As reported by American Thinker.  Text slightly amended from the original.

Mortgage Crisis

And now we have the mortgage crisis, which has sent a shock wave through Wall Street and panicked world financial markets like no other since the stock market crash of 1929. But this is a problem created in Washington long ago. It originated with the Community Reinvestment Act (CRA), signed into law in 1977 by President Jimmy Carter. The CRA was Carter’s answer to a grassroots activist movement started in Chicago, and forced banks to make loans to low income, high risk customers. PhD economist and former Texas Senator Phil Gramm has called it: “a vast extortion scheme against the nation’s banks.”

ACORN aggressively sought to expand loans to low income groups using the CRA as a whip. Economist Stan Leibowitz wrote in the New York Post:

In the 1980s, groups such as the activists at ACORN began pushing charges of “redlining”-claims that banks discriminated against minorities in mortgage lending. In 1989, sympathetic members of Congress got the Home Mortgage Disclosure Act amended to force banks to collect racial data on mortgage applicants; this allowed various studies to be ginned up that seemed to validate the original accusation.

In fact, minority mortgage applications were rejected more frequently than other applications-but the overwhelming reason wasn’t racial discrimination, but simply that minorities tend to have weaker finances.

ACORN showed its colors again in 1991, by taking over the House Banking Committee room for two days to protest efforts to scale back the CRA. Obama represented ACORN in the Buycks-Roberson v. Citibank Fed. Sav. Bank, 1994 suit against redlining. Most significant of all, ACORN was the driving force behind a 1995 regulatory revision pushed through by the Clinton Administration that greatly expanded the CRA and laid the groundwork for the Fannie Mae, Freddie Mac borne financial crisis we now confront. A young Chicago lawyer was the attorney representing ACORN in this effort. With this new authority, ACORN used its subsidiary, ACORN Housing, to promote subprime loans more aggressively.

As a New York Post article describes it:

A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities. It also let community activists intervene at yearly bank reviews, shaking the banks down for large pots of money.

Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department.

Flexible lending programs expanded even though they had higher default rates than loans with traditional standards. On the Web, you can still find CRA loans available via ACORN with “100 percent financing . . . no credit scores . . . undocumented income . . . even if you don’t report it on your tax returns.” Credit counseling is required, of course.

Ironically, an enthusiastic Fannie Mae Foundation report singled out one paragon of nondiscriminatory lending, which worked with community activists and followed “the most flexible underwriting criteria permitted.” That lender’s $1 billion commitment to low-income loans in 1992 had grown to $80 billion by 1999 and $600 billion by early 2003.

The lender they were speaking of was Countrywide, which specialized in subprime lending and had a working relationship with ACORN.

Investor’s Business Daily added:

The revisions also allowed for the first time the securitization of CRA-regulated loans containing subprime mortgages. The changes came as radical “housing rights” groups led by ACORN lobbied for such loans. ACORN at the time was represented by a young public-interest lawyer in Chicago by the name of [Name deleted]. (Emphasis, mine.)

Since these loans were to be underwritten by the government sponsored Fannie Mae and Freddie Mac, the implicit government guarantee of those loans absolved lenders, mortgage bundlers and investors of any concern over the obvious risk. As Bloomberg reported: “It is a classic case of socializing the risk while privatizing the profit.”

And if you think Washington policy makers cared about ACORN’s negative influence, think again. Before this whole mess came down, a bill on the table would have created an “Affordable Housing Trust Fund,” granting ACORN access to approximately $500 million in Fannie Mae and Freddie Mac revenues with little or no oversight.

Even now, unbelievably — on the brink of national disaster — [certain politicians] have insisted ACORN benefit from bailout negotiations! Senator Lindsay Graham reported last night (9/25/08) in an interview with Greta Van Susteren of On the Record that [certain politicians] want 20 percent of the bailout money to go to ACORN!

This entire fiasco represents perhaps the pinnacle of ACORN’s efforts to advance the Cloward-Piven Strategy and is a stark demonstration of the power they wield in Washington.

ADFollowing the negotiations this weekend one of the netgotiators said of the compromise, “It’s a crap sandwich, but we’ve got to eat it.”  How encouraging.

Here is a partial list of what is in the bill and a partial list of some things that were removed from the bill.

A summary of the tentative agreement released by Ms. Pelosi’s office said the plan “gives taxpayers an ownership stake and profit-making opportunities with participating companies; puts taxpayers first in line to recover assets if a participating company fails; (and) guarantees taxpayers are repaid in full — if other protections have not actually produced a profit.” (See Ms. Pelosi’s summary.)

Additionally, the summary said the legislation will expand the range of firms that can sell troubled assets to the government to include pension plans, local governments and community banks serving “low- and middle-income families.” …

The summary issued by Ms. Pelosi’s office said the legislation will include provisions giving Treasury the ability to work with cash-strapped homeowners whose mortgages are purchased by the federal government to refinance into a more affordable mortgage. Other foreclosure-prevention measures included in the agreement are an extension of the tax holiday for homeowners who face foreclosure, as well as a tax break for community banks who held shares of Fannie Mae and Freddie Mac. The rescue plan will allow affected banks to take an immediate tax deduction on losses from investments in the two firms, which were taken over by the federal government earlier this month.

Lawmakers also included provisions allowing them to keep a close eye on the Treasury program, including a bipartisan oversight board appointed by members of both parties in Congress, an inspector general to monitor Treasury decisions, and regular audits from the Government Accountability Office. Additionally, Treasury will be required to make transactions made through the troubled asset program available publicly online. Unlike the original Treasury proposal, which would have given the department legal immunity in the program, the tentative agreement reached late Saturday allows for judicial review of Treasury decisions.

Here is a list of some of the provisions removed from the bill.

• The funding of the Housing Trust Fund, the slush fund that feeds ACORN and La Raza, is out.
• Provision to provide unions and other activist groups with proxy access for corporate boards
• Provision to mandate shareholder votes on compensation issues (union priority)
• Diversion of funds into a housing fund to support left-wing activist groups like ACORN
  A provision to allow trial judges to arbitrarily adjust mortgages, creating bonanza for trial lawyers
• A provision to require the government to sell to state and local governments at a discount homes the government acquires as a result of foreclosure

It also suspends mark-to-market rules and requires a study on their effects on the collapse.

UPDATE: At this point it’s all academic anyway.  The bailout bill failed in the House, and it wasn’t especially close.  The final tally was 207-226, with Democrats supporting it 141-94, while Republicans opposed it 66-132.   This probably didn’t help.  To which one might reply with the following observation: People in glass houses shoudn’t throw stones.

As with all humor, it is underlain by a painful truth.

Informative article from Forbes. The argument: Government regulations are a way to achieve political results in markets. Imposed constraints on markets throws them out of whack. More regulation to force more political outcomes will continue to destabilize markets over time.

Back when I was young and stupid (Hey!) I had a very bad car accident. I was a new driver and as a result of another driver’s error I overreacted and started skidding. The more I tried to get the car to stop skidding and go in my chosen direction the more it skidded in another direction. Of course I was doing absolutely the wrong thing, sawing desperately at the wheel rather than steering in the direction of the skid and so dampening it and bringing it under control. I was fishtailing all over the highway and wound up flipped over and my car totaled. I’m lucky to be alive.

Greed, Or Incentives?
Richard Epstein 09.23.08, 12:01 AM ET

It had been my devout wish to write a set of disinterested columns about labor markets to illustrate the power of the presumption against state regulation of voluntary agreements. But the financial meltdown of the past week has rudely interrupted my plan to pillory the minimum wage.

Instead, I shall turn on a dime to address two connected questions: How did we get to that sorry state where great institutions topple, and what should be done?

On both questions, our bipartisan consensus is holding true to form. In a system that is chock-full of heavy regulation, they instantly blame the current collapse on the excesses of the free market, for which a still heavier dose of regulation supplies some supposed cure. That indictment contains few particulars. It typically rests on a populist broadside whose centerpiece is greed on Wall Street, but never on Main Street–where there are more voters.

This prior is all wrong. Greed is a constant of human nature. Financial meltdowns are not a constant of economic political life. It takes, therefore, an understanding of the overall incentive structure to explain why selfish economic behavior produces great progress on some occasions and financial ruination on others.

On this question, your stalwart libertarian is persona non grata in respectable company. If voluntary markets normally align private incentives with social welfare, then always look first for a government intervention that knocks those incentives off line. It’s not hard to find some culprits.

One bad move has government legislators and courts intervening to slow down mortgage foreclosures because it is socially unacceptable for people to lose their homes. Unpleasant yes, but unacceptable no. Start with this assumption: Individual tenants can be evicted at the termination of their lease. Only the ardent defenders of rent control (which has ruined New York City real estate markets) find this outcome is unacceptable. Everyone else rolls with the punches.

So what is the difference between the evicted tenant and the foreclosed owner? Only this: The owner has put a down payment on the house. But so what? Foreclosed homeowners typically made only small down payments, or even none at all. Treat their mortgage payments as lease payments, and bump up their amount a bit by dividing the down payment over the number of months before foreclosure. Not much of a financial difference between the tenant and the owner.

Yet once regulators slow down foreclosures, other potential homeowners are denied opportunities to purchase housing they can afford. The housing stock cannot recirculate. Banks that acquired this mortgage paper see their portfolios nosedive. That dicey paper, as William Isaac noted in last week’s Wall Street Journal, drives the entire economy over the edge by strict government regulations that require all financial institutions to “mark-to-market” the various instruments in their portfolio.

Unfortunately, there is no working market to mark this paper down to. To meet their bond covenants and their capital requirements, these firms have to sell their paper at distress prices that don’t reflect the upbeat fact that the anticipated income streams from this paper might well keep the firm afloat.

One bad regulatory turn leads to another, and lo, the bailouts come thick and fast. At the nth hour, wise heads often rightly conclude that some desperate measure has to be taken to prevent the financial disintegration brought on by, well, prior government regulation. Those bailouts, of course, come from the hides of taxpayers who borrowed prudently. The entire system subsidizes destructive behavior, which means that we will get more destructive behavior in the future. We might as well sell flood insurance at bargain prices in Galveston, Texas, and New Orleans.

The moral of this story is that bad regulation metastasizes. Short term heroics are no substitute for dispassionate deregulation, which won’t happen so long as our political leaders are fixated on greed. Taking steps to prevent financial meltdowns is more likely to hasten their unwelcome arrival, so says the libertarian.

Richard Epstein writes a weekly column for Forbes.com. He is a senior fellow at Stanford’s Hoover Institution and a professor of law at the University of Chicago.

Fishtailing our way to stable markets. Been there, done that.

This fascinating video ends by advancing a political perspective that you or I may or may not share. However, along the way it makes available facts not generally compiled in one place. It moves pretty quick so be ready to hit the pause button to read the data.

What makes this so interesting to anyone concerned about the the housing and credit situations today is how clearly it illustrates the synergy between the housing bubble and the credit collapse. The additional fact that many of these players are still in the game gives one pause.

The proposal to set CEO compensation limitations will basically scuttle any bail out plan. After all, who wants to take on so much responsibility for a pittance? Yet there are members of Congress (who more frequently than we know, I’m sure, line their own pockets at public expense) who insist that this is some kind of moral fix to the credit crisis. I don’t really think so, but let’s just say that they’re right. If so there should be quid pro quo, something for something.

If Congress is going to step outside it’s Constitutionally defined powers by arrogating to itself the right to set wage controls in the private sector on moral grounds, then it should lead the way. It should create and pass a bill with the following basic points:

1. Congress’ pay should be cut to whatever it was in 1908.
2. Congress cedes the right to grant themselves pay raises to the people on a state by state basis for Senators and a district by district basis for Representatives.
3. Any increase in compensation shall be a ballot measure requiring a 2/3 majority.
4. No increase shall be more than a 5% increase.
5. A pay raise measure shall not be placed on the ballot more than once every two years whether or not if passes.
6. Congress shall not have the authority to repeal this law.
7. Members of Congress shall make their personal and business accounts, including non-monetary compensation available to the public at all times.

That should settle their hash.

Which are the worst kind when the chickens come home to roost and it turns out that you led the way.

But wait!  There’s more!

Which is a refreshing change; scroll down the comments section.

Leo Linbeck III:

One of the things the current crisis highlights is the way in which monopolies die: with a bang, not a whimper.

The core of the issue that the troika of Bernacke, Paulson, and Cox are struggling with is that Fannie and Freddie were monopolies (OK, they were technically a duopoly, but any business executive or game theorist worth their salt know how to participate in a duopoly to extract monopoly rents.) AIG, in some markets like credit-default swaps, was also a dominant player. Their monopolistic behavior drove other competitors out of the market, behavior that was aided and abetted by their political stroke.

There are two fundamental forces at work as financial services firms such as Fannie, Freddie, and AIG (and Enron before them) grow. The first is related to the benefits of pooling risk. Any given security or insurance policy has a risk profile that can be approximated by a statistical distribution. As the number of securities grow, assuming that these risks are somewhat uncorrelated, the per-security risk of the pool shrinks (the total risk of the pool may still grow, but at a much lower rate than the face value of the security). This is the most important economy of scale for a financial firm.

The other force at work is that as any organization grows, it becomes more governed by perception than by reality. The height of the organizational pyramid grows, and the person at the top gets further and further away from the “facts on the ground.” The CEO eventually ends up in a “virtual” world, one in which lower level employees (and in the case of mortgages, originators) feed information up the organization in a manner that becomes more and more abstracted and manipulated at each layer. At the top, you get very aggregated information (revenue growth, default rates, etc.) that can, for a long time, remain disconnected from reality. Because of this distance, CEOs rely on trust and loyalty more than facts and evidence, since even the “facts” they receive are communicated through intermediaries (mid-level executives) that they must trust.

This simple fact of organizational life means that CEOs manage in a world of perception that can become radically disconnected from the facts. They spend a lot of their working hours managing perceptions and cultivating relationships, and this effort places a special premium on subordinate loyalty, who in turn learn that they boss can’t handle the truth. So, the CEOs make really lousy decisions (or non-decisions) that hurt the firm in the long run, but make them look great (and pay them well) in the short run. This is a major diseconomy of scale.

In the normal give-and-take of a competitive market, individual firms pay a steep price for letting perception and reality get out of whack – their competitors (often smaller and more nimble) take market share and eventually force a reckoning with the facts. But when the firm is a monopoly, this check on their behavior is gone, and the disconnect can grow greater and greater until there is a major correction such as we are witnessing today.

In the case of financial services firms, this situation is compounded by the fact that there is so little underlying equity in the firm. It has been reported that Morgan Stanley only had $3 of equity for every $100 of assets. So when a major disconnect is exposed between the perceived value of their assets (e.g. subprime mortgages) and their true value, there is not enough surplus capacity (i.e. equity) to absorb the correction. This means they either raise a bunch more equity, or they are out of business. In other words, they are bankrupt.

Now, in addressing this situation, so far the troika has acted fairly prudently. Their stepping into Fannie and Freddie simply affirms their government-approved monopoly status, and makes them accountable to their guarantor. Ideally, this takeover will lead to a gradual dismantling of these giants, and the restoration of true competition. The “bail-out” of AIG is, in fact, not a bail-out but instead an alternative form of liquidation, in which the Fed or the US Treasury or both will act as “debtor-in-possession” lenders while the profitable portions of their business are auctioned off. This may, in fact, be a more orderly way to liquidate than bankruptcy for a firm of this size and scope. Judgment call, but a reasonable one.

The Fed actions to inject huge amounts of liquidity into the market are also probably make sense. In a situation where assets move in very large amounts, insufficient liquidity can destroy the entire system. This is, in fact, what happened in the Great Depression, where the Fed tightened liquidity so much that we entered a deflationary spiral that killed the “real” economy. To be sure, adding this much liquidity will cause big inflationary pressures, but those are longer term challenges that are dwarfed by the risk of deflation.

Where the troika probably goes too far is in now setting up a “Resolution Trust Corporation” style buyer-of-last-resort for distressed assets. The expense and moral hazard of such a plan is almost certainly more greater than the benefits of letting a thousand flowers wilt. It also takes a market that can function reasonably well (so long as there is sufficient liquidity, which they have certainly provided) and convert it into a monopoly.

Now, the devil is in the details, to which we do not have access. It is certainly possible that the problem is so big that we have no other choice. But I think it is right to be skeptical and ask intelligent questions about what, exactly, is going to happen.

Finally, what is most remarkable about this entire situation is that it is basically a panic by institutional investors – the professional money managers. Individual bank deposits have hardly budged, largely because most of them are insured. (I had breakfast yesterday with the CEO of a large regional bank, and he said that his deposits have actually been growing at a healthy clip. Interesting.) This “panic of the pros” is part of the reason the press is going nuts, and the press drives the politicians to “Do something, dammit!”

Given that the money managers have largely built their businesses by giving people the impression that they are smarter than the market, what we are dealing with then is a complete meltdown of the “perception class” – investment pros, press, politicians – that has driven perception down so far that it is well below reality. That is what panic means: the world of perception << the world of reality.

However, eventually, these two worlds will realign. This can either happen by the recovery of their nerve or the deterioration of the real economy.

I pray that it is the former.

And more:

wretchard:

First, the economic crisis is serious. People could be out of work in a severe depression. Unfortunately, the media will not report that both Bush and McCain proposed years ago reforms that would prevented the crisis from occurring. And that the crisis is the result of Barney Frank, and Chris Dodd, and Chuck Schumer’s work, along with Barack Obama’s.

The Democrats may have started the fire, piled on the fuel, lit the match. But the Republicans didn’t put out the fire, or even give the alarm. Thus they bear responsibility, but not the only responsibility. Nobody really saw it coming. Oh, there were a few Cassandras. But by and large warning of the crisis never strode front and center into the public stage. In retrospect researchers will find evidence that it could have been foreseen, the way Pearl Harbor or 9/11 could have been foreseen. Yet the bottom line is that the professionals were caught out. That’s why Lehman is gone, why Wall Street as we knew it is over.

“Punishing” the Republicans while rewarding Frank, Dodd and Obama — or Wall Street — may not be logical; but politics often isn’t. Supposing for a moment that Obama does become President, with all his scurvy crew, then the probable outcome is a jump from the frypan into the fire. That is definitely a possible outcome which can be anticipated in several ways. The “smart” thing to do is to calculate how one can benefit from that outcome — it will be a happy hunting ground for wheeler-dealers. The other thing to do is figure out how utilize the rebound when it comes. And it will come.

On the night the Titanic sank, Captain Smith had two challenges. Regulating the launch of the lifeboats and making certain the order of embarkation was preserved. He failed in the first: many lifeboats were launched half-full. Hundreds of people who could have been saved died on the ship completely unnecessarily. The second challenge, ensuring that “women and children” were first, failed because of the influence of the First Class passengers. A disproportionate number of First Class passengers survived. Many Steerage passengers were locked below. When the ship sank, some were more equal than others.

The current financial crisis resembles the Titanic problem in some ways. ‘Not enough lifeboats’ equals not ‘not everyone gets all his money back’. Some people are going to go down with Wall Street. But how many and who gets to survive is still unresolved. Like Captain Smith, two challenges need to be faced by the captains of the ship. The first is to wind up business in such a way that panic doesn’t mean financial lifeboats are lowered half-empty. The argument for a bailout is precisely based on this rationale. The bankers argue that things must be done in an orderly way and there’s no denying that. Otherwise there will be runs and fundamentally sound firms will collapse leading to losses that will be worse than otherwise. But the bailout poses a moral hazard for meeting the other challenge: ensuring that nobody gets to jump the line. Like the Titanic there are first class passengers and there are the great unwashed. Given the record of the financial professionals, is it hard to believe that they will not try to get their money back ahead of the others? The “gentlemen” on the Titanic did it. Why not the Masters of the Universe?

So in the simplest terms, the problem can be posed as “design a bailout to minimize total economic loss while preserving the order and proportionality of loss.” Easy to say. Hard to do.

Indeed.

With the markets in crisis Congress is being asked The Fed and Treasury are demanding that Congress act. NOW. In my opinion, if there is anything in the bailout bill that should make the American people sit up and pay attention, it is this snippet:

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

No checks an balances. No oversight. No accountability.  No transparency.   I don’t like it. In fact, I fear it. I am reminded of any number of tyrants, from Napoleon to Mugabe who have risen to power by promising to solve the crisis of the day if only they were given the power to act. There is no surer way to drive the situation from crisis to catastrophe than to allow blind panic to guide policy.

This liquidity crisis is not an act of God, it is the result of a long series of decisions that have been observed and remarked upon by intelligent, informed people who were ignored by the authorities which should have known better. Economists, as might be expected, have been very busy these last few days writing up all kinds of analysis and prescriptions; it is their job, after all.  Some of them even make sense, some don’t.

How will all of this affect the housing market, property values and our personal economic situations?  Wish I could tell you.  The best solutions will probably be painful, which is why they are not likely to be implemented.  Probably we will be offered something that looks easy that will be disastrous in the long term.  Congress is deeply involved, after all, and what’s worse, they aren’t telling us the kinds of details we most need to know.  Worse, it will be played for partisan advantage rather than the common good.

Fannie Mae seems to have had a wealth of troubles which ultimately led to its downfall. One source of those troubles were political appointees installed in the ’90s. Here are some details:

Perhaps some of you may not remember what Fannie Mae was caught doing after a whistleblower exposed the fraud (and was fired in retaliation). It was obvious that the books at Fannie Mae were being cooked:

The magnitude of Fannie’s machinations is stunning, and in two key areas in particular they deserve to be better understood. By improperly delaying the recognition of income, it created a cookie jar of reserves. And by improperly classifying certain derivatives, it was able to spread out losses over many years instead of recognizing them immediately.

In the cookie-jar ploy, Fannie set aside an artificially large cash reserve. And — presto — in any quarter its managers could reach into that jar to compensate for poor results or add to it to dampen good ones. This ploy, according to Ofheo (Office of Federal Housing Enterprise Oversight), gave Fannie “inordinate flexibility” in reporting the amount of income or expenses over reporting periods.

This flexibility also gave Fannie the ability to manipulate earnings to hit — within pennies — target numbers for executive bonuses. Ofheo details an example from 1998, the year the Russian financial crisis sent interest rates tumbling. Lower rates caused a lot of mortgage holders to prepay their existing home mortgages. And Fannie was suddenly facing an estimated expense of $400 million.

Well, in its wisdom, Fannie decided to recognize only $200 million [of losses], deferring the other half. That allowed Fannie’s executives — whose bonus plan is linked to earnings-per-share — to meet the target for maximum bonus payouts. The target EPS for maximum payout was $3.23 and Fannie reported exactly . . . $3.2309. This bull’s-eye was worth $1.932 million to then-CEO James Johnson, $1.19 million to then-CEO-designate Franklin Raines, and $779,625 to then-Vice Chairman Jamie Gorelick.

As for other losses, they were routinely mischaracterized so that they could be amortized over years, not realized fully as they were supposed to be. By this method, the Fannie Mae management siphoned off millions of dollars in excess compensation to top management, including Gorelick.

It is certainly possible that the culture at Fannie Mae was so thoroughly corrupt that Jamie Gorelick did not know that cooking the books in this fashion was illegal, but it strains credulity to suppose that she did not know that the books were being cooked. I doubt that Gorelick was so stupid or incompetent not to notice that Fannie Mae profits were regularly reported in such a way as to maximize her bonuses.

And you would think that, as Vice Chairman and a lawyer, she would be one of the people who most clearly should have known that the fairly obvious cooking of the books was indeed improper.

It seems that both Gorelick and Raines did rather well during their stay at Fannie Mae. Reportedly Raines walked away with $100,000,000 and Gorelick with $75,000,000.