Only by understanding the factors that led to and amplified the crisis can we hope to guard against a repetition. Ben Bernanke, September 2, 2010
An outstanding new book by Peter Wallison, ”Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again” gives a voluminous and highly compelling explanation of the main cause of the financial crisis of 2008. Mr. Wallison worked at the Treasury Department in the 1980s, was a member of the Financial Crisis Inquiry Commission (2009 – 2011) and is currently a scholar at the American Enterprise Institute.
Here is the outline of Mr. Wallison’s story:
- The Department of Housing and Urban Development gradually increased the requirement that loans acquired by Fannie Mae and Freddie Mac be made to low- and moderate-income borrowers from 30% in 1992 to 56% in 2008.
- As a result of these policies, by the middle of 2008 there were 31 million Nontraditional (low down payment and/or poor credit) Mortgages (NTMs) in the U.S. Financial system, more than half of all mortgages outstanding, with an aggregate value of more than $5 trillion. At least 76% of these were on the books of government agencies such as Fannie, Freddie and the FHA or banks and S&L institutions, holding loans which they were required to make by the Community Reinvestment Act.
- The 24 million NTMs acquired or guaranteed by government agencies were major contributors to the growth of the housing bubble and its lengthy extension in time.
- The growth of the bubble suppressed the losses that would ordinarily have brought NTM type Private Mortgage-Backed Securities (PMBS) to a halt but rather made these instruments look like good investments.
- When the bubble finally burst, the unprecedented number of delinquencies and defaults among NTMs drove down housing prices.
- Falling home prices produced losses on mortgages, whether they were government backed or PMBS.
- Losses on mortgages caused investors to flee the PMBS market, reducing the liquidity of the financial institutions that held the PMBS.
- Once the housing bubble burst, four major errors were made by our top government financial officials: The first and major error was the rescue of Bear Stearns. The moral hazard created by this action reduced the incentive for other firms to restore their capital positions. Once Bear had been rescued it was essential to rescue Lehman Brothers. Treasury Secretary Paulson and Fed Chairman Bernanke’s arguing that they did not have legal authority to rescue Lehman provided an excuse for Congress to pass the destructive Dodd-Frank Act. Finally, TARP accomplished little but caused much popular resentment against the banks which supposedly got bailed out.
Conclusion: as long as the American people don’t understand that government housing policies were the main cause of the financial crisis, we are likely to repeat the same mistakes over again.
It is also important to note that the way this problem got into the financial system and became a systemic issue was when the Wall Street banks securitized the subprime mortgages and sold them to clients and used them as capital.
The reason this became a problem is because the GSEs did not disclose, until after the financial crisis had ended, how large their percentage of NTMs actually was.
Note: “NTM” is a term totally made up by Ed Pinto (the hack that Wallison gets all his numbers from) because the GSE’s basically had no sub-prime mortgages. So Pinto makes up his own definition (NTM) and lumps it with sub-prime and– voila– suddenly the GSE’s are full of toxic stuff!
You can read all about it here:
In the first Ritholtz link I gave you, he deals with this in “Whopper #5.” Then, in “Whopper #7,” he shows that, regardless of how Pinto and Wallison want to label things, the fact is that GSE defaults were minor compared to private banks. He goes on to say:
“The financial panic was not triggered by mortgage defaults, but by liquidity crises tied to derivatives. AIG lost $30 billion in liquidity because of ratings triggers following a ratings downgrade, which was precipitated by margin calls from Goldman Sachs. Thanks to credit default swaps, transparency in the credit markets was compromised. None of this had anything to do with the GSEs and their underwriting standards.”
There are few legitimate financial analysts in the world that disagree with that– the exceptions are Wallison, Pinto, and (apparantly) Heidel.
Note that Ritholtz ends his piece with:
“How dishonest is Peter Wallison? How deep is the ocean? How high is the sky? But the bigger scandal is not Wallison’s mendacity, but Wallison’s enablers, the perpetrators of that vast conspiracy of silence.”
Why on earth would you want to be an enabler of one of the most well-known liars in the country?
You continue to puzzle me…
I respond to this comment in my next post.