverage through the use of low or no down payments, increased debt ratios, no loan amortization, low credit scores and other weakened underwriting standards associated with NTMs. These policies were legislated by Congress, promoted by HUD and other regulators responsible for their enforcement, and broadly adopted by Fannie Mae and Freddie Mac (the GSEs) and the much of the rest mortgage finance industry by the early 2000s. Federal policies also promoted the growth of overleveraged loan funding institutions, led by the GSEs, along with highly leveraged private mortgage backed securities and structured finance transactions. HUD’s policy of continually and disproportionately increasing the GSEs’ goals for low- and very-low income borrowers led to further loosening of lending standards causing most industry participants to reach further down the demand curve and originate even more NTMs. As prices rose at a faster pace, an affordability gap developed, leading to further increases in leverage and home prices. Once the price boom slowed, loan defaults on NTMs quickly increased leading to a freeze-up of the private MBS market. A broad collapse of home prices followed.

Then, to show a good example of Mitchell’s Law, which is how bad government policy leads to more government policy, here’s a story about the fiasco surrounding President Obama’s mortgage subsidy program. The government is so bloody incompetent, it can’t even give away money effectively.

Nearly half of the 1.3 million homeowners who enrolled in the Obama administration’s flagship mortgage-relief program have fallen out. The program is intended to help those at risk of foreclosure by lowering their monthly mortgage payments. Friday’s report from the Treasury Department suggests the $75 billion government effort is failing to slow the tide of foreclosures in the United States, economists say. More than 2.3 million homes have been repossessed by lenders since the recession began in December 2007, according to foreclosure listing service RealtyTrac Inc. Economists expect the number of foreclosures to grow well into next year. “The government program as currently structured is petering out. It is taking in fewer homeowners, more are dropping out and fewer people are ending up in permanent modifications,” said Mark Zandi, chief economist at Moody’s Analytics. …Many borrowers have complained that the government program is a bureaucratic nightmare. They say banks often lose their documents and then claim borrowers did not send back the necessary paperwork. The banking industry said borrowers weren’t sending back their paperwork. They also have accused the Obama administration of initially pressuring them to sign up borrowers without insisting first on proof of their income. When banks later moved to collect the information, many troubled homeowners were disqualified or dropped out. Obama officials dispute that they pressured banks. They have defended the program, saying lenders are making more significant cuts to borrowers’ monthly payments than before the program was launched. And some of the largest mortgage companies in the program have offered alternative programs to those who fell out.

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I appeared on CNBC earlier today to explain why a stake should be driven through the heart of Fannie Mae and Freddie Mac. My debate opponents seems to be somewhat on the right side and admits that Fannie and Freddie are bad news, but inexplicably wants to keep them alive.

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Appearing on Fox Business News, I summarize the many reasons why the Bush-Paulson-Obama-Geithner TARP bailout was – and still is – bad policy.

I’m sure I have plenty of flaws, but at least I am philosophically consistent. Here’s what I said about the issue more than 18 months ago. The core message is the same (though I also notice I have a bad habit of starting too many sentences with “well”).

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John Stossel appropriately scolds the former Federal Reserve Chairman for blaming the financial crisis on the free market. I’ll go one step farther and say that Greenspan’s behavior is a reprehensible example of someone lacking the cojones to take responsibility for his mistakes. Greenspan is surely not responsible for the corrupt system of subsidies from the government-created nightmares known as Fannie Mae and Freddie Mac, but he definitely deserves the lion’s share of the blame for the Fed’s easy-money policy of artificially-low interest rates. Greenspan presumably knows he screwed up, which makes his attack on free markets especially despicable. The icing on the cake is that he’s also sucking up to the political establishment by endorsing higher taxes. Hasn’t he already done enough damage?

I’m getting tired of Alan Greenspan. First, the former Federal Reserve chairman blamed an allegedly unregulated free market for the housing and financial debacle. Now he favors repealing the Bush-era tax cuts. …During a congressional hearing two years ago, Greenspan shocked me by blaming the free market — not Fed and housing policies — for the financial collapse. As The New York Times gleefully reported, “(A) humbled Mr. Greenspan admitted that he had put too much faith in the self-correcting power of free markets.” He said he favored regulation of big banks, as if the banking industry weren’t already a heavily regulated cartel run for the benefit of bankers. Bush-era deregulation is a myth perpetrated by those who would have government control the economy. We libertarians were distressed by Greenspan’s apparent abandonment of his free-market philosophy and his neglect of the government’s decisive role in the crisis. …now Greenspan, going beyond what even President Obama favors, calls on Congress to let the 2001 and 2003 Bush tax cuts expire — not just for upper-income people but for everyone. …the stupidest thing said about tax cuts is the often-repeated claim that “they ought to be paid for.” How absurd! Tax cuts merely let people keep money they rightfully own. It’s government programs, not tax cuts, that must be paid for. The tax-hungry politicians’ demand that cuts be “paid for” implies the federal budget isn’t $3 trillion, but $15 trillion — the whole GDP — with anything mercifully left in our pockets being some form of government spending. How monstrous!

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The Wall Street Journal opines about the number of new regulations that will be generated by the so-called financial reform legislation that has been approved by Congress. The big winners will by lawyers, the federal bureaucracy, and politicians. The big losers will be shareholders and consumers.
The Dodd-Frank financial reform bill passed by the Senate yesterday promises to generate historic levels of red tape. But apparently the 2,300 pages are so complicated that a debate has broken out over precisely how many new regulatory rule-makings it will require. This week we reported on an analysis by the Davis Polk & Wardwell law firm that at least 243 new federal rule-makings are on the way, not to mention 67 one-time studies and another 22 new periodic reports. The attorneys were careful to note that this was a low-ball estimate, counting only new regulations mandated by the bill. Now comes Tom Quaadman of the U.S. Chamber of Commerce, who doesn’t quarrel with the Davis Polk estimate but has added rule-makings authorized by this legislation to those that are mandated and says that American businesses should expect a whopping 533 new sets of rules. To put this number in perspective, Sarbanes-Oxley, Washington’s last exercise in financial regulatory overreach, demanded only 16 new regulations. Thus he reasons that Dodd-Frank “is over 30 times the size of SOX.” …While it might seem that the regulatory uncertainty created by the bill won’t last much longer than a decade as new rules are implemented, that also could be optimistic. When regulators are granted new authorities without expiration dates on their powers, the rule-making possibilities are infinite. …The most likely result of Dodd-Frank in the near term is a generally higher cost of credit, and a bigger market share for the largest banks that can more easily absorb the new regulatory costs. In the longer term, do not expect it to prevent the next financial mania and panic.

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Russ Roberts of George Mason University has written a very good article for the Mercatus Center explaining – for economists and non-economists – how government intervention created distortions in the housing and finance sectors. He also blames Wall Street, paticularly for lobbying for the policies that caused the distortions and led to the financial crisis. Here’s an excerpt from the executive summary:

Some blame capitalism for being inherently unstable. Some blame Wall Street for its greed, hubris, and stupidity. But greed, hubris, and stupidity are always with us. What changed in recent years that created such a destructive set of decisions that culminated in the collapse of the housing market and the financial system? …public-policy decisions have perverted the incentives that naturally create stability in financial markets and the market for housing. Over the last three decades, government policy has coddled creditors, reducing the risk they face from financing bad investments. Not surprisingly, this encouraged risky investments financed by borrowed money. The increasing use of debt mixed with housing policy, monetary policy, and tax policy crippled the housing market and the financial sector. Wall Street is not blameless in this debacle. It lobbied for the policy decisions that created the mess. In the United States we like to believe we are a capitalist society based on individual responsibility. But we are what we do. Not what we say we are. Not what we wish to be. But what we do. And what we do in the United States is make it easy to gamble with other people’s money—particularly borrowed money—by making sure that almost everybody who makes bad loans gets his money back anyway. The financial crisis of 2008 was a natural result of these perverse incentives. We must return to the natural incentives of profit and loss if we want to prevent future crises.

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Kudos to Nicki Kurokawa, a former Cato employee, for this short but substantive video explaining “moral hazard.” She notes that government-subsidized risk played a pernicious role in the housing bubble and financial crisis, and warns that “too big to fail” may create similar problems in the future.

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The Wall Street Journal has more details about the sordid redistribution of our money to the insiders at Fannie Mae and Freddie mac:

…there’s still some ugly 2009 business to report: To wit, the Treasury’s Christmas Eve taxpayer massacre lifting the $400 billion cap on potential losses for Fannie Mae and Freddie Mac as well as the limits on what the failed companies can borrow. The Treasury is hoping no one notices, and no wonder. Taxpayers are continuing to buy senior preferred stock in the two firms to cover their growing losses—a combined $111 billion so far. When Treasury first bailed them out in September 2008, Congress put a $200 billion limit ($100 billion each) on federal assistance. Last year, the Treasury raised the potential commitment to $400 billion. Now the limit on taxpayer exposure is, well, who knows? …The loss cap is being lifted because the government has directed both companies to pursue money-losing strategies by modifying mortgages to prevent foreclosures. Most of their losses are still coming from subprime and Alt-A mortgage bets made during the boom, but Fannie reported last quarter that loan modifications resulted in $7.7 billion in losses, up from $2.2 billion the previous quarter. The government wants taxpayers to think that these are profit-seeking companies being nursed back to health, like AIG. But at least AIG is trying to make money. Fan and Fred are now designed to lose money, transferring wealth from renters and homeowners to overextended borrowers. Even better for the political class, much of this is being done off the government books. The White House budget office still doesn’t fully account for Fannie and Freddie’s spending as federal outlays, though Washington controls the companies. Nor does it include as part of the national debt the $5 trillion in mortgages—half the market—that the companies either own or guarantee. …This subterfuge also explains the Christmas Eve timing. After December 31, Team Obama would have needed the consent of Congress to raise the taxpayer exposure beyond $400 billion. By law, negative net worth at the companies forces them into “receivership,” which means they have to be wound down. Unlimited bailouts will now allow the Treasury to keep them in conservatorship, which means they can help to conserve the Democratic majority in Congress by increasing their role in housing finance. …All of which would seem to make the CEOs of Fannie and Freddie the world’s most overpaid bureaucrats. A release from the Federal Housing Finance Agency that also fell in the Christmas Eve forest reports that, after presiding over a combined $24 billion in losses last quarter, Fannie CEO Michael Williams and Freddie boss Ed Haldeman are getting substantial raises. Each is now eligible for up to $6 million annually. Freddie also has one of the world’s highest-paid human resources executives. Paul George’s total compensation can run up to $2.7 million. It must require a rare set of skills to spot executives capable of losing billions of dollars. Where is Treasury’s pay czar when we actually need him? You guessed it, Fannie and Freddie are exempt from the rules applied to the TARP banks.

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Even though politicians already have flushed $400 billion down the rathole, the Obama Administration has announced that it will now give unlimited amounts of our money to prop up Fannie Mae and Freddie Mac, the two government-created mortgage companies. While President Obama should be castigated for this decision, let’s not forget that this latest boondoggle is only possible because President Bush did not do the right thing and liquidate Fannie and Freddie when they collapsed last year. And, to add insult to injury, Obama’s pay czar played Santa Claus and announced that that a dozen top “executives” could divvy up $42 million of bonuses financed by you and me. Not a bad deal for a group of people that more properly should be classified as government bureaucrats. Here’s an excerpt from the Washington Post about the Administration’s latest punch in the gut for taxpayers:

The Obama administration pledged Thursday to provide unlimited financial assistance to mortgage giants Fannie Mae and Freddie Mac, an eleventh-hour move that allows the government to exceed the current $400 billion cap on emergency aid without seeking permission from a bailout-weary Congress. The Christmas Eve announcement by the Treasury Department means that it can continue to run the companies, which were seized last year, as arms of the government for the rest of President Obama’s current term. But even as the administration was making this open-ended financial commitment, Fannie Mae and Freddie Mac disclosed that they had received approval from their federal regulator to pay $42 million in Wall Street-style compensation packages to 12 top executives for 2009. The compensation packages, including up to $6 million each to Fannie Mae and Freddie Mac’s chief executives, come amid an ongoing public debate about lavish payments to executives at banks and other financial firms that have received taxpayer aid. But while many firms on Wall Street have repaid the assistance, there is no prospect that Fannie Mae and Freddie Mac will do so.

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I explain to a CNBC audience that government mistakes largely caused the financial crisis and that more government is not the answer. My debating opponent, Christian Weller, makes a jaw-dropping argument that Fannie Mae and Freddie Mac were not a problem, which is somewhat akin to saying Hitler had nothing to do with World War II.

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