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.
Bears Stearns (Remember them?) is finally, quietly sold
to JP Morgan — to the tune of $2.2 billion, with taxpayers
kicking in $29 billion via the Fed, to guarantee Stearns’
subprime mortgage assets.
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?)
But do the defenses and explanations why the Fed had to
bail out Bear Stears boil down to “love
thy neighbor”?
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?
David Corn’s article on former
Senator — and current economic advisor to John McCain — Phill Gramm’s
role in the housing credit crisis is a prime example.
Image details: John
McCain Campaigns In South Carolina served by picapp.comWho’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.
[Photos via C R,
respress,
and Ryan
Orr.]
