The Times Foretold the Crisis

One of the most remarkable aspects of the current financial crisis is that nobody seems to want to tell us what's going on even though the root cause of our financial disaster is extremely simple.  If it's simple, you ask, why haven't the newspapers told us about it?  Isn't it their job to inform the public?

Keeping us informed is their job, but they've decided that they don't want us to know why our markets crashed so badly, at least not until after the November election.

Scragged gave an early explanation why stocks were going down, but that was before the real disaster unfolded.

To explain the current crisis for which our leaders are saying we taxpayers need to pony up $700 billion, you have to go back nine years, to an article "Fannie Mae Eases Credit To Aid Mortgage Lending" which was published in the New York Times on September 30, 1999.  [emphasis added]

The article starts:

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring. [emphasis added]

Everyone has been talking about a crisis involving "subprime loans."  What's a "subprime loan?"  Lenders rate loans by risk.  If a loan is low risk, that is, the lender believes that it's nearly certain that the loan will be paid back, it's called a "prime loan" and the interest rate is lower than on loans that are more risky.

A risky loan is called a "subprime loan," which means it's not as valuable or as secure as a prime loan.  Lenders usually charge higher interest rates on subprime loans to pay for the risk that they might not get their money back at all.

Mortgage loans are secured by the right of the lender to take the house and sell it.  If the buyer puts, say, 10% down, the value of the house is not likely to fall by 10%, so if anything goes wrong with the payments, the lender can take the house and get the money back.  Being able to get all the money back makes home loans very low risk.  Such low-risk loans are called "prime loans."

What was the government doing?  The Times reported that they planned to "encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans."

What happens when a bank lends money to someone whose credit isn't good enough to qualify for a loan?  The loan is riskier than it should be and the bank might not get its money back.  Instead of being a prime loan as mortgage loans are supposed to be, it becomes a subprime loan.  No rocket science here, folks, just simple math.

Fannie Mae was saying that the government would buy riskier loans than before.  The government was encouraging banks to make riskier loans than they had been making.  In other words, the government wanted the banks to stop behaving like bankers and start behaving like riverboat gamblers - just the opposite of what you'd think regulators charged with ensuring bank safety ought to do.

Why would the government decide to push these riskier loans?

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits. [emphasis added]

Fannie Mae is the nickname assigned to a quasi-government agency which was chartered to make mortgage loans.  Although Fannie Mae wasn't officially part of the government, everybody believed that the government would stand behind its loans.

At the time, no loans were less risky than loans to the US Government.  These "super prime" loans carried the lowest interest rates around.  Thus, because of an implicit government guarantee, the folks at Fannie Mae paid less for money than their competitors.

Fannie Mae has most of the home mortgage business.  If you're in the business of lending money and you can get money cheaper than anyone else can, you'll get all the business over time.  It doesn't take brilliant management to make a lot of money when your costs are lower than anyone else's, but the Democrats who ran Fannie Mae rewarded themselves with multi-million dollar bonuses as if they'd actually earned bonuses through managerial brilliance.

Having the lowest cost of funds around let Fannie Mae become "the nation's biggest underwriter of home mortgages" as the Times put it.  Sure enough, fewer and fewer banks were able to compete with the government and backed out of the home mortgage market.  Thus, all our home mortgage eggs ended up in one basket - a basket perched on the edge of a cliff, placed there on purpose by the government.

The reason Fannie Mae wanted to buy riskier loans was that they had already made all the sound loans there were.  Everybody with good credit who could afford a down payment had already bought a house and didn't need another loan.

The only way to "maintain its phenomenal growth in profits" and keep those magnificent management bonuses rolling in was to lend money to "individuals whose credit is generally not good enough to qualify for conventional loans."

Now that it's too late, everybody realizes that's exactly what they did even though it wasn't a good idea.  There were reasons those people didn't qualify for conventional loans - they couldn't pay the money back.  Duh!

We've pointed out that everything was OK as long as nobody questioned the loans, but once the media started talking the economy down to help Mr. Obama win the election, lenders began to worry and the whole thing came crashing down.  As the Times reported, everybody who had good credit already had a loan.  In order to place more loans, Fannie Mae had to lower their standards, so they wanted banks to make subprime loans in spite of the risk:

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans. [emphasis added]

Nine years ago, the Times explained how the current crisis would occur:

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

The Times predicted  "significantly more risk" and spoke of "government rescue" which are precisely what happened.  The Times explained the crisis in a nutshell nine years before it happened:

1. Our government chartered Fannie Mae and Freddie Mac to make housing loans.
2. Being "government-subsidized," as the Times put it, Fannie and Freddie could borrow money more cheaply than anyone else; they had an implicit guarantee from the US Treasury.
3. Being the lowest-cost supplier of money, Fannie and Freddie soon had most of the business.  Duh!
4. Having already lent to everybody who had decent credit and wanting to keep profits rolling in, Freddie Mac decided to lend to people who didn't qualify for loans.
5. When they made too many bad loans, the system fell apart.

What About Other Banks?

Nine years ago, the Times explained how problems with Fannie Mae would destroy the entire financial system:

Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings. [emphasis added]

The "secondary market" is important.  If a bank makes a loan and then just collects payments, the bank doesn't have the money to lend again until the mortgage is paid off which can take years.  If the bank sells the loan to someone else and gets its money back, however, it can lend the money again right away.  So long as banks can keep selling loans, they can keep making loans, and their profits keep going up.

By saying the government would buy riskier loans, Fannie Mae made it possible for banks to make riskier loans and sell them to the government.

When the economy turned down, which it does from time to time, people who were bad credit risks to begin with stopped making payments, and the value of their loans became questionable.

Why did this hurt anyone other than Fannie Mae?  Because Fannie Mae sold their loans.

Fannie Mae couldn't make new loans without selling off the old ones.  They sold their loans to banks and insurance companies such as AIG.  When things went sour for Fannie and Freddie, things went sour for the banks who had bought their loans.  Those banks had also sold loans, and so on. Fannie Mae's government-sponsored follies rippled through the entire financial system.

When the music stopped, everybody had to sit down, and their simply weren't enough chairs.

But why, you may ask, was this such a disaster?  In theory, any bank could get its money back by selling the house?

Normally, that would be true, but when Fannie Mae ran out of high-end subprime borrowers, they extended credit to people who couldn't make any down payment at all.  A person who's put 10% down works very hard to keep the house.

If someone's gotten into a house without putting any money down, however, they can walk away without being hurt; that's what a lot of them did.  It's become so common that we have a new expression: "jingle mail," for when the buyer walks away from the house and mails the bank his keys assuming he's willing to pay for the stamp.  Not only does this bring the payment stream on the loan to a screeching halt, buyers who know they're likely to walk aren't all that concerned about maintenance.

It should be no surprise that house values have been plummeting under these abuses of what had been a sound system for financing homes before the government got involved.  Thus, instead of being as safe as traditional home loans, these newer home mortgages were far, far riskier than anyone thought.

The Times Won't Point the Finger!

The Times explained the current financial crisis before it happened.  It also explained who caused it:

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits. [emphasis added]

Here we have it.  This isn't a market failure at all.  It's exactly the opposite.  The market was working just fine; then the government, specifically a Democratic administration, messed with the market with disastrous results.

The Clinton administration wanted banks to make loans to people who couldn't qualify for normal mortgages; they put pressure on Fannie Mae to do so.  The stockholders wanted more profits, which meant making more loans, but there weren't any more qualified buyers.

To meet both pressures, management reduced the qualifications for getting a home mortgage.  Everybody involved sold these dicey loans to everybody else.  Unqualified buyers couldn't make their payments, so the entire system came crashing down.

Yes, folks, it really is that simple.

This isn't the first time our government has meddled in financial markets nor is this the first time our government made money available to people who were bad risks.  During the banking crisis of 1790, an earlier Secretary of the Treasury named Alexander Hamilton said:

If banks, in spite of every precaution, are sometimes betrayed into giving a false credit to the persons described, they more frequently enable honest and industrious men of small and perhaps no capital to undertake and prosecute business with advantage to themselves and to the community. [emphasis added]

Secretary Hamilton gave this explanation when he used the powers of the US Treasury to calm markets during his banking panic.  His justification for market intervention contained a number of gems of wisdom which were ignored by the Clintonistas who simply wanted Fannie Mae to shovel out as much money as possible:

• In saying "in spite of every precaution," Hamilton spoke of banks being as careful as possible; the Clintons wanted banks to abandon prudence and knowingly lend to unqualified borrowers.
• He said "sometimes betrayed," implying that it took chicanery or fraud to persuade banks to make unsound loans.  He didn't anticipate government urging banks to make bad loans.
• He spoke of "false credit," implying fraud.  The FBI has found that many loan applications were falsified in the years leading up to the crash; we hear them referred to as "liar loans" or "NINJA loans," for "No Income, No Job or Assets."  People got away with this because banks had suspended their normal standards at the government's request.  After all, they weren't going to hang onto the loans, they were going to sell them to the government who'd sell them on to some other sucker anyway.
• He also spoke of "honest men" undertaking businesses which would help the entrepreneur and the community.  Helping people start businesses helps the economy; helping people buy houses doesn't.  A person who didn't buy a house would rent a house or apartment; the overall economic effect of encouraging people to buy houses instead of renting is nil.  There can be good societal effects from encouraging home ownership, but that's a completely different issue.

Mr. Hamilton believed that the banks which were at risk during the crisis of 1790 had made bad loans because they'd been deceived; he did not anticipate that government would urge banks to make bad loans.

A Prophet Who Doesn't Seek Honor

Having told it as it was, the Times told it as it would be:

"From the perspective of many people, including me, this is another thrift industry growing up around us," said Peter Wallison a resident fellow at the American Enterprise Institute. "If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry."

The Times knew back in 1999 that Fannie Mae was taking on "significantly more risk" and that there would have to be a massive bailout if things went sour.

Why don't they pat themselves on the back and tell everybody how smart they were?  Because a Democratic administration laid the foundation for the crisis by encouraging banks to make subprime loans.  Not only that, Fannie Mae was run by Democrats who not only made millions in bogus bonuses but the worst of the lot are now working for Mr. Obama's Presidential campaign.

Early in the Bush administration, the Republicans tried to curtail Fannie Mae's lending, but that would have cut the bonuses management was awarding to themselves.  Being a creature of government from the beginning, Fannie Mae was skilled at lobbying and urged their friends to keep the money flowing.  The Wall Street Journal reminds us that the House Financial Services Committee held hearings on Sept 10, 2003; they printed some very revealing testimony from the past:

Rep. Barney Frank (D., Mass.): I worry, frankly, that there's a tension here. The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see. I think we see entities that are fundamentally sound financially and withstand some of the disaster scenarios...

Rep. Frank received a great deal of money as campaign contributions from Fannie Mae, no wonder he couldn't see any serious risks to the Treasury, they were making regular payments to him, what could possibly go wrong?

Rep. Maxine Waters (D., Calif.), speaking to Housing and Urban Development Secretary Mel Martinez:

Secretary Martinez, if it ain't broke, why do you want to fix it? Have the GSEs [government-sponsored enterprises] ever missed their housing goals? [emphasis added]

Rep. Waters stated a) that the agencies making the loans were government-sponsored and b) asked if they'd ever missed their "housing goals"!  She wasn't concerned with getting the loans paid back, she was worried about selling houses.  Is there any wonder that there was a housing bubble?

In predicting this collapse nearly a decade before it came to pass, the Times has much to be proud of.  If they started bragging about their prediction, however, they'd call attention to their earlier article which puts the Clinton administration at the heart of the problem.

Admitting that the crisis was brought on by Democrats over the objections of Republicans who didn't want the government to take on so much risk would hurt Mr. Obama's chances of winning the election.  Hence the sound of silence from the Times, the rest of the media, and everyone else who might normally be expected to be crowing "I told you so!"

The Times has a long history of journalistic coups.  They generally boast about them and rightfully so.

We've been forcing ourselves to read them for years - an occupational hazard, alas - and we've seldom seen a more accurate prediction about a more important matter.  They're evidently suffering from an acute case of Bush Derangement Syndrome for them to pass up such a wonderful chance to brag about their uncannily accurate prophesying.