The ABA, Obama And Government's Role

Anyone listening to President Obama's State of the Union Address could note help but notice his disdain for banks. The American Bankers Association, representing 8,000 banks noticed and took offence, especially with Obama's statement,

So I know how unpopular it is to be seen as helping banks right now, especially when everyone is suffering in part from their bad decisions.

Victoria McGrane, writing for Politico in "Bankers to Obama: Stop trashing us," Politico, February 27, 2009, states,

In a letter to the White House, ABA CEO Edward Yingling says bankers across the country were "disappointed and concerned" with rhetoric like that.

"Mr. President, of the over 8,000 banks in this country, very few ever made a single subprime loan, and they did not engage in the highly leveraged activities that brought down Wall Street firms," Yingling said.

I would go further than the ABA and suggest (politely of course) to President Obama that the government should acknowledge its own errors in contributing to the housing bubble and financial crisis in addition to those made by the private sector.

Part of the government's misadventure came in pursuing an increase in home ownership for Americans. The government sponsored entities (GSE's), Fannie and Freddie, were directed by the Department of Housing and Urban Development (HUD) to increase the share of loans they made to borrowers with income below the median to 40% in 1996. In 2000, the share was upped to 50%, and in 2008, to 56%. Yes, they were regulated into financing these loans. The debacle was bipartisan as noted by Slate (Shafer, Jack. "Fannie Mae and the Vast Bipartisan Conspiracy," Slate, September 16, 2008.).

They also granted the GSE's authority to lower underwriting standards. Underwriting standards are the quality guidelines used by lenders to gauge the creditworthiness of borrowers.

Stan Liebowitz ("Anatomy of a Train Wreck: Causes of the Mortgage Meltdown," Independent Policy Report, October 3, 2008.) tracks changes in income verification standards from the Boston Fed to the GSE's and on to Countrywide Home Loans, Inc., a paragon of lending virtue according to an article published in the Housing Policy Debate published by the Fannie Mae Foundation (Listokin, David and Elvin K.Wyly "Making New Mortgage Markets: Case Studies of Institutions, Home Buyers, and Communities," Housing Policy Debate, Volume 11, Issue 3, 2000.).

According to the transcript of an American Enterprise Institute event, "How Serious Is the Mortgage Problem That Will Confront President Obama?," Ed Pinto states,

There are 57 million, approximately, mortgage loans in the United States and fully 25 million or 44 percent are nonprime. That’s roughly double the estimates that a number of people were making pre-September 2008, and it also startled a lot of people to find out that Fannie Mae and Freddie Mac had ten million of these 25 million loans or about 40 percent of the total. Then you throw in FHA, which has another three and a half million or another 14 percent and you’re looking at the federal government having direct involvement in well over half of the total of subprime and Alt-A lending or nonprime lending.

The private sector was also involved, and their role should not be diminished. But if we do not mention the failure of the government, we are missing a big piece of the puzzle and regulatory reform is likely to be ill-formed.

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What Can Regulators Regulate?

In an important article titled, "What Can Regulators Regulate? The Case of Electricity" written in 1962, George Stigler and Claire Friedland observe,

The literature of public regulation is so vast that it must touch on everything, but it touches seldom and lightly on the most basic question one can ask about regulation: Does it make a difference in the behavior of an industry?

As the House Committee on Oversight and Government Reform hearings begin, the washingtonpost.com reports that

Internal Freddie Mac documents show that senior executives at the company were warned years ago that they were offering mortgages that could pose dangers to the firm, hurt borrowers and generate more risky loans throughout the industry.

The documents also suggest that the GSE's executives knew their firms were falling behind private sector firms in product innovation and market share. Parenthetically, this suggests that the GSE's were not the culprit of the housing bubble, its bursting, or the ensuing financial crisis, but rather a somewhat late player. Fannie's CEO, Daniel Mudd expressed concern in 2005 that

A business presentation in 2005 expressed concern that unless it didn't [push into new markets], Fannie could be relegated to a "niche" player in the industry. Mudd later reported in a presentation that Fannie moved into this market "to maintain relevance" with big customers who wanted to do more business with Fannie, including Countrywide, Lehman Brothers, IndyMac and Washington Mutual.

In a wonderful Cato Policy Report touching on the social value of free markets and the impact of regulation, titled, "Are We Ailing from Too Much Deregulation," David R. Henderson notes that the GSE's were important players in the mortgage industry

Of the more than $15 trillion in mortgages in existence in early 2008, about one third were owned by, or were securitized by, Fannie Mae, Freddie Mac, Ginnie Mae, the Federal Housing and Veterans Administration and other government agencies [GSE's] that subsidize mortgages.

Despite falling behind private financial companies, the GSE's knew their importance in the industry. The washingtonpost.com reports that

The documents suggest than Fannie and Freddie knew they were playing a role in shaping the market for some types of risky mortgages. An e-mail to Mudd in September 2007 from a top deputy reported that banks were modeling their subprime mortgages to what Fannie was buying.

When Representative Darrell Issa (R-Calif.) who said (washingtonpost.com) that the executives at the GSE's need to take responsibility for their actions and the companies failure, and other members of Congress who have said similar things should remember with some humility their institution's failures to oversee their creations. Regulators, both those at the Office of Federal Housing Enterprise Oversight (OFHEO), and in Congress were unable to successfully regulate Fannie Mae and Freddie Mac. Particularly egregious were members of Congress who blocked regulatory reform.

Why did regulation fail? Henderson suggested two reasons: regulators have little incentives to regulate well, and regulatory agencies are often captured by the industry they regulate. Slate's Jack Safer beautifully illustrates political capture by Fannie and Freddie in, "Fannie Mae and the Vast Bipartisan Conspiracy." Let me suggest a third reason regulators, congressional or otherwise, fail: they do not have the knowledge needed to control a spontaneously and organically growing market, nobody does.

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