Democrats Responsible for Financial Crisis

                               (Image from swamppolitics.com)

At Bloombergs today see "How Democrats Created the Financial Crisis" by Kevin Hassett, at http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_hassett&sid=aSKSoiNbnQY0

This crisis seems so complex, but really, it isn't.

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.

Their large presence created an environment within which even mortgage-backed securities assembled by others could find a ready home.

But all this worked only as long as real estate prices stayed high.

Once they began to fall, the entire house of cards came down with them.

Turning Point

Take away Fannie and Freddie, or regulate them more wisely, and it's hard to imagine how these highly liquid markets would ever have emerged. This whole mess would never have happened.

It is easy to identify the historical turning point that marked the beginning of the end. 

Back in 2005, Fannie and Freddie were...on the ropes...enmeshed in accounting scandals.  At one telling moment in late 2004...the SECs chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's position on the relevant accounting issue was not even ``on the page'' of allowable interpretations.

Than a movement in Congress emerged to create a "world-class regulator" to oversee Fannie and Freddie.  It would impose...

...strict requirements on their ability to take excessive risks. Politicians who previously had associated themselves proudly with the two accounting miscreants were less eager to be associated with them. The time was ripe.

Greenspan's Warning in 2005:

Alan Greenspan told Congress how urgent it was for it to act...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 said. `` 

Then something extraordinary happened.  For the first time, a serious Fannie/Freddie reform bill was passed by the Senate Banking Committee.

The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.

The world would be different today if that bill had become law.

Without (Fannie/Freddie) checkbooks keeping the market liquid and buying up excess supply, the (sub-prime) market would likely have not existed.

But the bill didn't become law.

Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.

That such a reckless political stand could have been taken by the Democrats was obscene even then. Wallison wrote at the time: ``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.''

The roadblock

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.

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.

Who is to blame for this crisis?  Take a look at the story of 2005.

       ...there is one little footnote to the story that's worth keeping in mind...Senator John McCain was one of the three cosponsors of S.190, the bill that would have averted this mess.  (All emphases added.)

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(Kevin Hassett, director of economic-policy studies at the American Enterprise Institute, is a Bloomberg News columnist. He is an adviser to Republican Senator John McCain of Arizona in the 2008 presidential election. The opinions expressed are his own.)