The best possible contemporary example of the law of unintended consequences is the federal policy (actually several policies) enforced since 1992 to expand home ownership through promotion of non-traditional, sub-prime mortgages. This policy, enforced to an extent not even known to the government at the time, let alone to the financial community, provoked a US housing bubble that grew for more than ten years--and then deflated as 27 million government-induced bad mortgages began to go under. A financial panic ensued and a recession soon followed. Trillions of dollars of public funds were spent. The repercussions were international.
The true story of the public policy blunders that created the housing and financial crisis has been sidestepped for two years now . A new Congressionally commissioned report out today would like to continue down the path of truth avoidance. But a courageous, well-researched and ultimately devastating report by a dissenting member of the Commission, Peter J. Wallison, a former Counsel to President Ronald Reagan, serves to expose the problem--and the Commission majority cover-up.
The majority (Democratic) report of the Financial Crisis Inquiry Commission issued today seems to have been written to support preconceived opinions that the financial crisis was the product of Wall Street greed and under-regulation from Washington. That is an ideological fairy tale. The minority report of three of the Republican members, though better, mainly widens the responsibility for the financial crisis so far as to become nearly useless itself. It finds fault with so many public and private entities, and every conceivable exterior development and force short of global warming, that one is left feeling that, since everyone is responsible, no one is responsible. Neither report gives to the truth.
The Commission report therefore would be a one-day news story except for the explosive, factual revelations in the 98 page, dissenting report by Wallison. A lawyer who served in the Reagan Treasury before his White House stint, Wallison is one of the very few people who warned for years about the dangerous lowered loan standards being enforced, first on Fannie Mae and Freddie Mac, the government chartered agencies, and then the banking world.
Wallison provides evidence now of the determinative role of "NTM" (non-traditional mortgages) in the housing bubble and ensuing financial collapse.
"In March 2010," he states, "Edward Pinto, a resident fellow at the American Enterprise Institute (AEI) who had served as chief credit officer at Fannie Mae, provided to the Commission staff a 70-page, fully sourced memorandum on the number of subprime and other high risk mortgages in the fi nancial system immediately before the financial crisis. In that memorandum, Pinto recorded that he had found over 25 million such mortgages (his later work showed that there were approximately 27 million). Since there are about 55 million mortgages in the U.S., Pinto's research indicated that, as the financial crisis began, half of all U.S. mortgages were of inferior quality and liable to default when housing prices were no longer rising.
"In August," he continues, "Pinto supplemented his initial research with a paper documenting the efforts of the
Department of Housing and Urban Development (HUD), over two decades and through two administrations, to increase home ownership by reducing mortgage underwriting standards. This research raised important questions about the role of government housing policy in promoting the high risk mortgages that played such a key role in
both the mortgage meltdown and the fi nancial panic that followed. Any objective investigation of the causes of the financial crisis would have looked carefully at this research, exposed it to the members of the Commission, taken Pinto's testimony, and tested the accuracy of Pinto's research. But the Commission took none of these steps. Pinto's research was never made available to the other members of the FCIC (Financial Crisis Inquiry Commission")..."
In his conclusion, Wallison summarizes the copious evidence and iron logic he has assembled. It should provoke members of Congress and the media to read the full Dissent with great care:
"U.S. government's housing policies were the major contributor to the fi nancial crisis of 2008. These policies fostered the development of a massive housing bubble between 1997 and 2007 and the creation of 27 million subprime and Alt-A loans, many of which were ready to default as soon as the housing bubble began to deflate. The losses associated with these weak and high risk loans caused either the real or apparent weakness of the major financial institutions around the world that held these mortgages--or PMBS (private mortgage backed securities) or the other factors that were cited in the report of the FCIC's majority were not determinative factors. The policy of this conclusion are significant. If the crisis could have been prevented simply by eliminating or changing the government policies and programs that were primarily responsible for the financial crisis, then there was no need for the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, adopted by Congress in July 2010 and oft en cited as one of the important achievements of the Obama administration and the 111th Congress.
"The stringent regulation that the Dodd-Frank Act imposes on the U.S. economy will almost certainly have a major adverse eff ect on economic growth and job creation in the United States during the balance of this decade. If this was
the price that had to be paid for preventing another fi nancial crisis then perhaps it's one that will have to be borne. But if it was not necessary to prevent another crisis--and it would not have been necessary if the crisis was caused by actions of the government itself--then the Dodd-Frank Act seriously overreached. Finally, if the principal cause of the financial crisis was ultimately the government's involvement in the housing fi nance system, housing fi nance policy in
the future should be adjusted accordingly."
How important is the Wallison Dissent document? It is no mere historical exercise. Wallison points out that the Dodd-Frank bill was written and passed without the Commission's report in hand, and that Rep. Barney Frank tried to pass in the lame duck session a new Community Reinvestment Act--affecting all "U.S. nonbank financial companies." That would have compounded the very mistakes that--in Wallison's view--led to the housing and financial breakdown.
Memo to Congress: Read and heed the Wallison Dissent or we may be visited with a repeat of the financial crisis of '08, and the next one could be worse.
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