LEARNING FROM HISTORY:
THE CAUSE OF
AND SOLUTION TO
THE CURRENT FINANCIAL CREDIT CRISIS
By R. Dan Edwards, Ph.D., CPA
One of the often overlooked primary causes of the current financial
crisis is the unintended consequences of the Community Reinvestment Act which
forced banks to make loans (grant mortgages) to individuals and families whose
chances of making the payments to repay the loans were slim to none.
The first question to be answered is, “How did this happen?” To properly answer the question, we must
examine the related historical events which go back to the Great Depression.
1938 during the government caused Great Depression, Franklin Delano Roosevelt
and Congress created a government owned business, Fannie Mae, in order to buy
mortgages from financial institutions.
Thirty years later, in 1968, Lyndon Johnson along with Congress took
Fannie Mae’s debt portfolio off the government balance sheet by converting it
into a publicly traded company, owned by investors. Freddie Mac began less than two years later to
quiet claims that Fannie Mae was a monopoly.
During Jimmy Carter’s term as president, the Community
Reinvestment Act of 1977 was passed. The
CRA was opposed by every bank in the US
except for one bank on the South side of Chicago. The CRA required banks to “meet the credit needs
of all the community”. In practicality
this meant that loans had to be made to less than credit worthy people in
minority groups if they could come up with the down payment without regard to
their ability to make the payments. Fannie
Mae and Freddie Mac were required to only buy mortgages originated by banks
which complied with the CRA. (As a side note, in 1977 Franklin Delano Raines
became Carter’s Associate Director of Economics and Government in the Office of
Management and Budget.)
In late 1994 with the Democrats controlling both houses of
Congress the Clinton Administration, with pressure from a radical organization
named ACORN, pushed through revisions to the CRA which became effective on January 31, 1995. These new requirements substantially
increased not only the dollar amounts but also the number of home loans to low
and moderate income borrowers and cut the down payment requirement to 3%. These revisions caused the CRA loans to
increase at double the rate of non-sub-prime loans. In November of 2000, shortly before Clinton left office his
Secretary of HUD announced that the new regulations had resulted in $2.4
trillion in additional mortgages for “affordable housing” being issued to 28.1 million
revisions to the CRA had the full support of Franklin Delano Raines who had
been serving as Vice Chairman of Fannie Mae, a post he left in 1996 to become
Clinton’s Director of the Office of Management and Budget. In 1999, Raines returned to Fannie Mae as its
Chief Executive Officer replacing James A. Johnson who had been the Executive
Assistant to Jimmy Carter’s VP, Walter Mondale.
In 1997, First Union Capital Markets (which later became
Wachovia) and Bear, Stearns offered the first $384 million of sub-prime CRA
securities backed by Community Reinvestment Act (CRA) loans. Hundreds of billions would follow. All were rated AAA.
In 2003 new regulators for Fannie Mae and Freddie Mac
uncovered the scheme by their top executives to overstate profits by $10
billion in order to boost their bonuses.
President Bush proposed what the New York Times called “the most
significant regulatory overhaul in the housing finance industry since the
saving and loan crisis a decade ago.”
Senate Democrats killed the Bush reform plan. With Representative Barney Frank stating,
“Fannie Mae and Freddie Mac are not facing any kind of financial crisis.” Representative Melvin Watt accused the White
house of “weakening the bargaining power of poorer families and their ability
to get affordable housing.”
Then inexplicitly in March of 2004, after failing to
achieve reform at Fannie Mae and Freddie Mac, Bush signed into law and took
credit for the “American Dream Down Payment Act” which supplemented the minimum
3% down payment with a zero down payment for sub-prime mortgage loans to low
income and minority families with poor credit ratings. The preponderance of these sub-prime loans
were primarily held or guaranteed by Fannie Mae and Freddie.
As the number of these loans grew and the risks of default
increased, in 2005 there were further congressional investigations into the
actives and accounting methods at Fannie Mae. After it was discovered that Franklin Delano
Rains himself and his top associates were behind cooking the accounting books
of Fannie Mae in order to receive “bonuses” for successfully operating Fannie
Mae, Raines, who by this time had been the CEO of Fannie Mae for six years,
“retired”. During this six years, Raines
padded his pockets to the tune of almost $100 million, while his Fannie Mae
associates Jamie Gorelick pocketed $75 million.
The just passed and signed bailout solution for this primarily
government caused financial crisis is only a short term solution. Unfortunately, no one in Washington seems to be even considering a
permanent fix to the problem. The long
term solution must first include getting rid of the Community Reinvestment Act
and its related coercions to force financial institutions to make less than
credit worthy loans in the name of affordable housing. Second, Fannie Mae and Freddie Mac must be
phased out and eventually completely eliminated. Lastly, government required zero and 3% down
payments must be eliminated and the United States Government must completely
get out of the so called “affordable housing” business.