Remember subprime mortgages? They’ve been nudged out of the headlines by gas prices lately, but they — and the crisis catalyzed by the collapse of the subprime market — are still news.
Bank of America has been cleared to buy Countrywide Financial (Remember them?), and apparently still wants to seal the deal. (BofA didn’t want Countrywide’s no. 2 executive, and it only took them about $28 million to get rid of him.)
Meanwhile, more than 1 million homes are now in foreclosure.
We all heard the outcry when, in the midst of rising foreclosures, our government moved to bail out one of the biggest (and most reckless) Wall Street players in the subprime debacle. We know that president Bush backed the move, though he’s sworn to veto the supposed foreclosure relief bill that’s heading his way after a Senate deal saved it from oblivion. The treasury secretary defended the Stearns bailout again in mid-May. (A “preemptive strike” in light of the impending final sale, perhaps?)
Let me point out that whatever you call the Fed’s actions dealing with Bear Stearns, J.P. Morgan Chase Co. and the financial markets and whoever may appear to benefit directly from these steps, the fact remains that everyone (taxpayers and non-taxpayers alike) has a stake in keeping the markets running smoothly.
That said, in my view, it is wrong for the Times (or anyone else) to insinuate that using funds obtained from the general public via tax revenues to help prevent such an important sector of the economy as our financial system from seizing up benefits only a few: it actually helps everyone.
If you don’t believe me, just consider what might have happened had Bear been allowed to go under. Although a relatively small player on Wall Street, Bear was heavily involved in the financial markets; its demise might well have brought other firms down as well.
And Wall Street’s affliction might have spread to Main Street.
The same holds true for the ongoing decline in housing prices. Falling home values affect not just those who owe more than their home is worth or are being forced to sell at a loss, but everyone who owns a home.
For example, all homeowners in a neighborhood are hurt when many become vacant due to foreclosures. Falling property values will depress occupied and empty homes alike, so all homeowners have a stake in the government trying to avert this.
Now, don’t get me wrong; I am no more in favor of the government rescuing people from unwise (or speculative) decisions than the next person. But I do believe that we should try to take care of our neighbors, for, in doing so, we will take care of ourselves
Or does that explanation really just trying to have it both ways? Who was more speculative or more unwise, and aggressively so? Homeowners who acquired loans they couldn’t afford or didn’t understand? Bear Stearns and other Wall Street players when it came to the mortgage securities market? Or conservative philosophy and political actors who’s policy moves made the current crisis all but inevitable?
Who’s to blame for the biggest financial catastrophe of our time? There are plenty of culprits, but one candidate for lead perp is former Sen. Phil Gramm. Eight years ago, as part of a decades-long anti-regulatory crusade, Gramm pulled a sly legislative maneuver that greased the way to the multibillion-dollar subprime meltdown. Yet has Gramm been banished from the corridors of power? Reviled as the villain who bankrupted Middle America? Hardly. Now a well-paid executive at a Swiss bank, Gramm cochairs Sen. John McCain’s presidential campaign and advises the Republican candidate on economic matters. He’s been mentioned as a possible Treasury secretary should McCain win. That’s right: A guy who helped screw up the global financial system could end up in charge of US economic policy. Talk about a market failure.
…But Gramm’s most cunning coup on behalf of his friends in the financial services industry—friends who gave him millions over his 24-year congressional career—came on December 15, 2000. It was an especially tense time in Washington. Only two days earlier, the Supreme Court had issued its decision on Bush v. Gore. President Bill Clinton and the Republican-controlled Congress were locked in a budget showdown. It was the perfect moment for a wily senator to game the system. As Congress and the White House were hurriedly hammering out a $384-billion omnibus spending bill, Gramm slipped in a 262-page measure called the Commodity Futures Modernization Act. Written with the help of financial industry lobbyists and cosponsored by Senator Richard Lugar (R-Ind.), the chairman of the agriculture committee, the measure had been considered dead—even by Gramm. Few lawmakers had either the opportunity or inclination to read the version of the bill Gramm inserted. “Nobody in either chamber had any knowledge of what was going on or what was in it,” says a congressional aide familiar with the bill’s history.
It’s not exactly like Gramm hid his handiwork—far from it. The balding and bespectacled Texan strode onto the Senate floor to hail the act’s inclusion into the must-pass budget package. But only an expert, or a lobbyist, could have followed what Gramm was saying. The act, he declared, would ensure that neither the sec nor the Commodity Futures Trading Commission (cftc) got into the business of regulating newfangled financial products called swaps—and would thus “protect financial institutions from overregulation” and “position our financial services industries to be world leaders into the new century.”
…Credit default swaps are essentially insurance policies covering the losses on securities in the event of a default. Financial institutions buy them to protect themselves if an investment they hold goes south. It’s like bookies trading bets, with banks and hedge funds gambling on whether an investment (say, a pile of subprime mortgages bundled into a security) will succeed or fail. Because of the swap-related provisions of Gramm’s bill—which were supported by Fed chairman Alan Greenspan and Treasury secretary Larry Summers—a $62 trillion market (nearly four times the size of the entire US stock market) remained utterly unregulated, meaning no one made sure the banks and hedge funds had the assets to cover the losses they guaranteed.
In essence, Wall Street’s biggest players (which, thanks to Gramm’s earlier banking deregulation efforts, now incorporated everything from your checking account to your pension fund) ran a secret casino. “Tens of trillions of dollars of transactions were done in the dark,” says University of San Diego law professor Frank Partnoy, an expert on financial markets and derivatives. “No one had a picture of where the risks were flowing.” Betting on the risk of any given transaction became more important—and more lucrative—than the transactions themselves, Partnoy notes: “So there was more betting on the riskiest subprime mortgages than there were actual mortgages.” Banks and hedge funds, notes Michael Greenberger, who directed the CFTC’s division of trading and markets in the late 1990s, “were betting the subprimes would pay off and they would not need the capital to support their bets.”
These unregulated swaps have been at “the heart of the subprime meltdown,” says Greenberger. “I happen to think Gramm did not know what he was doing. I don’t think a member in Congress had read the 262-page bill or had thought of the cataclysm it would cause.” In 1998, Greenberger’s division at the CFTC proposed applying regulations to the burgeoning derivatives market. But, he says, “all hell broke loose. The lobbyists for major commercial banks and investment banks and hedge funds went wild. They all wanted to be trading without the government looking over their shoulder.”
Neither thought is particularly comforting — that the man who stands to direct U.S. economic policy in a McCain administration either (a) didn’t know what he was doing when he kick started the engine of the subprime mortgage debacle, or (b) that he knew exactly what he was doing and proceeded anyway. Corn’s article points out, however, that whether Gramm knew what he was doing or not, he went on to profit handsomely from what his legislative move eventually wrought.
With the U.S. economy now battered by a tsunami of mortgage foreclosures, the $30-billion Bear Stearns Companies bailout and spiking food and energy prices, many congressional leaders and Wall Street analysts are questioning the wisdom of the radical deregulation launched by Gramm’s legislative package. Financial wizard Warren Buffett has labeled the risky new investment instruments Gramm unleashed “financial weapons of mass destruction.” They have fed the subprime mortgage crisis like an accelerant. While his distracted peers probably finalized their Christmas gift lists, Gramm created what Wall Street analysts now refer to as the “shadow banking system,” an industry that operates outside any government oversight, but, as witnessed by the Bear Stearns debacle, requiring rescue by taxpayers to avert a national economic catastrophe.
While the nation’s investment bankers are paying a heavy price for their unbridled greed (in billions of dollars of write-offs), Gramm has fared quite nicely. He currently serves as a vice president at UBS AG, a colossal, Swiss-owned investment bank, the post, no doubt, a thank you for assiduously looking out for Wall Street interests during his 23 years in public office. Now, with the aid of his longtime friend Arizona Sen. John McCain, Gramm may be looking at a quantum leap in power and influence.
Indeed, after virtually cutting the ribbon on Wall Street’s “secret casino,” Gramm took a prime spot at the high rollers’ table.
But it just defies belief that McCain would have, as his main economic advisor and one of the people responsible for his plan to deal with the mortgage crisis, someone who was a paid lobbyist for a bank that was heavily involved in that crisis, a firm that has just advised some of its employees not to travel to the U.S. for legal reasons, and that stands to gain or lose a lot depending on what the federal government decides to do about it. What’s next: the revelation that McCain’s policy on Iran is being written by a lobbyist for the makers of cruise missiles? Or that he has outsourced his health care policy to a lobbyist for the National Funeral Directors Association?
And he may not be done wreaking economic havoc either, for in our debt-driven economy — in which everything from gas and groceries, to health care is bought on credit — the buying and selling of credit is essentially the buying and selling of our lives. Homes, after all, can be foreclosed upon, but much of what we buy on credit is either gone by the time the bill comes due — like gas and groceries — or intangibles like health care services, so there’s nothing left to repossess.
On the economy, McCain’s most daring manifesto is his healthcare plan. Not surprisingly, it bears the Gramm imprint. In fact, McCain has been heeding Gramm’s “power-to-the-consumer” approach for more than a decade. The two senators bonded when they linked arms to fight Hillary Clinton’s ill-fated healthcare program in 1993. “We couldn’t get any press coverage in Washington, DC, so we traveled all over the country, to the regional media markets,” says Gramm. In 150 meetings at hospitals and clinics, McCain and Gramm relentlessly pounded the Clinton plan, helping fire the voter outrage that killed the plan in 1994.
Today, McCain is advocating a plan that’s radically different from those of Clinton and Barack Obama, and – if he goes all the way by following Gramm – could revolutionize America’s healthcare system. For McCain and Gramm, the problem with our healthcare system – and the reason why over 47 million Americans are uninsured – is that it’s excessively, scandalously expensive. The solution, they say, is to let Americans shop for healthcare with their own money. McCain advocates giving tax rebates of $2500 per individual or $5000 per family. With that money, families could purchase policies on their own. What’s truly radical about the plan is that it eliminates the tax exclusion for healthcare benefits offered by companies to their employees, and replaces it with the $2500 to $5000 rebates.
Consumers could then use that cash to buy their own insurance in what Gramm foresees as a vibrant, consumer-driven marketplace for healthcare packages.
Add to the mix that hospitals are now putting patient debt up for auction, peering into patients’ credit reports, and demanding cash before treatment, and it’s not hard to predict what might result from the American’s increasing reliance on credit to secure health care. Especially when you take in to consideration that health care is the fastest growing industry in America, health care costs are only going up, securitized debt is making a comeback, and the solutions proposed by Treasury Secretary Henry Paulson, does nothing to regulate the financial institutions and inventions that drove the current crisis.
But it was never conservatism’s intention to regulate in the first place. I’ve noted earlier in this series that authorities like Alan Greenspan simply ignored warnings of impending financial disaster if the subprime boomtime was allowed to continue. Now it’s being reported that — under the leadership of the now deposed and disgraced Alphonso Jackson— HUD ignored similar warnings and helped drive the subprime and credit crisis, by labeling subprime mortgages as “affordable loans,” and requiring Fannie Mae and Freddie Mac— two government-run mortgage finance firms — to purchase more of these loans made to minority and low-income borrowers as a means of putting more of those borrowers in their own homes.
Eager to put more low-income and minority families into their own homes, the agency required that two government-chartered mortgage finance firms purchase far more “affordable” loans made to these borrowers. HUD stuck with an outdated policy that allowed Freddie Mac and Fannie Mae to count billions of dollars they invested in subprime loans as a public good that would foster affordable housing.
Housing experts and some congressional leaders now view those decisions as mistakes that contributed to an escalation of subprime lending that is roiling the U.S. economy.
The agency neglected to examine whether borrowers could make the payments on the loans that Freddie and Fannie classified as affordable. From 2004 to 2006, the two purchased $434 billion in securities backed by subprime loans, creating a market for more such lending. Subprime loans are targeted toward borrowers with poor credit, and they generally carry higher interest rates than conventional loans.
Today, 3 million to 4 million families are expected to lose their homes to foreclosure because they cannot afford their high-interest subprime loans. Lower-income and minority home buyers — those who were supposed to benefit from HUD’s actions — are falling into default at a rate at least three times that of other borrowers.
“For HUD to be indifferent as to whether these loans were hurting people or helping them is really an abject failure to regulate,” said Michael Barr, a University of Michigan law professor who is advising Congress. “It was just irresponsible.”
In an upcoming edition of this series, we’ll look in more at how this has all worked out for those minority and low-income borrowers, but the point is that whether it was irresponsible or not depends on your point of view. Or, in the case of HUD and its conservative leadership, it depends on who you’re responsible to.
The result, as a professor quoted in the Washington Post story above put it, was to “pump more capital into a very unregulated market.” Not just that, but a market that conservatives made sure was unregulated. How and why has been described in detail by John Atlas and Peter Deier in their article on the conservative origins of the subprime mortgage crisis, as well as our own Bill Scher in his “The Mortgage Crisis: Yet Another Conservative Failure” post. And Rick Perlstein’s “Mythbusting the Right’s Subprime Excuses” and “The Foreclosing of America” (parts one, two, three, and four) are must-reads on the subject of how conservatism created the current crisis.
But that’s only one part of the story. The other is conservatives’ efforts to preserve the consequences of the current crisis, by making arguments about “moral hazards” that are really a cover for their hazardous morals that drove and continue to drive the current crisis.
In a recent Financial Times column, Ian Morley provides a definition of “moral hazard” in the context of the subprime crisis.
In the recent case of subprime mortgages, bankers lent money to anyone, irrespective of their credit history, because the risk was securitised and the financial equivalent of explosive pass-the-parcel ensued. When the game ended, bankers walked away with much of the gains while the parcel exploded in all our faces. The paper gains disappeared and the losses were added to our tax bill.
This is real moral hazard. It just happens more quickly in bear markets. In the midst of this the regulators tinker with the safety rules of the Titanic (it always sinks, regardless). What they cannot change is greed and stupidity.
Moral hazard is when risk and reward have an asymmetrical relationship – usually a lot of reward for one person and most of the risk for the other. This is the root cause of the subprime and credit crisis. And it is at the heart of most financial meltdowns. They just manifest themselves differently and therefore catch us unawares. It is like generals planning for the next war based on the experience of the last one; and just as failed generals get medals, bankers get bailed out.
John McCain, advised by an architects of the subprime debacle and former employee of one of the biggest risk takers in the subprime market, just a few months ago opined that “it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers.” Yet, he didn’t see anything wrong with the Fed financing the Bear Stearns buyoutone of the most irresponsible actors in the subrime bonanza. Just a month before that statement, his own campaign finessed a bailout its own — via public funds, of course — if the campaign tanked.
The hazardous “bailouts for me, but not for thee” conservative morality that deregulates financial markets, but protects the biggest financial players from the consequences of their irresponsible, reckless, and often deceptive finaicial practices, means that those players will live to roll the dice another day in their “secret casino.” Conservatism will make sure it’s always open, and that the players never lose.
Their gambling debts will be paid by the rest of us, both in the form of bailouts, and in what happens to our communities. That’s something we’ll explore in the next part of this series.