After the financial collapse as I expected a flood of books swept the market to explain why it happened. Some were written by people on the right and some by people on the left. If you’re interested in reading a book that explains how the housing bubble burst and, more important, how it was inflated in the first place from a non-ideological source I recommend Reckless Endangerment. The authors do a good job of detailing how the people within Fannie Mae cooked the books and used various means to ensure folks who normally wouldn’t qualify for loans got them. It also details how some within government, both Republicans and Democrats, defended Fannie Mae.
Gretchen Morgenson, the lead author, is a business reporter and writes the Fair Game column in The New York Times. She won a Pulitzer Prize in 2002 for her coverage of Wall Street. Her co-author, Joshua Rosner is a partner at Graham Fisher & Co., an independent research consultancy.
Morgenson and Rosner report how Barney Frank and Chris Dodd vigorously defended Fannie/Freddie against various people who questioned the economic wisdom of what they were doing.
It’s not a perfect book but it details the greed that drove the key participants within these organizations. It’s ironic because the only time I recall the media or liberals use the word greed was to chastise Wall Street’s role, not those within government and the Government Sponsored Enterprises, Fannie Mae and Freddie Mac. As the authors say:
We found that this was a crisis that crept up, building almost imperceptibly over the past two decades. More disturbing, it was the result of actions taken by people at the height of power in both the public and private sectors, people who continue, even now, to hold sway in the corridors of Washington and Wall Street.
Reckless Endangerment is a story of what happens when unfettered risk taking, with an eye to huge personal paydays, gains the upper hand in corporate executive suites and on Wall Street trading floors. It is a story of the consequences of regulators who are captured by the institutions they are charged with regulating. And it is story of what happens when Washington decides, in its infinite wisdom, that every living, breathing citizen should own a home.
They don’t use these terms but Reckless Endangerment exams the perils of crony capitalism. I’d also reverse their order of cause and effect: government policies to encourage home ownership lead to the formation of GSEs which blend the private and public sectors.
Reckless Endangerment shows that the seeds were set several decades before 2008. The change in the tax code in 1986 eliminated the interest deduction on debt except for mortgages thus setting the stage for making housing “Americans’ most favored asset.” Then in 1994 President Clinton launched the National Partners in Homeownership, a private-public cooperative with one goal: raising the numbers of homeowners across America. As they point out this cooperative had a problematic feature: it teamed regulators with the organizations they were supposed to be policing.
The book then shifts to the role of James Johnson who took over Fannie Mae and began relaxing loan underwriting standards. In addition the executive pay structure changed. “Compensation became tied almost solely to earnings growth.”
[CBO study revealed that] the companies passed on to borrowers only about two thirds of the billions in benefits they received. Fannie and Freddie kept $2.1 billion for themselves and their shareholders. … [It became clear] how Fannie Mae could pay its executives as much as they did. Equally evident: Holding on to so much of its subsidy let Fannie Mae fund its elaborate self-preservation scheme, make its massive charitable contributions, pay for it extensive ‘political outreach,’ and hire academics to write favorable studies about its role in the mortgage market.
Federal investigators later found that you could predict what Fannie’s earnings-per-share would be at year-end, almost to the penny, if you knew the maximum earnings-per-share bonus payout target set by management at the beginning of the year.
Towards the end of the book Morgenson comments on the attempt to “fix” the earliest abuses by passing the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. “The irony of having two of the nation’s most strident defenders of Fannie Mae sponsoring the new reform act was lost on few of those who knew the sordid Fannie story.”
While Reckless Endangerment nicely reports on the shenanigans of those in government, the GSEs and on Wall Street it suffers from a lack of a clear understanding of free market economics. Nor does it address the philosophical premises that support the efforts to expand home ownership. For a nice analysis with a philosophical explanation check out Altruism: The Moral Root of the Financial Crisis by Richard M. Salsman. I would add that those who pushed for home ownership did indeed justify it by pointing out that people who normally couldn’t afford homes now could but a number of those advocates obviously had purely self-promoting reasons for doing so such as the Fannie Mae execs who reaped huge bonuses for their “selfless” work. So you end up with deadly recipe for disaster: altruistic justification for bad policies, profit taking by those who administered the GSEs, politicians who made political hay with their support, financiers who sold derivatives that rested on an inherently faulty foundation, regulators and financial rating agencies who turned a blind eye and finally (as covered in the book) academics who cooked their numbers in their analyses to hide the flaws.
I’d like to say we (speaking collectively) learned a lesson from all of this but based on the passage of the Dodd-Frank bill plus other more recent developments I’m afraid we’re no better off than we were before the 2008 crash. In other words Reckless Endangerment continues.
