Partisan blame for financial crisis not so easily affixed

By Lisa Mascaro (contact)

Sunday, Nov. 30, 2008 | 2 a.m.

A few days before the November election, Nevada Republican Sen. John Ensign suggested the financial meltdown that was killing his party’s electoral chances was caused not by too little regulation from Washington — but too much.

Ensign’s position ran counter to the Democrats’ argument that an unregulated, freewheeling Wall Street and its accomplices got us into this mess.

But Ensign, on a Sunday morning talk show, drew on a popular point that had emerged in the conservative blogosphere and talk radio. If Democrats were going to pin the disaster on unchecked capitalism, Republicans would finger liberal-led meddling in the housing markets.

Two days after Ensign’s remarks, voters gave Democrats even larger majorities in Congress and put a Democrat in the White House. Nonetheless, Ensign’s arguments will matter when the new Congress opens in January.

Ensign now directs the Republican policy committee in the Senate as his party’s fourth-ranking leader. In the new Congress, Republicans will advance their own agenda to try to prevent future financial meltdowns and Democrats will have to address those views in negotiations over reform legislation.

So is Ensign’s analysis correct?

For the record, both parties have cherry-picked accounts in their attempts to affix partisan blame.

For example, Democrats pointed the finger at former Republican Sen. Phil Gramm of Texas, a onetime adviser to presidential nominee John McCain, for having led the late 1990s drive to deregulate financial institutions and the now-toxic credit default swaps.

Yet in truth, the Clinton administration’s financial team helped lead the deregulatory push. After the Republican-led Congress in the late 1990s passed the Gramm bills, President Clinton signed them into law and many Democrats in Congress were on board, Nevada’s lawmakers included.

Here is the essence of Ensign’s argument:

The system’s problems do not come from the deregulation of the mortgage banking industry and its innovative securities products — such as credit default swaps — that allowed risky behavior to flourish over the past decade.

Instead, the meltdown stems from the Clinton administration’s push to make mortgage loans to those who could ill afford them (read: poor and minority borrowers) through industry giants Fannie Mae and Freddie Mac, who were encouraged by Congress to boost homeownership.

Under this argument, the roots of the liberal effort lie in the Community Reinvestment Act of 1977, a bill to curb discriminatory red-lining that also ended up pushing for loans the market may not otherwise have made because they were too risky.

“The fact that Bill Clinton allowed Fannie Mae and Freddie Mac to get into the subprime market, and then encouraged, every single year, for Fannie and Freddie to increase the amount of these subprime loans, these high-risk loans, under the Community Reinvestment Act, it required banks to lend more and more of their money to these high-risk loans,” Ensign said that Sunday before the election.

More recently, Ensign said, “the financial crisis was caused by the government. This wasn’t a failure of free market. It wasn’t a lack of regulation. It was overregulation.”

True? Here are some other takes on that theory.

The Community Reinvestment Act has been celebrated for helping end discriminatory practices in mortgage lending and increasing homeownership among lower-income and minority borrowers.

The act requires local banks to participate in their neighborhoods by issuing home loans in communities where they collect deposits. Studies show, however, that the subprime loans now at the root of the financial meltdown were not being made in great numbers by these banks.

A recent report from Harvard University’s Joint Center for Housing Studies says just

9 percent of the nation’s subprime loans during the height of the lending frenzy came from banks regulated by the act.

The great majority of subprime loans were in fact made by independent mortgage houses — places such as Countrywide and others that operate beyond the regulatory reach of the act and could offer more enticing deals, according to the Harvard study and others.

“My own judgment is that the worst and most widespread abuses occurred in the institutions with the least federal oversight,” University of Michigan law professor Michael Barr, also a scholar at the Brookings Institution, said in testimony this year before Congress.

Researcher Kevin Park, who wrote the Harvard study, said an argument can be made that local banks should not have been in the subprime business at all. But to blame the meltdown on the small share of loans being made by the dwindling number of institutions regulated by the Community Reinvestment Act? “It’s a stretch,” he said.

The role of Fannie Mae and Freddie Mac is more complicated.

The two quasi-government mortgage giants got heavily into the subprime business in 2005, as the boom was peaking, reports show.

Why they did so requires a multifaceted answer. Some observers, including Peter Wallison, a scholar at the American Enterprise Institute, think the companies sought to curry favor with Congress after having been badly bruised over Enron-like accounting scandals.

Remember, Fannie and Freddie buy loans from banks and other lenders, which frees up more lending. If Fannie and Freddie gobbled up subprimes, lenders could put more low-income people in housing. Congress would be pleased.

Other observers suggest the companies were essentially pressured into buying bad loans — on the one hand by Congress, worried about rising home prices, on the other by big players such Countrywide that intimated they would take their business elsewhere if Fannie turned up its nose at the risky loans, according to an October story in The New York Times.

Fannie and Freddie are not saints. Their executives were paid exorbitant salaries and their lobbyists lined the campaign coffers of members of Congress, including many Democrats.

The companies were taken over by the government in September under the weight of their bad loans as the mortgage mess devolved to today’s black hole.

Ensign noted that Congress tried in 2005 to rein in Fannie and Freddie with Republican-led legislation shot down by Democrats.

The bill never made it to the Senate floor. Critics say Democrats were reluctant to halt the flow of pork in the form of loan money being directed to their districts. Yet Republicans were in charge of Congress then, and President Bush was in the White House.

Harvard’s William Apgar, a senior scholar at the housing studies center, reminds that Fannie and Freddie did not operate in a vacuum.

Entire segments of the mortgage lending apparatus were operating without regulation, from the brokers making the loans, to the Wall Street firms buying them up, to the markets reselling the bundled products as complex mortgage-backed securities.

Any discussion of misdeeds by Fannie and Freddie, Apgar said, needs to take place “in the context of all the other regulatory failings.”