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Peter J. Wallison

Elizabeth Warren gets Glass-Steagall wrong

By Peter J. Wallison

May 21, 2012, 10:32 am

Elizabeth Warren, as everybody knows, is a Harvard Law School professor. She was also the chair of the Congressional Oversight Panel, which oversaw the implementation of TARP, and she was tasked by the Obama administration to set up the Consumer Financial Protection Bureau, a powerful government agency established under the Dodd-Frank Act. Now she’s running for the Senate in Massachusetts, a seat held by Republican Scott Brown. One of the planks in her platform is the reinstatement of the Glass-Steagall Act, a depression-era law partially repealed under Bill Clinton in 1999. With the recent news about a $2 billion loss at JP Morgan Chase, she was on NPR over the weekend saying that Glass-Steagall should be reinstated in order to prevent losses like that.

If you heard that NPR broadcast—and you still can at www.npr.org—you’d have heard Warren say that “the thing about Glass-Steagall is that it makes banking boring… If you want to do all those exciting things like make $100 billion bets or lose $2 billion, or 3, you have to do that over in the Wall Street trading kind of business. Glass-Steagall says there needs to be a wall between those two kinds of activities.”

Well, Warren isn’t a senator yet, and that’s a good thing because she doesn’t have an understanding of Glass-Steagall that we might expect from a Harvard law professor. The first thing she has to understand is that Glass-Steagall still applies to banks. The only thing that changed in 1999 was that banks were allowed to affiliate with securities firms, but Glass-Steagall still forbids banks themselves to engage in underwriting or dealing in securities.

Well, if Glass-Steagall still applies to banks, how is it that JP Morgan Chase could make those trades that cost the bank $2 billion? They can do it because even under Glass-Steagall banks were able to buy and sell (that is, trade) loans and securities backed by loans. How could it be otherwise? Loans are banks’ stock in trade, and it would be as crazy to forbid them from buying and selling loans and securities backed by loans as it would be to prohibit Exxon Mobil from buying and selling oil.

What’s more, JP Morgan Chase’s CEO, Jamie Dimon, says the bank lost the $2 billion in hedging transactions, which means they were making trades to protect other assets against losses. Banks have always been allowed to hedge, not only under Glass-Steagall but also under the Volcker rule that is in the Dodd-Frank Act, which Warren said she supports.

$2 billion is a lot of money, of course, but it’s only 1/1000th of the assets of this $2 trillion bank. Warren fell for the media hype that this was a huge “bet,” and that doesn’t speak well for her ability, as a Harvard law professor, to distinguish between facts and what the media says. She’ll have to do that if she ever gets to be a senator, and maybe before.

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Categories:  Economic Policy, Financial Services, U.S. Politics   |   Tags: , ,

Peter J. Wallison

JP Morgan’s losses prove that the Volcker rule is unworkable

By Peter J. Wallison

May 11, 2012, 2:53 pm

Much of the commentary about the JP Morgan Chase losses suggests that either this is proof of the need for the Volcker rule, or is a reason to get the Volcker rule in place promptly. Neither is true. In fact, as thus far reported, what happened at JPMC is proof that the Volcker rule is unworkable and should be abandoned.

The rule bans proprietary trading by banks, but specifically authorizes hedging transactions. It appears from news reports that JPMC has suffered the losses while pursuing a hedging strategy. If so, the losses would not have been prevented by the Volcker rule.

More broadly, it is virtually impossible to determine whether a specific trade or a series of trades is a hedging transaction—an effort to reduce risk that the bank has already taken on—or speculation, a risk that the bank is taking. That is the fundamental flaw in the Volcker rule, and the reason why it should be repealed.

If the answer cannot be determined except by knowing all the circumstances surrounding a trade, and what was in the mind of the trader when the trade was put on, it is not suitable for a regulation—i.e., for a written rule like the Volcker rule. Instead, it is suitable for a subsequent supervisory action; an investigation by a bank supervisor to determine the facts after the event, which may then result in a penalty for the bank if it has failed to comply with the distinction between speculation and hedging.

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Categories:  Economic Policy, Regulation   |   Tags: , ,

Peter J. Wallison

The Left misunderstands the definition of ‘mainstream’

By Peter J. Wallison

May 2, 2012, 10:19 am

Lately, there have been more articles than usual about the fact that the Left does not understand America or Americans. Jonah Goldberg has just had justifiable fun with the writings of pseudoscientist Chris Mooney, who tries to explain conservatism as a birth defect, and there have been numerous articles by conservatives about the fact that liberals either don’t bother to read—or don’t seem able to grasp—what conservatives are writing. Now we have our own Norman Ornstein (with Tom Mann) writing in the Washington Post this weekend:

The GOP has become an insurgent outlier in American politics. It is ideologically extreme; scornful of compromise; unmoved by conventional understanding of facts, evidence and science; and dismissive of the legitimacy of its political opposition.

When one party moves this far from the mainstream, it makes it nearly impossible for the political system to deal constructively with the country’s challenges.

It must be said: These two have completely lost their bearings. We can’t, of course, predict the outcome of the elections in November, but one thing is clear: They will be close. It is not beyond the realm of possibility—some, reading the polls, may actually say it is likely—that after the elections the American people may have given the Republicans control of the presidency, the House, and the Senate. In other words, by the lights of Ornstein and Mann, a political party that is “far from the American mainstream” could be put fully in control of the U.S. government. If there’s a better definition of “mainstream”—or a  better demonstration that liberals do not understand America or Americans—it’s hard to imagine.

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Peter J. Wallison

Dodd-Frank threatens to reduce credit availability by $1.2 trillion

By Peter J. Wallison

April 16, 2012, 11:03 am

The Financial Times today carries a story that U.S. banks have been resisting a new Fed regulation—issued under the Dodd-Frank Act—that would limit their credit exposure to one another. According to the article, the banks have data showing that this would reduce credit availability by about $1.2 trillion.

Similar restrictions will apply to all nonbank financial firms—insurers, finance companies, securities firms, hedge funds, and others—that could be designated as systemically important financial institutions (SIFIs) by the Financial Stability Oversight Council (FSOC), a group of federal financial regulators created under the Dodd-Frank Act. If that occurs, these firms will become subject to the Fed’s regulation and credit availability in the U.S. economy will be further restricted.

The Fed’s proposed regulation—like the Dodd-Frank Act itself—is based on the notion that there are “interconnections” among financial institutions that will cause the failure of one large firm to drag down others.

However, events after Lehman’s bankruptcy disprove this idea. With the exception of one money market mutual fund—which probably believed that Lehman would be rescued like Bear Stearns—there is no example of a financial firm that was dragged down or made insolvent by Lehman’s failure. Wachovia, Citibank, Washington Mutual, Merrill Lynch, and AIG all got into trouble through their exposure to subprime and other low quality mortgages, not because of their exposure to Lehman.

If Lehman could fail at a time when large numbers of other firms were weak and seemingly unstable—without this failure having any knock-on effects—it is obvious that the “interconnections” theory that Dodd-Frank and the Fed are pursuing is invalid.

This is another reason why the authority of the FSOC to designate nonbank firms as SIFIs should be repealed before it does further harm to economic recovery.

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Categories:  Economic Policy, Fiscal Policy and Taxes, Regulation   |   Tags: , ,

Peter J. Wallison

Liberals trapped inside their own echo chamber

By Peter J. Wallison

April 12, 2012, 2:32 pm

Andrew Biggs’s article today put me in mind of other examples of liberals’ failure to understand what goes on outside their world. Many commentators have noticed the Left’s sudden realization that Obamacare might actually be invalidated by the Supreme Court. This was no surprise to conservatives, who have long observed that the Left and the media create a kind of echo chamber, where only a few acceptable thoughts are allowed to circulate. The questionable constitutionality of the individual mandate—well-known to conservatives—was not among them.

In the past, consequential misjudgments of this kind have been frequent. It’s well-known, for example, that the Democrats and President Carter were eager for the Republicans to nominate Ronald Reagan in 1980; he would be, they were sure, the easiest Republican to beat. It’s obvious now that they understood little about the American people. More recently, the Democrats and the media were full of stories that the Tea Party’s “extremism” would ruin the GOP’s chances of taking over the House in 2010. And who can forget that Occupy Wall Street—and their protest against… well, whatever it was—would energize the Democratic base in 2012.

There are likely to be more shocks in store for the Left as the country moves into the election season:

–Mitt Romney’s theme about an opportunity society rather than a government-centered society will prove far more popular than Obama’s politics of envy; and

–Tying Mitt Romney to Paul Ryan’s budget will not, as the Left believes, be a boon to the Democratic campaign; Ryan will become a powerful spokesman for acting responsibly to gain control of the nation’s ballooning debt.

The final surprise, of course, will be the outcome of the election.

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Peter J. Wallison

A brokered convention would be a disaster for the GOP

By Peter J. Wallison

March 2, 2012, 11:09 am

Get a hold of yourselves, folks. You are not thinking this through. Every time Mitt Romney loses a state or a caucus in this topsy-turvy Republican race, the media starts talking about a boomlet for Jeb Bush, Mitch Daniels, or some other candidate who might enter the race now or be nominated at a “brokered convention.” And there is always a Republican pundit or two—someone not aligned with any of the campaigns—who’s available to stroke his chin and opine that yes, we’re getting closer to just that kind of scenario.

Now, no one should exclude the possibility of really weird events occurring in U.S. politics this year. The international economic, financial, military, political, diplomatic, and oil scene—quite apart from the economic, employment, and energy picture in the United States—could easily produce major changes in the political lineup before November. But these are what Donald Rumsfeld used to call “known unknowns,” and not something anyone can plan to exploit.

However, there’s one fact that everyone should know and keep in mind: this year, there are 67 days between the end of the convention and the election. No matter what might have been possible in 1924, 1932, or even 1952, it is simply impossible for a candidate chosen at a convention in 2012 to raise the funds and put together a credible campaign in a little over two months. Can’t be done.

Republicans who want to beat Obama should stop talking about the possibility of a brokered convention. It only encourages the losing candidates to stay in the race and savage one another, and—even more likely—it stimulates financing sources that are keeping these tigers in the ring. To have any chance of beating Obama, the Republican convention this year will have to nominate one of the four candidates now in the field. Any other idea is both unrealistic and ultimately destructive to Republican chances.

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Peter J. Wallison

Is Obama serious about privatizing the housing market?

By Peter J. Wallison

February 29, 2012, 10:04 am

Despite publishing a series of options for housing finance reform over a year ago, the Obama administration has done nothing to follow up. In early February, however, in a report to the Financial Stability Oversight Council, Treasury Secretary Geithner promised to make progress this year on winding down the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac and reviving the moribund private securitization market. As I discuss in a new AEI Outlook released today, if this is the extent of the administration’s plan, it will fail.

To be sure, the private securitization market will not revive until the GSEs are wound down, but that in itself will not be sufficient. For the administration’s plan to be credible, it has to include significant limitations on the scope of the Federal Housing Administration’s activities, and amendment or repeal of provisions in the Dodd-Frank Act that stand as obstacles to a revival of private sector activity. Today, the government’s housing finance role, which principally includes the GSEs and FHA, accounts for 95 percent of the market. Pressure from Congress and the administration to reduce mortgage standards in order to revive the housing market will once again result in future losses for the taxpayers, who may have to pay as much as $300 billion to bail out the GSEs and an unknown amount to recapitalize the FHA.

To avoid these recurring and unnecessary costs, the only sensible policy for this country is to gradually turn over the financing of homes to the private sector. The rest of our economy does perfectly well with private sector financing, and there is nothing about the financing of housing that requires government backing. Private securitization has worked well in the past, and if properly structured as outlined in the white paper on housing finance that my AEI colleagues and I issued in March 2011, it can provide stable financing for housing in the future without the need for taxpayer subsidies.

But reviving the private securitization market will not be easy. Fannie and Freddie are serious competitors for any private firm because of their government backing, and FHA—after increases in the size of loans it can insure voted by Congress in November—is an even more formidable obstacle for any firm that wishes to enter the private securitization market. Moreover, the Dodd-Frank Act also creates serious impediments for the private sector, by exempting FHA (and likely the GSEs) from the risk retention requirements in the act and setting up other legal or regulatory obstacles to such things as true sales accounting treatment, hedging under the Volcker rule, requirements for risk retention that favor the largest banks, and many other provisions.

These are serious political hurdles that the administration has allowed to grow—and in some cases encouraged—over the past year. It will be tougher now to turn around the tide that is running against the revival of the private market. But if the administration and Secretary Geithner are serious about restoring a private market in the future, the plan they produce this year must deal with all these issues.

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Categories:  Economic Policy, U.S. Economy   |   Tags: ,

Peter J. Wallison

CFTC’s Gensler is wrong on credit default swaps

By Peter J. Wallison

February 23, 2012, 10:55 am

Commodity Futures Trading Commission Chairman Gary Gensler today:

In 2008, swaps helped concentrate risk in the financial system that spilled over into the real economy, affecting businesses and consumers across the country. Eight million Americans lost their jobs and thousands of small businesses were lost as a result of the crisis. … The derivatives reforms in the Dodd-Frank Act, once implemented, will lead to significant benefits for the real economy – that which makes up over 94 percent of private sector jobs in America. The derivatives reforms also will bring significant benefit to all Americans who depend on pension funds, mutual funds, community banks and insurance companies.

They will benefit from lowering the risk of the swaps market and increasing transparency. Today is our 24th open meeting on Dodd-Frank reforms, and we will consider rules addressing both of these goals. To lower risk, we will consider business conduct standards for swap dealers and major swap participants – what we’ve come to call internal business conduct. To promote greater transparency, we will consider a proposal of the block rule.

Chairman Gensler’s statement about credit default swaps is right out of the same playbook that brought us the destructive Dodd-Frank Act. There is no evidence that credit default swaps were a significant cause of the financial crisis. One company, AIG, got in trouble because they made foolish commitments. Would we regulate the lending of all companies because one company made imprudent loans? No other company needed a bailout or was driven into insolvency by its dealings in the credit default swap market.

Lehman’s failure proves this point. Lehman was a major player in the CDS market. When it went into bankruptcy, and could not meet its CDS obligations, some companies suffered losses, others made gains, but the market continued operating effectively all through the financial crisis. Efforts to regulate CDS will actually increase risks, because CDS are the most effective risk management device ever developed. By adding costs through regulation and requiring collateral where it is unnecessary, the Commodity Futures Trading Commission will make risk management more expensive and difficult for financial and nonfinancial firms.

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Peter J. Wallison

Compared to ’08, Obama is having major money troubles

By Peter J. Wallison

February 22, 2012, 6:39 am

The media still has not recognized the real reason for President Obama’s new-found interest in a Super Pac, but the latest campaign finance figures confirm the view I expressed in my posting of February 8. The story put out by the Obama campaign was that in light of the huge fundraising success of Republican Super Pacs, the president was not going to go into the coming campaign unarmed. This story was largely accepted by the media.

However, the new report about fundraising in January shows that the reason for the president’s reversal was likely motivated by a much more serious problem. The Obama campaign is falling seriously behind its fundraising goals, and must begin to rely on wealthy donors who have already maxed out on their personal contributions. In January, from all donors, the president’s campaign and the Democratic National Committee, together, raised $29 million. That is far ahead of the Republicans, to be sure, but it is far behind the $36 million that the Obama campaign, alone, raised at this point in 2008.

This is an important story—an incumbent president who is having difficulty matching the funds he raised when he was just an aspiring and underdog candidate for his party’s nomination. We’re left to  wonder why the media has not remarked on this.

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Peter J. Wallison

The Left’s financial crisis narrative lies behind Obama’s new tax proposal

By Peter J. Wallison

February 14, 2012, 11:00 am

If there was ever any doubt that the causes of the financial crisis are still a relevant issue, it has been erased by the president’s budget and his call for new assessments on banks and other financial institutions. The budget contains a “financial crisis responsibility fee,” purportedly to pay back the taxpayers for the bailouts of financial institutions during the crisis. In calling for the fee, the president said, “the free market was never meant to give the financial system free license to take irresponsible and reckless risks of such size that they can harm our economy and leave taxpayers with the bill.”

Naturally, the president did not mention Fannie Mae and Freddie Mac in this statement, although their losses thus far—over $150 billion and counting—dwarf the costs of the bailouts. Nor did the president point out that before the financial crisis there were 28 million subprime and other weak and risky mortgages in the U.S. financial system, 74 percent of which were on the books of government agencies such as Fannie and Freddie, FHA, the Federal Home Loan Banks, the Veterans administration, and insured banks acting under the requirements of the Community Reinvestment Act. This makes clear where the demand for these irresponsible mortgages actually came from. When these weak and low quality loans began to default in 2007, they drove down housing values and caused the 2008 financial crisis.

The Left’s preferred narrative is that Wall Street and the private sector caused the financial crisis, and President Obama faithfully repeated and built upon this mantra in calling for further milking of financial institutions. The only way the financial industry can stop the seemingly endless calls for reparations is to make clear that the responsibility for the financial crisis rests with the government and not the private sector. The housing policies pursued by HUD between 1992 and 2007, seeking to increase home ownership by reducing mortgage underwriting standards, was the ultimate source of the mortgage meltdown and the financial crisis.

Ideas have consequences. If it wants to avoid continuous whipping boy status, the financial industry should inform the American people about what actually happened in the financial crisis. Don’t expect the media to do it.

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Peter J. Wallison

The real significance of Obama’s reversal on super PACs

By Peter J. Wallison

February 8, 2012, 3:11 pm

It’s somewhat amazing that the media, and even the Republicans, have failed to comment on what might be the real significance of the Obama campaign’s reversal on the use of a super PAC. When the campaign began many months ago, Obama’s advisers seemed reasonably confident that his campaign would be well funded, some suggesting that he could have the first billion dollar war chest.

Recently, however, the campaign has walked back that idea, suggesting that while he was doing very well in his fundraising efforts, a billion-dollar campaign was never on their screen. The early numbers, indeed, show him doing better than he did at this stage in 2007. But that has to be expected. He is now a sitting president; in 2007, he was just a new face running an uphill campaign against a heavy favorite.

However, the decision to endorse a super PAC may suggest that the Obama campaign’s money problems are more serious than anyone had thought. In 2008, Obama raised almost $800 million, a record. If he were able to do just as well this year, he wouldn’t need a super PAC, but apparently his advisers have recognized that he will fall well short of the 2008 total.

The news reports on this reversal have focused on whether this was a hypocritical move, some showing the president scolding the Supreme Court about the Citizens United decision in his 2010 State of the Union address. On the other hand, the Obama campaign has defended the decision by saying that, given all the money being raised by Republican super PACs, Obama could not afford to enter this battle less than fully armed.

Both of these reports may be obscuring the real news—that by endorsing a super PAC, the Obama campaign may be acknowledging serious funding problems. This is because a super PAC must remain completely independent of the candidate it is supporting and thus cannot be relied on to project the consistent and integrated message that a modern campaign requires, or to run ads in the places and on the issues that a candidate may need to shore up his or her support.

Despite the attention they have received in the media, super PACs are not always helpful to well-run campaigns and can seriously compromise campaign strategies and tactics.

For example, let’s suppose that the Obama campaign’s internal polling shows that he is losing support in, say, the Midwest, and that the reason is a shift away from Obama by Catholic women. This information cannot legally be transmitted to the super PAC, so it is unable to provide assistance where it is really necessary. Even more important, a super PAC can do affirmative harm to the campaign it is supporting. Let’s assume that the Obama campaign uses its own funds to develop and run a soft-focus ad that shows him speaking earnestly about his concern for the future of parochial school education, a tack that is designed to appeal to middle class Catholic women. However, at the same time and in the same states, the super PAC runs an ad criticizing the Republican candidate for opposing abortion—an appeal to young single women. The appeal to Catholic women will be compromised or even vitiated by the message in the super PAC ad.

Thus, to rely on a super PAC is not an easy decision for a campaign, entailing benefits and risks. It doesn’t mean that the Obama campaign is girding for a fight; it may just as well mean that the Obama campaign is facing unexpectedly serious funding problems.

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Peter J. Wallison

How Dodd-Frank is a big obstacle to closing down Fannie and Freddie

By Peter J. Wallison

February 6, 2012, 1:55 pm

On Friday, Treasury Secretary Geithner said that the Obama administration is preparing to move forward with closing Fannie Mae and Freddie Mac and bringing back a robust private housing market. Ironically, the secretary’s statement was made almost one year to the day after the administration released its white paper on reform of the housing market. Since then, there has been virtual silence on the administration’s plans, while the private housing market has continued to grow weaker. Many banks, large and small, are abandoning the mortgage business, and MetLife had to close down its own large mortgage business when it couldn’t find a buyer.

One of the options in the administration’s white paper was a fully private market; in response, I and my AEI colleagues Alex Pollock and Ed Pinto circulated our own white paper in March 2011 in the belief that a deal between the administration and House Republicans that produces a wholly free housing finance market was possible. Although House subcommittees have considered some important legislation that moves toward reviving the private market, it is unlikely that anything will get through this Congress without the administration’s support.

Accordingly, we welcome the Treasury secretary’s renewed interest, but it is important for him and the administration to understand that it will be extremely difficult to close down Fannie and Freddie without amending the Dodd-Frank Act in significant ways. Among them, and by no means all, are the following impediments to the return of a robust private market:

· Although Fannie and Freddie might be privatized or otherwise eliminated over time, a robust private market cannot develop as long as FHA is able to insure mortgages up to $729,500 and remains exempt from the 5 percent risk retention requirement in Dodd-Frank. No matter what standards are ultimately adopted for the Qualified Residential Mortgage, FHA will always be able to out-compete private securitizers as long as it does not have to bear this additional cost and is able to insure most mortgages issued in the United States.

· In addition, the 5 percent retention requirement strongly favors the biggest banks, which alone have balance sheets large enough to hold the retention amount and still carry on an active securitization business. This would be bad enough as a competitive matter, but given the fact that many of the large banks are now substantially reducing their mortgage financing activity, the continued application of the risk retention requirement will prevent the growth of any private sector substitutes for the GSEs or FHA.

· The Volcker rule, which has already drawn opposition in many other quarters, is also an impediment to the development of a private securitization market. That market depends heavily on the ability of lenders to hedge their interest rate risks while they are assembling a pool of mortgages for securitization. The Volcker rule applies to any firm that is affiliated with an insured bank, and prohibits proprietary trading, which is very difficult to distinguish from hedging transactions. Until there is a safe harbor for hedging transactions, the risks of running afoul of the Volcker rule may prevent many bank-affiliated securitizers from entering the private housing finance market.

It is good news that the administration is now willing to go forward with GSE reform, but if it is serious about privatizing or eliminating Fannie and Freddie it will have to propose some serious reforms in Dodd-Frank at the same time.

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Peter J. Wallison

The Left’s desperate grasp for greater regulation of the financial system

By Peter J. Wallison

January 6, 2012, 12:35 pm

In the week before Christmas, I was the subject of two articles on the op-ed page of the New York Times by Joe Nocera, a regular Times columnist. Both were pretty nasty, but the second one accused me, with the help of my AEI colleague, Ed Pinto, of propagating a “Big Lie” (hat tip, apparently, to Goebbels) that Fannie Mae and Freddie Mac were responsible for the financial crisis. Parenthetically, that’s actually not my position; my view, expressed fully in my dissent from the majority report of the Financial Crisis inquiry Commission, is that but for government housing policy—of which Fannie and Freddie were the principal implementers—there would not have been a financial crisis.

In any event, it’s relatively rare for anyone who is not a government official to be attacked in such personal terms in a major newspaper, let along twice in a week, and since then a number of people have asked me what I might have done to deserve that extraordinary treatment.

My answer is that the question of what caused the 2008 financial crisis is not a trivial or academic pursuit. It matters a lot whether we get it right. The view that the crisis was caused by Wall Street greed and insufficient regulation of the financial system—essentially the narrative that was propagated by the government and adopted by the major media right after Lehman Brothers’s bankruptcy—resulted in the adoption of the Dodd-Frank Act, legislation so extraordinarily broad that it amounts to a government regulatory takeover of the U.S. financial system. If the government’s housing policies were in fact the cause of the financial crisis, then the Dodd-Frank Act is illegitimate and should be repealed. For this reason, the left did not and does not want a debate about this question. When my dissent from the FCIC report was published, Nocera called it “loony.”

If you think this and his two articles in December are out of proportion to the importance of the issue, think again. If the Dodd-Frank Act is not a sufficient consequence of a failure to understand the causes of the financial crisis, try putting the issue in a broader context. The left wants greater political control of the economy. If the private sector’s actions were responsible for the financial crisis, there are strong grounds for subjecting the financial system and the economy generally to controls of all kinds. Avoiding another financial crisis caused by the private sector can be the basis for much more political control; the Dodd-Frank Act is only the beginning.

For the three years since the financial crisis, the story that it was caused by the greed and lack of regulation of the private sector prevailed. Now, for the first time, that narrative is being challenged, and it is being torn apart by facts (most recently the SEC’s suit against top officers of Fannie and Freddie) that are gradually seeping into the public consciousness. Nocera and others on the left instinctively understand that their continuing success in gaining regulatory control of the financial system and the economy depend on the American people’s continued acceptance of their narrative. Now that it is being challenged, they are getting desperate.

That, to me, explains Nocera’s extraordinary actions.

 

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Peter J. Wallison

Barney Frank continues distorting the truth on his role in the financial crisis

By Peter J. Wallison

December 29, 2011, 11:03 am

Soon-to-be former Congressman Barney Frank continues to try to defend his record on Fannie and Freddie by distorting, or simply reversing, the truth. Here he is in the TheAtlantic.com today on his history as he hopes we will remember it:

In 2004, the administration of President George W. Bush began a conscious plan of trying to increase levels of homeownership as part of its ‘Ownership Society,’ raising affordable housing targets for Fannie and Freddie. I opposed this policy because I thought people could end up with mortgages they could not afford.

A pretty categorical statement, right? Replete with context that makes it sound as though it actually happened. Unfortunately for him, there’s a written record—a letter to President Bush, dated June 28, 2004, that he authored for 76 colleagues, including minority leader Nancy Pelosi:

We write as members of the House of Representatives who continually press the GSEs to do more in affordable housing. Until recently, we have been disappointed that the administration has not been more supportive of our efforts to press the GSEs to do more. We have been concerned that the administration’s legislative proposal regarding the GSEs would weaken affordable housing performance by the GSEs, by emphasizing only safety and soundness. While the GSEs’ affordable housing mission is not in any way incompatible with their safety and soundness, an exclusive focus on safety and soundness is likely to come, in practice, at the expense of affordable housing.

We have been led to conclude that the administration does not appreciate the importance of the GSE’s affordable housing mission, as evidenced by its refusal to work with the House and Senate on this important legislation. It now appears that, because Congress has not been willing to jeopardize the GSE’s mission, the administration has turned to attacking the GSEs publicly. We are very concerned that the administration would work to foster negative opinions in the financial markets regarding the GSEs, raising their cost of financing. If the intent is to get prohousing members of Congress to weaken their support of the GSEs’ mission, it is a mistaken strategy.

Our position is not based on institutional loyalty, but on concern for the GSE’s affordable housing function. We appeal to you to agree to work on legislative proposals that foster sound oversight and vigorous affordable housing efforts instead of mounting assaults in the press. We also ask you to support our efforts to push the GSEs to do more affordable housing.

If Barney Frank has any credibility after this, it will only be with those who—for ideological reasons—support him in his efforts to distance himself from the government’s affordable housing requirements, which were so destructive to Fannie and Freddie and the financial system as a whole.

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Categories:  Economic Policy, Politics and Public Opinion, Society and Culture, U.S. Politics   |   Tags: , ,

Peter J. Wallison

Top Fannie and Freddie officers to face the music

By Peter J. Wallison

December 16, 2011, 11:14 am

The SEC filed suit today against six top officers of Fannie Mae and Freddie Mac for failure to disclose the firm’s exposure to subprime and other low quality loans. The companies themselves were not charged, in part because they are now supported by the taxpayers, but the companies each agreed to “accept responsibility for its conduct and not to dispute, contest, or contradict the contents of an agreed-upon statement of facts, without admitting or denying liability.”

This is an extremely important event, because it will expose for the first time the extent to which the subprime and other risky loans that were made by Fannie and Freddie in the 1990s and 2000s were hidden from the market. These facts are important because, by 2008, before the financial crisis, Fannie and Freddie were holding or had guaranteed 12 milllion subprime or other risky loans but had not reported that fact to the markets. This made it extremely difficult for risk managers at banks, investment banks, rating agencies, and other financial institutions to understand the risks of securities backed by subprime  and other weak loans, and this was one of the major causes of the financial crisis.

As outlined fully in my dissent from the majority report of the Financial Crisis Inquiry Commission, it was the government’s housing policies that caused the financial crisis, and Fannie and Freddie—in complying with the affordable housing requirements established by Congress in 1992 and gradually increased by HUD between 1992 and 2007—were the key players in implementing these policies. The SEC disclosures in the trial to come will show beyond question that the report of the Financial Crisis Inquiry Commission, in claiming that Fannie and Freddie were only “marginal” in the financial crisis, was a politically motivated whitewash.

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Categories:  Economic Policy, U.S. Economy   |   Tags:

Peter J. Wallison

G-fees are a danger in disguise

By Peter J. Wallison

December 14, 2011, 1:05 pm

The House and Senate bills that would extend the payroll tax cut each contain a provision that would increase the fees (known as g-fees) that Fannie Mae and Freddie Mac charge for guaranteeing mortgages. The increased revenue would go directly to the Treasury. The American Banker has a story today that suggests there is support in the private sector for this increase because higher g-fees will enable private securitizers to compete more effectively with Fannie and Freddie, and thus may bring back the private securitization market that has been essentially moribund since the financial crisis in 2008.

Would it were true. At the margin, the theory is correct. Higher g-fees do indeed make it more likely that the private sector can compete with Fannie and Freddie, but sad to say this is highly unlikely to happen until a large number of additional obstacles—many of them in the Dodd-Frank Act—are cleared away. In testimony that I gave on November 3 at a hearing in the House Financial Services Committee, I listed nine impediments to the revival of a private market securitization market, in addition to the difficulty of competing with Fannie and Freddie. These include the high conforming loan limits at Fannie and Freddie (and now there are even higher ones for FHA that Congress adopted only a few weeks ago); the fact that Fannie, Freddie, and FHA are exempted from the risk-retention requirements of the Dodd-Frank Act; the threat that risk-retention poses to a “true sale” under accounting rules; and the effect of the Volcker rule on the ability of securitizers to hedge their risks. For a complete discussion of these and others, see the testimony here.

In addition, the American Banker article did not mention the most troubling part of the legislation—that it turns Fannie and Freddie into sources of funds for the government, estimated at $38 billion over ten years. That means, sadly, that if Congress is ever to do anything to eliminate or privatize Fannie and Freddie it will be necessary to find substitute funds or expense cuts of an equivalent amount. This is not impossible—there are some possibilities—but it makes the task much more difficult.

The bottom line is that with this provision in the tax cut extension act, Congress is in danger of cementing Fannie and Freddie into place as a permanent source of government revenue.

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Categories:  Economic Policy, Fiscal Policy and Taxes   |   Tags: , ,

Peter J. Wallison

Senate GOP right to demand restructuring of new consumer agency

By Peter J. Wallison

December 9, 2011, 5:22 am

No matter what you may think of Richard Cordray, President Obama’s nominee to head the Consumer Financial Protection Bureau, it is important to remember why the Senate Republicans refused to allow a vote on his nomination yesterday.

Several months ago, 44 Republicans signed a letter to the president, advising him that they would vote against the consideration of any nominee to head the CFPB unless the structure of the agency is substantially changed. This was an unusual stance, but the CFPB is an unusual agency. Its regulatory jurisdiction is unprecedentedly broad—far wider than any other agency of the government—extending nationwide and covering every business that had financial dealings with consumers, from the largest banks to the smallest check-cashing firm. Its decrees could mean life or death for whole industries.

Yet, the CFPB appears to be inconsistent with the governmental structure set up by the U.S. Constitution. The Framers of the Constitution believed that the liberties of the American people would best be protected by a government of divided functions. The Congress would appropriate funds and make the laws, the president would be accountable for executing the laws, and the judiciary for interpreting the laws. No one branch would have complete authority over the people, and the political branches would be subject to regular elections where they could held accountable by the people.

The CFPB appears to violate this constitutional structure. First, the agency would be headed by a single director, appointed for a five-year term, and removable by the president only for inefficiency, neglect of duty, or malfeasance in office. In other words, the director—unlike most other members of the executive branch—does not serve at the pleasure of the president. Once appointed, the director could operate independently of the president, although the president is supposed to be accountable for the director’s decisions. Second, the CFPB—unlike other agencies with such plenary authority over the entire country—does not have to go to Congress for annual appropriations; by statute, it is given access to the funds of the Federal Reserve Board, and is thus both outside the government’s budget process and insulated from the congressional appropriations process.

In their letter to the president, the Senate Republicans asked for changes in this structure—changes that would turn the CFPB into a five-member board, like the SEC, CFTC, and FCC, with members from each political party. This would assure that the agency’s decisions are subject to some collegial consideration—with the opportunity for expression of different points of view. The president would still appoint the chair, but the other members could bring additional judgments to bear on its decrees. In addition, the board would, like all other similar regulatory bodies, have to seek appropriations from Congress and be subject to congressional supervision.

These requirements would restore at least a minimal accountability to the political branches, and would fit within the Framers’ unique concept for assuring the liberties of the American people.

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Categories:  Economic Policy, Financial Services   |   Tags: ,

Peter J. Wallison

A mixed legacy for Barney Frank

By Peter J. Wallison

November 28, 2011, 12:45 pm

It is always unfortunate to see a highly intelligent and knowledgeable member of Congress retire, and that is also true of Barney Frank (D-Massachusetts). Although he was the principal protector of Fannie Mae and Freddie Mac for many years—claiming that he could see no need for additional regulation and arguing that the Bush administration’s effort to control the GSEs would have the adverse effect of reducing their commitment to affordable housing—he had the good sense to change his mind and develop strong regulatory legislation that became law just before the financial crisis hit.

Still, his career was marred by excessive partisanship, defensiveness, and an intellectual arrogance that prevented him from recognizing his errors until it was too late to save Fannie and Freddie or prevent the 2008 financial catastrophe in which they played the primary role. By the time Fannie and Freddie failed, they had accumulated 12 million subprime and other low quality and risky loans—about 40 percent of the 27 million outstanding—mostly for the purpose of meeting the affordable housing goals he fought to protect. The defaults on these loans, which are continuing, will ultimately cost the U.S. taxpayers $300 to $400 billion.

He will say, of course, that he did not become chairman of the House Financial Services Committee until 2006—that the Republicans were at fault for failing to act sooner when they were in the majority. There is some truth in this, but if he had been willing to work with the Republicans on the HFSC instead of insisting that there were no problems with Fannie and Freddie, legislation might have been adopted in the early 2000s that could have prevented the financial crisis and saved the taxpayers from severe losses.

In the end, he realized his mistake, telling Larry Kudlow in a 2010 interview: “I hope by next year we’ll have abolished Fannie and Freddie . . . it was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.”

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Categories:  Politics and Public Opinion, U.S. Politics   |   Tags: , ,

Peter J. Wallison

Let’s get real on entitlements

By Peter J. Wallison

November 21, 2011, 3:59 pm

Lost in the media babble about the SuperCommittee’s failure is any sensible assessment of the real issue. As the Congressional Budget Office (CBO) numbers show, the entitlements—Social Security, Medicare, and Medicaid—are too large to be attacked with increased taxes. If we tried, we would crush any hope for economic growth and thus the continuation of entitlements in any form.

The Democrats on the SuperCommittee apparently wanted additional revenue from the “wealthy,” but were unwilling—as were the Republicans—to increase the taxes of anyone under $200,000 by eliminating all of the Bush tax cuts. Let’s leave aside the sterile debate over the Bush tax cuts and look at the numbers from the perspective of what’s actually possible.

According to CBO, the cost of entitlements alone rises from $1.5 trillion in 2011 to $2.5 trillion in 2021. The Wall Street Journal, using the boom year of 2005 and IRS numbers, reported that if all income over $200,000 that year were simply confiscated the total additional government revenue would be about $1.9 trillion. In other words, that would pay for the average cost of the entitlements for one year between now and 2021. No matter where you are in the tax- versus entitlement-cuts debate, you probably recognize that confiscation would not work as a tax or economic policy, at least for more than one year.

Accordingly, those who are seeking to balance entitlement reductions with tax increases either cannot do the math or are playing a political game, perhaps buying time at the expense of the national welfare. Unfortunately for the Democrats, they have created an entitlement system that has simply outrun the ability to pay for it. The beginning of a solution will be at hand when the Democrats admit that whether and how much taxes are increased is not the issue. The entitlements problem can only be addressed by thoroughgoing reform.

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Categories:  Economic Policy, Retirement and Social Security, U.S. Economy   |   Tags: ,

Peter J. Wallison

Fannie/Freddie overseer shouldn’t bend on bonuses … or underwriting standards

By Peter J. Wallison

November 14, 2011, 11:23 am

Last week, 58 senators sent a letter to Edward DeMarco, the acting director of the Federal Housing Finance Agency, complaining about his approval of $12 million in bonuses for the top officials of Fannie Mae and Freddie Mac in 2010.

No doubt some of the complainants realize that the top officials of Fannie and Freddie now in place are not the people who bought the toxic assets they now have to manage, and that it’s important to have people in that management role who know something about finance and the mortgage business. In their heart of hearts, they probably also know that to find and hold people for these jobs, DeMarco will have to compete for them against financial firms that will pay just as much, and probably more.

The senators may also suspect that if DeMarco were actually to pay what the senators are probably asking—say, what a cabinet department pays its top officials—that would not ensure greater competence in the management of Fannie and Freddie’s assets. After all, it’s not as though there is widespread satisfaction in the Senate or among the American people with the services they are getting from the federal government under the current compensation arrangements.

But it’s one of the privileges of being senators to complain about things like this, and then to complain again, later, when the consequences of acceding to their demands has produced a bad outcome. So it often works out reasonably well for the senators, but not so well for the American taxpayers who will ultimately suffer the loss.

However, these senators must know, as the media has reported, that DeMarco has been under intense pressure from the Obama administration and some in Congress to ease up on the mortgage underwriting standards he has imposed on Fannie and Freddie, so that they can once again use their virtually unlimited resources to inflate housing prices.

But the good news is that DeMarco apparently has the courage to keep the taxpayers’ interests firmly in view. So, when he is before the Senate Banking Committee this week, he is unlikely to bend on the bonus issue any more than he would bend on compromising underwriting standards. That way everyone gets what they want. The senators get to complain, and the taxpayers get the best management of Fannie and Freddie that a diligent government servant can acquire.

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Categories:  Economic Policy   |   Tags:

Peter J. Wallison

GOP debate educates public on how housing caused the financial crisis

By Peter J. Wallison

November 10, 2011, 11:55 am

In last night’s Republican debate, every Republican presidential candidate who was called on to discuss the condition of the housing market made the point that the financial crisis—and the current deplorable state of U.S. housing—resulted from the government’s housing policies, and that the government-sponsored enterprises Fannie Mae and Freddie Mac were at the center of this government-caused disaster.

This recognition is a major step forward. Since the financial crisis of 2008, the Left has pushed the narrative that the private sector, particularly the banking system, was responsible for the crisis. Once this idea was accepted—and the main stream media accepted and propagated it immediately—greater regulation of the financial system was a foregone conclusion. The result was the Dodd-Frank Act, which has been one of the principal reasons that the U.S. economy has recovered so slowly from the deep recession that followed the financial crisis.

Once policy makers understand that government housing policies caused the financial crisis, we are on the path to recovery. The Dodd-Frank Act can be repealed because it is destructive, costly to the private sector, and not directed at the causes of the crisis. For that reason, it cannot possibly prevent a future crisis. In addition, we can eliminate Fannie and Freddie over time, replacing them with an efficient private-sector system for housing finance—based on prime mortgages—that will deliver sufficient financing for homes, eliminate the distortions caused by government interventions, and contribute to the stability of the U.S. financial system in the future.

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Categories:  Economic Policy, U.S. Politics   |   Tags: , , ,

Peter J. Wallison

US-EU debt crises: The parallels are striking—and disheartening

By Peter J. Wallison

October 27, 2011, 4:54 pm

The deal to save Greece from default, just brokered in Europe, requires investors (mostly banks) to write off about 50 percent of their loans to Greece. One of the reasons the banks made these loans in the first place is that bank regulators from all the eurozone countries got together in Basel, Switzerland, many years ago and decreed that when banks calculate their capital needs they don’t have to include any cost for their sovereign debt.

That ruling made sovereign debt the cheapest loans banks could buy, and—after the financial crisis—when the banks were required to increase their capital positions, they loaded up on sovereign debt because these were loans that did not require a charge against the capital they were trying to rebuild. Now the politicians, after encouraging banks to buy governments’ debt, have turned around and forced the banks to take a 50 percent cut in the value of the same assets.

This comes just a few weeks after a similar event in the United States. In September, the Federal Housing Finance Agency, the regulator of Fannie Mae and Freddie Mac, brought suit against a large group of banks for selling subprime and other low quality loans to Fannie and Freddie. What was not mentioned in the suit was that Fannie and Freddie were required to buy these mortgages in order to meet the quota of so-called “affordable housing” loans that had been imposed on them by Congress and the Department of Housing and Urban Development’s regulations. In other words, the government is now suing the banks for providing the kind of loans the government required Fannie and Freddie to buy.

There are parallels here for anyone who wants to see them.

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Categories:  Economic Policy, Europe and Russia, Regulation   |   Tags: , , , ,

Peter J. Wallison

Another political fumble: New Obama refi plan would leave housing ‘flat on its back’

By Peter J. Wallison

October 25, 2011, 10:11 am

They keep doing it. Yesterday, the Obama administration offered a new plan for easing the housing crisis—a modification of the previously unsuccessful HARP program that would permit more underwater homeowners to apply for refinancing of their mortgages so that they could take advantage of the lower interest rates.

Apparently, the White House talking points said that this would make lower cost mortgages available to four million homeowners (a number used by Housing Secretary Sean Donovan). This would reduce monthly mortgage costs by an average of $250 dollars, and produce a total reduction of $12 billion annually.

Even if it actually worked for all those homeowners, $12 billion in savings is not going to revive the housing market—although of course it would be wonderful relief for those underwater homeowners who have acted responsibly to meet their mortgage obligations month after month.

But while many media reports duly followed the White House talking points (NPR somehow managed to report this morning that the saving would be $50 billion, and suggested that it would be like a tax cut of that size), a few things must have been left out.

—The program only applies to those mortgages that are held or guaranteed by Fannie Mae and Freddie Mac—probably 800,000 mortgages, according to their regulator, the Federal Housing Finance Agency. This means that the total saving for these homeowners would be $2.4 billion annually.

—If the interest on these mortgages is reduced, the losses will be taken in part by Fannie and Freddie, meaning that the taxpayers will pick them up.

—If the losses are taken by the holders of securities guaranteed by Fannie and Freddie, the losses will be taken by the investors in these securities, and this new government intervention will mean that it will be harder to sell Fannie and Freddie securities to investors in the future.

—Finally, the vast majority of the holders of these Fannie and Freddie securities are banks and S&Ls, which are already weak because they suffered vast losses on mortgages and mortgage-backed securities they held in the past. Reducing their revenues further at this point will of course reduce the funds they have to lend to businesses, thus keeping unemployment high.

The remarkable thing about all of this is that the administration keeps doing the same thing—adopting programs to “fix the housing market” that are far too puny to have any significant effect overall, but advertising them as game changers.

Beyond the political fumbling, the administration’s continuing intervention in the housing economy is also counterproductive. This program, if everyone eligible applies and gets the promised relief, might free up $2.4 billion to go—hopefully—to retailers. But it will also reduce the earnings of banks by some substantial portion of this number, and the rest will be further liabilities for the taxpayers.

These results were not in the White House talking points, and the compliant media that reported the story based on the talking points will then be surprised in the future when the economy in general—and the housing economy in particular—remains flat on its back.

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Categories:  Economic Policy, Financial Services, Fiscal Policy and Taxes   |   Tags: ,

Peter J. Wallison

Little love for Obamacrats from Occupy Wall Street

By Peter J. Wallison

October 18, 2011, 11:01 am

The Occupy Wall Street protests must be unbearably frustrating for the leaders of the Democratic Party. This is a party that has spent more than a generation making itself into the vicar of the victims—the putative tribune for all Americans who feel victimized by the system—and then when real victims begin to organize themselves into a protest movement they ignore the Democrats, their president, and their ideas.

What can be sadder than the image of President Obama running from venue to venue, trying desperately to stimulate interest in his jobs plan, while actual unemployed people are expressing rage against the machine but hardly a whimper of support for what the president is selling? Actually, there is something sadder; it’s the president making believe that the OWS protesters are really out there supporting him, while they express nothing but contempt for the politics of which he is the avatar.

From the outset of the OWS demonstrations, the Democrats have said the occupiers are sending a message. Yes they are. But it’s like the poem by John Donne: “Send not to know for whom the bell tolls, it tolls for thee.”

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Categories:  Society and Culture, U.S. Economy, U.S. Politics   |   Tags:

Peter J. Wallison

Volcker Rule Plants Seeds of Next Bank Crisis

By Peter J. Wallison

October 11, 2011, 4:00 pm

The regulation that would implement the so-called “Volcker Rule” contained no surprises. It has all the deficiencies of the original Dodd-Frank language, which would prohibit “banking entities” from engaging in proprietary trading. A “banking entity” is any company under the control of a firm that also controls a bank—in other words, a bank holding company (BHC). Thus, although the supporters of Dodd-Frank and the ban on prop trading assert that banks should not be using depositors’ FDIC-insured funds to engage in risky trading activities, they fail to mention that BHCs and their nonbank subsidiaries have no access to depositors’ funds. The only funds they use are those they earn, raise in the form of equity, or borrow. Since regulations make it very onerous to borrow from a bank that any BHC controls, that is seldom done. And when it is done, it has to be at arms’ length rates and collateralized, usually with U.S. government securities.

So the Dodd-Frank provision is simply another example of the act’s intent to exact penalties from U.S. banks for (allegedly) “causing the financial crisis.”

Ironically, however, short-sighted legislation and regulation like this will be responsible for the next banking crisis, because it will deprive BHCs of another perfectly legitimate source of profits and thus weaken their ability to support their subsidiary banks with additional capital. More important, by limiting the permissible range of activities for BHCs, it restricts their ability to diversify, and thus weakens them for the future.

This lack of diversification is apparent when one looks at the increasing concentration of banks and bank holding company lending to the real estate business. This is particularly perilous because commercial and residential real estate is notoriously volatile, and the concentration of lending in these areas will make banking organizations vulnerable to a crisis whenever there is trouble in the real estate business—historically an all-too-frequent occurrence.

In 2008, before the financial crisis, more than 55 percent of bank lending was to real estate or real estate-related activities—up from less than 25 percent in 1964. This dangerous concentration in real estate lending is the result of a change in the nature of the financial markets since 1965. At that time, banks had a robust business in lending to corporations of all kinds, but the growth of the securities markets made it possible for corporations to finance themselves through public offerings—not only through long-term bonds but also medium-term notes and short-term commercial paper.

Left alone, banking organizations would have had the flexibility to respond to this change, but they were confined by laws and regulations. Not until 1999, when Congress modified the Glass-Steagall Act to permit bank holding companies to control securities dealers, were bank holding companies (but not banks themselves) able to engage fully in the securities business. The Dodd-Frank Act now takes back most of that flexibility and consigns banking organizations to lending—but only to those firms, like real estate developers, that cannot easily raise their funds in the securities markets.

In this, the destructive policies of Dodd-Frank Act, of which the Volcker Rule is just one more example, have planted the seeds of a banking crisis in the future.

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