I asked Peter Wallison of AEI if he would like to respond to a number of reactions to his May issue cover piece on the causes of the financial crisis. His reply (to a few different critics) is below. -- J.L.
I appreciate your request that I respond to the criticism -- on a number of leftwing blogs -- of my article in your May 1 edition, The True Story of the Financial Crisis. I was pleased to see that they read The American Spectator.
Many of these posts, including one by Paul Krugman that uses the same information, cite the work of David Min, a former congressional staffer now at the Center for American Progress. Min's work is virtually the only writing on the left that includes an attempt to use data. Most other commentators -- like the ones I'm dealing with here -- either cite Min or throw around words like "lying" without apparently doing any serious work of their own. By the way, the mere fact that Min uses data does not make his work one of scholarship. If you entitle your work "Faulty Conclusions Based on Shoddy Foundations" you're not looking to persuade scholars; you're writing a political screed.
The "Shoddy Foundations" piece is a critique of my work as well as that of Edward Pinto, my AEI colleague (a former chief credit officer at Fannie Mae) who has done the most extensive research of anyone I've found on the role of low quality and risky mortgages in causing the financial crisis. As I will show, however, Min completely misses the boat, and -- while it's likely he will continue to be cited on the left because they have no one else who has done any data-based work to critique Pinto and me -- his analysis is almost entirely beside the point. The key language in Min's report is in his summary:
Unfortunately, Pinto's research findings relied upon so heavily by Wallison and others are false. Pinto's work is based on a series of faulty assumptions and serious methodological flaws. Pinto's controversial conclusion that federal housing policies were responsible for 19 million high-risk mortgages is based on radically revised definitions for the two main categories of high-risk mortgages, subprime loans and so-called Alt-A mortgages, which refer to loans with low documentation of income and wealth. Importantly, these revised definitions are not consistent with how the terms subprime and Alt-A are used for data collection, as this paper will demonstrate. [emphasis supplied]
Let's consider what Min is saying here. He's arguing that Pinto's definitions of subprime and Alt-A loans are not consistent with the definitions others have used for data collection and analysis. In other words, Pinto has used his own definitions to analyze the data in a new way. What Pinto did, that no one had done before, is show that loans made to people with FICO credit scores lower than 660 (which he called "subprime") had substantially higher rates of delinquency and default than loans to people with credit scores above 660 (which he called "prime"). In addition, Pinto found that loans with various deficiencies such as interest only, no documentation, no or low downpayments, or were investment properties (not owner occupied) -- which Pinto called, collectively, "Alt-A" -- also had much higher rates of default than loans that were not subject to these deficiencies. Pinto then found that these kinds of loans began to increase substantially after 1992, when affordable housing requirements were imposed on Fannie Mae and Freddie Mac, and began to default in unprecedented numbers when the 1997-2007 housing bubble started to deflate. In my dissent from the majority report of the Financial Crisis Inquiry Commission, using data from Fannie Mae (Table 5, p.61), I show that both subprime and Alt-A mortgages were necessary for meeting the affordable housing goals.
In reality, then, Min is simply complaining that Pinto discovered the sources of the huge mortgage losses that caused the financial crisis. The way the data had been looked at before -- and the way Fannie and Freddie reported that data -- obscured the fact that half of all outstanding mortgages were either subprime or Alt-A just before the bubble deflated and the financial crisis began. Min is arguing that it's unfair to use the terms "subprime" or "Alt-A" in a way different from how others had used those terms in the past. Even if we grant him that and call subprime and Alt-A something else (perhaps "bananas" and "peaches") the important point is that bananas and peaches -- which had far higher delinquency and defaults rates than prime mortgages -- were half of all mortgages in the financial system as we approached the financial crisis of 2008. In fact, as I pointed out in my dissent from the FCIC majority report, by 2008 19.2 million bananas and peaches were on the balance sheets of government entities or entities that the government could control. That is one reason that the government was responsible for the financial crisis.
Min's fallacious argument -- that it makes a difference what you call the loans -- was picked up by Mike Konczal and now by Paul Krugman, who continues to jeopardize his reputation as a Nobel-winning economist by accepting the leftwing nonsense he repeats on his blog.
The other reason, as I noted in my article, was that the government's huge investment in bananas and peaches during the 1990s built a gigantic housing bubble that was five years old by 2002. In that year, we had the beginnings of a significant market in privately securitized mortgage-backed securities based on subprime loans (four percent of the market in that year). This market -- the first we'd ever had based on subprime loans -- developed because the growth in housing prices suppressed delinquencies and defaults, misleading investors into thinking that bananas and peaches were sound investments. To meet the resulting investor demand, the private sector securitized an additional 7.8 million bananas (subprime) and peaches (Alt-A) -- for a total of 27 million weak and risky loans in the financial system before the financial crisis.
Pinto did this work in 2009 and reported it to the FCIC in early 2010. Below is the table that Pinto's work produced, showing the differences in serious delinquency rates between and among the various categories of weak loans. These delinquency rates are then compared to the rates on prime loans. (The totals do not add up to 27 million because there were about one million bananas and peaches reported in the non-agency prime categories that Pinto could not separate out.) What it shows is that bananas and peaches -- even those on the books of Fannie and Freddie -- were six to eight times more likely to default than the prime loans Fannie and Freddie were acquiring at the same time. These weak loans were there, as I pointed out in my dissent, because of government policies such as the affordable housing goals.
Finally, although apparently unnoticed by Min and the others, since 2008 Fannie Mae has been filing a Credit Supplement with its annual 10-K report to the SEC. This report adopts Pinto's categories and shows the losses that Fannie has suffered from buying loans made to people with credit scores below 660 (i.e., bananas) and loans with the kinds of deficiencies that Pinto called Alt-A (i.e., peaches). The 10-K report filed for 2008 appears in page 78 of my dissent.
Before leaving this subject, I'd like to comment on the fact that at least one of these posts complains about my use of the term "subprime and other risky loans" in the American Spectator article. It hints darkly that I am hiding something. Actually, by using the term "other risky loans" I was referring to Alt-A loans, and was trying to make the article less technical. The total of bananas and peaches outstanding in 2008 consisted of 60 percent subprime and 40 percent Alt-A loans, so both were significant contributors. This is all shown in the table above.
Now I'd like to turn to the other charges that have been circulating on the leftwing fringes of the web. Copied below is an excerpt from Konczal's post about my May 1 American Spectator article that has been picked up in several places, including by Andrew Leonard ("Zombie financial crisis lies eat fact-checker brains") on Salon.
Is there a fact-checker at the American Spectator?
I only ask because they published the following from Wallison (my bold):
"After the majority's report was published, many people lamented that it was not possible to achieve a bipartisan agreement even on the facts....This information, which highlighted the role of government policy in fostering the creation of these low-quality mortgages, raised important questions about whether the mortgage meltdown would have been so destructive if those government policies had not existed. Any objective investigation of the causes of the financial crisis would have looked carefully at Pinto's research, exposed it to the members of the Commission, taken Pinto's testimony, and tested the accuracy of his research. But the Commission took none of these steps. Pinto's memos were never made available to the other members of the FCIC, or even to the commissioners who were members of the subcommittee charged with considering the role of housing policy in the financial crisis.
Here I was addressing the Commission's lack of objectivity. The important points are in the material bolded by Konczal. Pinto had produced material that provided an alternative explanation for the financial crisis. His data provided strong evidence that the financial crisis was caused by the delinquency and failure of subprime and Alt-A mortgages that Fannie Mae, Freddie Mac and other government controlled or regulated entities had been required to originate or acquire because of government housing policies. This evidence went to the heart of the Commission's assignment -- to determine for Congress and the American people what caused the financial crisis. Yet Pinto's testimony was never formally taken by the Commission, either publicly or privately, he never had an opportunity to make his case to the members of the Commission, and the members never had an opportunity to question him or, with the assistance of the staff, to test the accuracy of his research or the strength of his position.
The attack continues with this charge of inaccuracy (which Konczal took from DailyKos):
Let's count the lies:
1. The FCIC did look carefully at Pinto's research (pdf);
3. The FCIC did test the accuracy of Pinto's research (pdf), and
4. Pinto's research was made available to all members of the FCIC.
5. The FCIC considered and debunked Pinto's claims, and detailed the process in its report, on page 219 and elsewhere.
Okay, let's count.
1. "The FCIC did look carefully at Pinto's research (pdf)." The link is to Pinto's Triggers memo. Pinto also submitted a longer chronology on the development of the bubble and the growth of subprime loans under HUD's policies. These memos were probably read by the staff. As I said in the article, the members of the Commission never had an opportunity to question Pinto, and he was never permitted to testify in open or closed session. In addition, there were no transcripts of his interviews with the staff. People who are reading the Commission's report should think about the objectivity of a study that was supposed to discover the causes of the financial crisis but never exposed the members of the Commission to Pinto's arguments.
2. "The FCIC did question Pinto at length and accept all his submissions (pdf)." Yes, the Commission's staff (not the Commission's members) met with and questioned Pinto several times. The link is to a recording of one such interview. A recording is not as useful as a transcript or even a written memo, but even the recording was not furnished to the members of the Commission. For virtually all the other 700 witness the Commission said that it interviewed there was either a transcript of the interview or a memorandum, and sometimes both. In Pinto's case, there appears to have been neither. In other words, Pinto's work was not taken seriously and the Commission furnished nothing to the members that would give them any clear idea of what Pinto was arguing.
3. "The FCIC did test the accuracy of Pinto's research (pdf)." This link is to a memorandum by the executive director, Wendy Edelberg, and a senior staff member, Ron Borzekowski. The memo argued that the subprime mortgages made by Fannie and Freddie were of higher quality than the mortgages made by the private sector. This is true but a completely irrelevant point, and did not amount to a test of the accuracy of Pinto's research. Pinto never claimed that the subprime mortgages bought by the GSEs were the same quality as those securitized by the private issuers. In fact, the table above (and on p 21 of my dissent), drawn from Pinto's research, makes clear that there were major differences between the GSEs' subprime and the private label subprime.
In reality, it didn't matter which loans were worse. The loans that Fannie and Freddie bought were bad enough so that both are insolvent today. Let me repeat that: Fannie and Freddie are insolvent today. The Treasury has provided them with over $150 billion thus far to keep them solvent, and their regulator has estimated that the losses could go as high as $360 billion. Pinto was making the simple point that the defaults among the vast number of weak and risky loans made by Fannie and Freddie and others under government requirements were the underlying cause of the mortgage meltdown in 2008 and the financial crisis. The fact that these same loans caused the insolvency of Fannie Mae and Freddie Mac is proof positive of their low quality.
4. "Pinto's research was made available to all members of the FCIC." As far as I can tell, this was never done by the staff or the Commission's chair, although over time I tried to make sure that the other Commission members were at least aware of some of the material Pinto had furnished to the Commission.
5. "The FCIC considered and debunked Pinto's claims, and detailed the process in its report, on page 219 and elsewhere." There was less than one page (219) in the Commission's report "debunking" Pinto's 200 pages of submitted data. Everyone should read page 219. It repeats the same irrelevant argument about which mortgages were the worst. "Elsewhere" appears to be a reference to my dissent, because nowhere else in the majority's report is Pinto mentioned, let alone debunked.
Thanks for the opportunity to respond to the arguments cooked up by the left. In my view, these show both their desperation to protect the government and the affordable housing policies it followed, and their failure to understand the subject before making charges.
Peter J. Wallison
Arthur F. Burns Fellow in Financial Policy Studies
American Enterprise Institute
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