Democrats Refused To Regulate GSEs, Created Financial Tsunami

Over the past several days, the airwaves have been flooded with statements by Democrats and by the media “intelligentsia” that the financial crisis was created due to the atmosphere of deregulation that dominated during the last 8 years of the Bush administration and Republican rule.  It sounds right – Republicans generally DO favor fewer regulations which all too often stagnate business and reduce our competitiveness in a global marketplace – but in this case it is simply false.  And Democrats who point the finger of blame at Republicans over deregulation of the finance industry are lying to you.

We can begin by looking at leading Democrat Charles Schumers’ incredibly disingenuous and patently demagogic statements blaming Republicans for “a lack of regulation”:

Democratic Senator Charles Schumer of New York says a lack of regulation by the Bush administration is responsible for the current economic troubles. The New York Sun reports Schumer says, “Eight years of deregulatory zeal by the Bush administration, an attitude of ‘the market can do no wrong,’ have led us down a short path to economic recession.”

But Schumer fails to mention he has been a leading voice of deregulation. The Sun reports he championed the repeal in 1999 of the Glass-Steagall Act, the law which separated commercial and investment banking.

He also wrote an opinion piece for The Wall Street Journal in 2006 which warned about what he called “overzealous regulators” and opposed a bill in 2005 that would have transformed Freddie Mac and Fannie Mae from large investment funds into “conduits” that only bought mortgages, packaged them into securities and sold them on the market.

We can go back to 2003 to see just how fallacious the Democrats charge against Republicans are.  In 2003, President Bush tried to implement regulatory reform of Fannie Mae and Freddie Mac, which were at the epicenter of the current housing financial crisis.  In the words of a New York Times story:

Fannie Mae, which was previously known as the Federal National Mortgage Association, and Freddie Mac, which was the Federal Home Loan Mortgage Corporation, have been criticized by rivals for exerting too much influence over their regulators.

”The regulator has not only been outmanned, it has been outlobbied,” said Representative Richard H. Baker, the Louisiana Republican who has proposed legislation similar to the administration proposal and who leads a subcommittee that oversees the companies. ”Being underfunded does not explain how a glowing report of Freddie’s operations was released only hours before the managerial upheaval that followed. This is not world-class regulatory work.”

Significant details must still be worked out before Congress can approve a bill. Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing.

”These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,” said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ”The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.”

Representative Melvin L. Watt, Democrat of North Carolina, agreed.

”I don’t see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing,” Mr. Watt said.

Notice that Barney Frank – in an effort to stave off Republican efforts to regulate the housing finance industry, claimed that there was no problem.

And Barney Frank, the Chairman of the powerful House Finance Committee, and a key player in the Democrats’ effort to shape the bailout package now, represented the Democrats’ philosophical opposition to reform or regulation of Fannie Mae and Freddie Mac:

The strategy of presenting themselves to Congress as the champions of affordable housing appears to have worked. Fannie and Freddie retained the support of many in Congress, particularly Democrats, and they were allowed to continue unrestrained. Rep. Barney Frank (D., Mass), for example, now the chair of the House Financial Services Committee, openly described the “arrangement” with the GSEs at a committee hearing on GSE reform in 2003: “Fannie Mae and Freddie Mac have played a very useful role in helping to make housing more affordable . . . a mission that this Congress has given them in return for some of the arrangements which are of some benefit to them to focus on affordable housing.” The hint to Fannie and Freddie was obvious: Concentrate on affordable housing and, despite your problems, your congressional support is secure.

The effort failed with Democrats in lock-step effort against the Republicans efforts to implement regulatory reform of the Housing Finance industry.

Again, in 2005, there was yet another Republican-led effort: the Federal Housing Enterprise Regulatory Reform Act of 2005.  Four Republicans’ names were on the Senate version of the bill, and twenty Republicans’ names were on the House version.  The bill was killed because Democrats in the Committee on Banking, Housing, and Urban Affairs unanimously voted against the bill, and Senate Democrats signaled their intent to filibuster its passage.

John McCain, in vigorous support of the 2005 effort to regulate an increasingly out-of-control industry, said in part:

The Office of Federal Housing Enterprise Oversight’s report goes on to say that Fannie Mae employees deliberately and intentionally manipulated financial reports to hit earnings targets in order to trigger bonuses for senior executives. In the case of Franklin Raines, Fannie Mae’s former chief executive officer, OFHEO’s report shows that over half of Mr. Raines’ compensation for the 6 years through 2003 was directly tied to meeting earnings targets. The report of financial misconduct at Fannie Mae echoes the deeply troubling $5 billion profit restatement at Freddie Mac.

The OFHEO report also states that Fannie Mae used its political power to lobby Congress in an effort to interfere with the regulator’s examination of the company’s accounting problems. This report comes some weeks after Freddie Mac paid a record $3.8 million fine in a settlement with the Federal Election Commission and restated lobbying disclosure reports from 2004 to 2005. These are entities that have demonstrated over and over again that they are deeply in need of reform.

For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac–known as Government-sponsored entities or GSEs–and the sheer magnitude of these companies and the role they play in the housing market. OFHEO’s report this week does nothing to ease these concerns. In fact, the report does quite the contrary. OFHEO’s report solidifies my view that the GSEs need to be reformed without delay.

Franklin Raines, a Democrat and a Clinton appointee, misrepresented $11 billion in Fannie Mae’s accounting system in order to game the system so that he and other senior executives could collect multi-million dollar bonuses.  Fannie Mae was fined some $500 million for the violations.  Raines paid a $25 million fine for his role in the corruption.   Leland Brendsel – yet another Democrat – had earlier been forced out as Chairman of Freddie Mac under a similar cloud of suspicion.

We learn that, in the fall of 2004:

At a dramatic hearing in Richard Baker’s subcommittee, Fannie’s chair, Franklin Raines, stood by the company’s accounting, claiming that Fannie was being victimized by an overzealous regulator.

Notice that Raines – who as already shown was later proven to have committed fraud – blamed Republican regulators for misrepresenting the health of GSEs that we now known were on the verge of a disaster.

Federal Reserve Chairman Alan Greenspan, supporting the Republican-led effort to place the very sort of regulations that Democrats now claim that Republicans prevented, said:

“If [Fannie and Freddie] continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road.” He added, “Enabling these institutions to increase in size–and they will, once the crisis, in their judgment, passes–we are placing the total financial system of the future at a substantial risk.”

Peter Wallison wrote in a May 2005 article describing Democrats’ opposition at the time:

The sudden appearance of this new threat changed the attitude of the GSEs toward the legislation. Although they had begun 2005 offering conciliatory statements and suggesting that they had no serious problems with the regulatory proposals that Congress was then contemplating, the GSEs were clearly alarmed by the idea that their portfolios might be limited or reduced. Fannie and Freddie and their constituent support groups–the homebuilders and the realtors, among others–made clear that they would fight limitations on GSE portfolios, and Senator Charles Schumer (D-N.Y.) and other Democrats made clear that they, too, would oppose any effort to limit this aspect of the GSEs’ operations.

Wallison also stated:

Under these circumstances, allowing Fannie and Freddie to continue on their present course is simply to create risks for the taxpayers, and to the economy generally, in order to improve the profits of their shareholders and the compensation of their managements. It is a classic case of socializing the risk while privatizing the profit. The Democrats and the few Republicans who oppose portfolio limitations could not possibly do so if their constituents understood what they were doing.

A Bloomberg article describes how the lack of timely reform created an economic tsunami:

Enough cards on this table have been turned over that the story is now clear. The economic history books will describe this episode in simple and understandable terms: Fannie Mae and Freddie Mac exploded, and many bystanders were injured in the blast, some fatally.

Fannie and Freddie did this by becoming a key enabler of the mortgage crisis. They fueled Wall Street’s efforts to securitize subprime loans by becoming the primary customer of all AAA-rated subprime-mortgage pools. In addition, they held an enormous portfolio of mortgages themselves.

In the times that Fannie and Freddie couldn’t make the market, they became the market. Over the years, it added up to an enormous obligation. As of last June, Fannie alone owned or guaranteed more than $388 billion in high-risk mortgage investments. Their large presence created an environment within which even mortgage-backed securities assembled by others could find a ready home.

The problem was that the trillions of dollars in play were only low-risk investments if real estate prices continued to rise. Once they began to fall, the entire house of cards came down with them.

Keven Hasset concludes an article titled, “How the Democrats Created the Financial Crisis“, concludes by saying:

Now that the collapse has occurred, the roadblock built by Senate Democrats in 2005 is unforgivable. Many who opposed the bill doubtlessly did so for honorable reasons. Fannie and Freddie provided mounds of materials defending their practices. Perhaps some found their propaganda convincing.

But we now know that many of the senators who protected Fannie and Freddie, including Barack Obama, Hillary Clinton and Christopher Dodd, have received mind-boggling levels of financial support from them over the years.

Throughout his political career, Obama has gotten more than $125,000 in campaign contributions from employees and political action committees of Fannie Mae and Freddie Mac, second only to Dodd, the Senate Banking Committee chairman, who received more than $165,000.

Clinton, the 12th-ranked recipient of Fannie and Freddie PAC and employee contributions, has received more than $75,000 from the two enterprises and their employees. The private profit found its way back to the senators who killed the fix.

There has been a lot of talk about who is to blame for this crisis. A look back at the story of 2005 makes the answer pretty clear.

Tags: Alan Greenspan, Barack Obama, Barney Frank, blame, Charles Schumer, Chris Dodd, Democrats, deregulation, failure, Fannie Mae, Franklin Raines, Freddie Mac, GSEs, Hillary Clinton, Leland Brendsel, privatizing, regulation, Republicans, risk, socializing