In search of a new angle on the financial crisis, Gretchen Morgenson and Joshua Rosner’s (M&R) new book, Reckless Endangerment, seems to pin a lot of the blame on misguided do-gooders who were trying to make the dream of “home ownership” in America a reality for all. These include Bill Clinton, who they say pushed for making home ownership easy through his “National Partnership in Home Ownership” (p. 1), the Federal Reserve Bank of Boston’s researchers who did a path-breaking study of discrimination in lending, and even community organizing groups like ACORN. M&R say that ACORN and other housing groups let themselves be taken in and bought off by James A. Johnson, the CEO of Fannie Mae.
To be sure, Johnson, his successor Franklin Raines and other Fannie Mae executives, got very, very rich (Johnson pocketed more than $100 million in pay and Raines made more than $90 million, though he had to give more than $20 million back in a settlement for accounting fraud). While Johnson and Raines were making their fortunes, they were hiding under a protective cloak of pretending to make home ownership easy in America, viciously attacking their enemies while paying off their friends on both sides of the aisle.
But in spite of the authors’ desire to highlight the role of Fannie and Freddie, (the so called Government sponsored enterprises – GSEs – that helped finance home mortgages and after failing in 2008 have been taken over to the tune of 180 billion dollars by the tax payers) what comes through clearly from the dozens of interviews and reporting in Reckless Endangerment, the real culprits were not primarily Johnson and his pals, but rather the political establishment. These include the financial regulators, like Alan Greenspan and his subordinates at the Federal Reserve, the credit rating agencies, like Moody’s and S&P and the big bankers at Goldman, Country Wide, Citibank and elsewhere, who were dedicated to only one thing: paving their own road to riches by promoting widespread “debt owe-nership” that would lead to the ruin of millions of middle class and poor Americans.
These bankers, their regulators and the politicians who supported them effectively adopted policies to strip away as much equity from the public’s balance sheets as they could by getting people to take on more and more debt at outrageous prices and with predatory conditions. And what they could not get from home buyers, they took from the tax payers after the system crashed. Real home ownership, in the end, had nothing to do with it. It was nothing more than a cynical ploy. Had the political elite really been concerned about home ownership, would they not have pushed through serious loan modifications following the crisis to keep people in their homes? Would they not have stopped the robo-signers and other fraudsters from taking back homes that they didn’t even really own? Would they not have forced banks they bailed out to take cuts to keep people from losing their homes? If they were truly concerned about widespread home ownership – rather than “debt owe-nership” and asset stripping — would they not have done all of these things?
Indeed, Rosner made this false equity building ploy quite clear in his prescient and important paper published in 2001, “Housing In the New Millennium:A Home Without Equity Is Just a Rental With Debt.” Way ahead of its time and very important in identifying some key, dangerous trends that were to crash the system, this paper became the basis for the main story line of the book, even though it was written a full decade earlier and well before Morgenson and others had uncovered the true depths of the manipulations and corruption inherent in operations of the large banks, the derivatives markets and their regulators, such as the Federal Reserve and the SEC. Indeed, a brilliant example of this reporting by Morgenson was very recently published with Louise Story in June 1st’s New York Times suggesting how widespread deep conflicts of interest pervaded the management and rain-makers at Goldman Sachs, as they designed securities to fail, shorted them to make money, and then sold them to their unsuspecting customers.
As for the narrative that blames Fannie and Freddie for the crisis, Paul Krugman seemed to get it right as Fannie and Freddie were going under in 2008. At that time he pointed out that in the current crisis, Fannie and Freddie were late to the game, playing catch-up and at most contributed toward keeping the bubble going toward the end. This view agrees with astute observers such as Marc Jarsulic, an economist and lawyer on the Senate Banking Committee and Kathleen Engel and Patricia McCoy, two legal experts and law professors who were among the first to break the story on the abusive lending that contributed to the crisis. Engel and McCoy show that Fannie and Freddie were just among a number of important factors and institutions that contributed to the mess we are in, with the regulators and the large banks up there as among the key culprits. Of course, everyone agrees that Fannie and Freddie cost tax payers billions of dollars when it ultimately did collapse in the summer of 2008.
“Reckless Endangerment” should have more carefully examined these questions: to what extent was the problem a push for homeownership or the perverse public-private partnership that gave all the gains to the executives and shareholders and put all the risks on the tax payers? Would a truly public approach have worked better? To what extent was the problem a lowering of credit standards, as MR suggest, or was it really a problem of the corruption in the mortgage/securitization supply chain? How do we apportion blame among these different dynamics and actors? Unfortunately, these questions are not carefully posed much less explicitly answered.
The attempt to place a lot of the blame on government’s misplaced do-good desire to spread home ownership leads the book to some odd places. To present one example: the book claims that the path-breaking Federal Reserve Bank of Boston Study on lending discrimination in the early 1990’s was deeply flawed and contributed to the misplaced effort to spread home ownership. Reckless Endangerment trots out old and discredited critiques of the study to conclude that the Federal Reserve Bank of Boston “was making a fool of itself” (MR, p. 40). Housing expert Jim Campen an emeritus Professor of Economics from Umass Boston, disagrees. In a personal email Campen noted: “the Boston Fed study…probably received more scrutiny than almost any other econometric study — perhaps ever — and survived it incredibly well. The Boston Fed published it as a Working Paper in Oct 1992. Three and one-half years later — March 1996 — a revised version was published in the American Economic Review (AER). The AER version was revised in various ways, but the basic methodology and conclusions were essentially the same. And you can be sure that the editorial review process was particularly stringent.” The Journal of Economic Perspectives, another American Economic Association journal also published a very strong review of the Boston Fed Study, demolishing many of the critiques cited by MR. Campen goes on to say:
“It is completely unjustified to say that it was a seriously flawed study or to blame it for the rise of subprime lending. The conclusion of the study was that applications from black and Latino applicants were not reviewed and decided upon using the same standards as those from white applicants…. The policy conclusion was that they should be treated the same – this has NOTHING to do with how loose or tight lending standards should be.”
While the corrupt web of influence peddling and massively dangerous actions by Fannie and Freddie are an important and very costly – if over-blown- part of the story of the crisis told by M&R, of perhaps greater value is the new evidence they present on regulators’ complicity with the private banks, and of the ways in which the banks and the regulators themselves tried to quash opposing research and buy off academic work that fit with their narrow interests. Fed researcher Walker Todd and CBO analyist Marvin Phaup are among the brave researchers they cite.
With respect to complicity of regulators, they present damning new evidence about the SEC and the Federal Reserve. With respect to the Fed, they show how Roger Ferguson, Vice President of the Federal Reserve Board, represented the banks interests in pushing to water down bank capital requirements at negotiations in Basel Switzerland. They report that: “…internally at meetings in which the new standards were discussed…granting the banks’ wishes seemed to be the Fed’s priority, according to a regular attendee” (MR, 131). “The Fed’s worldview was dominated by the big banks, (a) regulatory colleague said.” “If you look back at all the things that were done, all the rulemaking was in the same directions – that the banks knew what they were doing and we needed to rely more on their internal systems” (MR, p. 132).
Another example of the Fed’s support of policies that would increase the profits of the big banks but that would dangerously threaten the economy was its support for looser accounting standards of exotic instruments, instruments that ended up crashing the system. In 2003, the banks’ proposed accounting rules that would essentially allow them to hide these activities off their balance sheet, hold less capital, and be able to book fake profit which would increase their bonus pools. M&R report that “The Fed had lobbied for elements of this rule change that benefited the banks, according to a former Federal Accounting Standards Board official who was there at the time. “The Federal Reserve was closely aligned with the banks; they seemed to be asking for the same things”, the official said. “As far as I could see, the Fed was one of the biggest problems from a standard-setting point of view, of not wanting to provide investors with more transparency”(MR, p. 234).
The result of this was catastrophic. For example, Citibank, which was bailed out by the taxpayers, used these “structured investment vehicles” to generate and hide profits that contributed to bonuses for management and rainmakers. But when the crisis hit, “Citigroup’s investors were stunned when the flood of losses and assets from entities they were unaware of began backing up onto its books. So were officials at the Federal Deposit Insurance Corporation” who had no idea how many assets the bank had shifted….from its balance sheet” (MR, p. 235). Even as Citigroup was building up its hidden off- balance sheet risks in 2006, its overseers at the New York Fed, notably Timothy Geithner and company, “did nothing to rein in the risk”. M&R show how Sanford Weill and Robert Rubin of Citgroup cultivated Geithner, suggesting this might have had something to do with his lack of attention. A recent New Yorker cartoon captures this nicely: Standing by some office cubicles, one older man in a suit and tie says to a younger guy in a suit: “I want you to play a bigger role in the day-to-day operations of ignoring the obvious” (May, 23, 2011,p. 54).
Reckless Endangerment contains many invaluable discussions and new evidence about these dynamics. These few examples just scratch the surface of the treasure trove Morgenson and Rosner provide.
And that is not all. Among its other valuable services, the book reminds us of many of the key figures who contributed to the financial crisis, have profited handsomely from it but are still in important positions of authority. For example, M&R remind us about Robert Zoellick, currently President of the World Bank. Zoellick was chief lobbyist for Fannie Mae when we worked for James A. Johnson, between 1993 -1997. Morgenson and Rosner describe in vivid detail how Zoellick and others, including Larry Summers, bullied critics and won and influenced friends for Fannie Mae. (MR, pp. 80, 86, 90). June O’Neill, head of the Congressional Budget Office (CBO) when they published a report critical of Fannie Mae, reports: “Frank Raines and Bob Zoellick came and met with me and the people from CBO. All of us had the same feeling – that we were being visited by the mafia” (p. 86).
Bob Zoellick is not the only one whose “where is he now?” moment is of interest. Morgenson and Rosner report in their handy little appendix that Roger Ferguson, the Fed Vice President that worked so hard to reduce capital requirements on the banks is now chief executive of TIAA-CREFF, the big pension fund for University professors, among others; and James Johnson is a trustee emeritus of the Brookings Institution and director of Target and Goldman Sachs. Unfortunately, there are many others listed there.
In the end, Reckless Endangerment provides enormous, detailed, and interesting evidence of the complex and numerous ways in which the nefarious connections between the bankers at Fannie Mae and Freddie Mac, Goldman Sachs, Citibank, Bank of America and others, with the aid of the political and regulatory elite, including, Alan Greenspan and Timothy Geithner of the Federal Reserve, spun a web of deceit built on money and intimidation that enriched a few and impoverished the many.
But to overemphasize the narrative about “do – gooders” and their “push for home ownership” as the main culprit – a narrative that is being promoted by the current Republican leadership who even more than the Democrats, are being paid to let the bankers off the hook, gut financial reform, hamstring financial regulators, and turn the financial system back over to the same bankers who destroyed it in the first place – is, in this political environment, a bit reckless itself.