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America’s Fannie Pack

Just how guilty are Fannie and Freddie for the financial crisis? Read Reckless Endangerment and decide.

By From the September 2011 issue

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Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon
By Gretchen Morgenson & Joshua Rosner
(Times Books, 352 pages, $30)

THE "EVIL MAN" theory of the Great Recession, coined by the Atlantic's Megan McArdle, parallels the Great Man theory of history. The idea is that all of our economic problems can be traced back, ultimately, to one mustache-twirling malefactor.

The left has plenty of favorite Evil Men, George W. Bush first among them. Alan Greenspan is not far behind. Clinton treasury secretary Larry Summers, who provided intellectual cover for deregulating investment banks, is a frequent progressive scapegoat.

With Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon, Gretchen Morgenson and Joshua Rosner have provided the right with an Evil Man of their own: James Johnson, the former CEO of Fannie Mae and Mondale campaign manager. Morgenson, a New York Times financial reporter, and Rosner, a financial analyst, recount Johnson's transformation of the government-sponsored housing enterprise (GSE), intended to stabilize the housing market for the middle class, into a government-backed profit machine.

Johnson's evil genius was to combine the most advantageous features of government -- income tax-free status in D.C., opaque accounting, and implicit taxpayer support in the case of failure -- with those of the private sector -- profit seeking and executive bonuses -- into one entity. Johnson doled out both political and financial favors in lobbying Congress relentlessly, ensuring that there would be no obstacles to Fannie's growth. His actions guaranteed that the company would one day implode, leaving taxpayers to foot the bill. More than anyone else, Johnson pushed the industry toward the kinds of abusive and reckless mortgage lending that led to the financial crisis.

In Morgenson and Rosner's narrative, Johnson's accomplices included almost every major figure of the Democratic establishment of the past 20 years. From the open-borders group La Raza to Obama budget chief Peter Orszag, they're all involved, either buying influence or peddling it. The normally cautious Walter Russell Mead of the American Interest read Reckless Endangerment and concluded that "If the GOP can make this narrative mainstream, and put this picture into the heads of voters nationwide, the Democrats are toast.…If Morgenstern [sic] and Rosner are to be believed, the American dream didn't die of old age; it was murdered and most of the fingerprints on the corpse come from Democratic insiders."

START WITH THE ROLE played by the Association of Community Organizations for Reform Now. More commonly known as ACORN (a major right-wing bogeyman), the group catalyzed Fannie's disastrous push into affordable housing by publicizing a flawed study showing racial discrimination in mortgage lending. Johnson responded by taking up the mantle of affordable housing and using it as political cover for its otherwise naked greedy ventures. After all, who could criticize a company that gave lower-class minorities the opportunity to own their own homes? Ultimately, however, Congress's 1992 bill imposing affordable housing mandates on the GSEs, "more than any single act," led to the home lending abuses of the 2000s, according to Morgenson and Rosner.

The mandate meant that, in 1999, 42 percent of Fannie and its counterpart Freddie Mac's loan purchases serviced low- and moderate-income families. Bill Clinton's director of the Department of Housing and Urban Development raised the requirement to 50 percent, funneling even more loans to people who could hardly afford them. That director was Andrew Cuomo, now the governor of New York and rising Democratic Party star. Cuomo had great visions for HUD's housing goals, predicting that "it will strengthen our economy and create jobs." In order to meet the goals set by Cuomo, Fannie and Freddie had to buy riskier and riskier loans, including subprime. Morgenson and Rosner report that GSE purchases of subprime began increasing sharply in 1999, and in 2008 Fannie and Freddie purchased $1.6 trillion of toxic mortgages, almost half of the entire market.

When critics challenged that Fannie and Freddie, which were technically private companies, posed financial risks to taxpayers in the case of a market downturn, the noted economists Peter Orszag and Joseph Stiglitz defended the companies in an academic paper published in a journal sponsored by Fannie Mae. Orszag, of course, would become the director of the Office of Management and Budget under Obama, while Stiglitz, a Nobel Prize winner, is a preeminent left-wing public intellectual. Today, taxpayers have already spent more than $300 billion bailing out the GSEs, and are on the hook for much more.

Similar scenarios would play out countless times before the financial crisis: an independent voice would point out the recklessness of Fannie and Freddie's lending and the dangers they posed to the housing market and the taxpayers, and in response Fannie and Freddie would mobilize bought-and-paid-for elected officials, administrators, academics, and businessmen to their defense.

In this respect, the ultimate Johnson henchman was Massachusetts representative Barney Frank. Frank established a rewarding relationship with the GSEs early on (his boyfriend landed a job at Fannie in 1991, among other things), and he steadfastly defended the GSEs until after they were bailed out. He overruled objections to affordable hosing mandates in 1991, complaining about an undue "focus on safety and soundness." When regulators looked into Fannie's rigged executive compensation scheme in 2004, he brushed them off by claiming that "it serves us badly to raise safety and soundness as a kind of general shibboleth, when it does not seem to be the issue." Even in 2010, after the financial regulation bill co-sponsored by him totally left the GSEs alone, Frank stated that "blaming Fannie and Freddie as a primary cause of the crisis is a mistake."

As Peter Wallison has demonstrated in The American Spectator, by 2008 half of all mortgages in the U.S. would have traditionally been considered low-quality loans. Slightly fewer than half of those were on the books of the GSEs. The affordable housing mandates and relentless quest for profits ushered in by Johnson, aided by Frank, are largely to blame.

Why did Johnson do all this? For personal gain. Morgenson and Rosner claim that a study found that for many years, you could predict Fannie's year-end earnings per share almost to the penny, based on what the earnings-per-share bonus payout target was. Over the course of his tenure, Johnson banked $100 million.

ASSIGNING BLAME for the financial crisis is tricky, because there are levels of causality. As with a murder, what's of interest is not the proximate cause (the banks collapsing), but the ultimate cause, which could be any one of a thousand possibilities. If the economy is a victim, what we want to know is who fired the gun, not what wounds exactly caused it to die.

Some, like Mead, have suggested that Reckless Endangerment proves, once and for all, that government policy, through Fannie and Freddie, was squarely behind the trigger. That proof--definitive proof--would reinforce, and reward, the political right's prejudices.

Yet the book doesn't quite do that. It provides plenty of circumstantial evidence: Fannie and Freddie owned the same model of gun that was used in the crime, they associated with known murderers, their recent behavior was alarming, and investigators found unexplained deposits in their bank accounts. And Morgenson and Rosner establish that, without a doubt, the crisis would have been less severe without Fannie and Freddie's influence.

The difficulty is proving a negative: incomprehensible assets backed by toxic mortgages would not have brought Wall Street down without Fannie and Freddie's influence. It's possible, even likely, but extremely hard to prove beyond a reasonable doubt.

Of course, Reckless Endangerment makes it seem likely that the large market for subprime loans wouldn't have existed without the GSEs. Morgenson and Rosner demonstrate that, for instance, Countrywide Financial--one of the most abusive lenders--was "at heart a Fannie Mae clone," with its CEO, Angelo Mozilo, enjoying an extremely close relationship with James Johnson.

Yet regardless of who is to blame for the crisis of 2008, Reckless Endangerment powerfully undercuts the progressive narratives about economic growth and social advancement, as well as explanations for the financial crisis. The idea that concentrated government can be directed toward specific societal goals has been irrevocably shaken. There is no denying that, in one decade, progressivism's brightest lights decided to increase homeownership using the tools of power, and then, in the next decade, they were co-opted by rent-seekers and the housing market was utterly destroyed. In the end, regardless of who pulled the trigger of the gun, it was progressives who ordered the hit. 

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About the Author

Joseph Lawler, former managing editor of The American Spectator, is editor of Real Clear Policy. Follow him on twitter: @josephlawler.