If I live to be 120 years old, I wont hear another statement so brazenly and knowingly mistaken as the one uttered by Congressman Barney Frank (D-MA) regarding the current financial crisis: The private sector got us into this mess. The government has to get us out of it.
Say the statement out loud. Swish its sour taste in your mouth. This statement is the precise opposite of the truth. As chairman of the House Financial Services Committee, Frank knows better.
It was in fact the public sector that got us into the subprime mess: specifically, Fannie Mae and Freddie Mac. These Government Sponsored Enterprises engaged in social engineering of the housing market. Because of Fannie and Freddie's policies, lenders had no incentive to consider the credit worthiness of borrowers, as they could quickly off-load even absurd mortgages to the GSEs.
On September 30, 1999 the New York Times reported on Congressional efforts to expand subprime lending. Fannie Mae, the nations biggest underwriter of home mortgages, has been under increasing pressure from the Clinton administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain phenomenal growth in profits, the Times reported.
Fannie Mae has expanded home ownership for millions of families in the 1990s by reducing down payment requirements, Franklin Raines, former Clinton administration official and Fannie Mae chairman told the Times. Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.
Raines made this statement as a justification for Fannie Mae easing the credit score requirements on loans it purchased from lenders. In other words, Fannie blew even harder into the housing bubble. By expanding the types of loans it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than stellar credit ratings, the New York Times reported.
Sadly in all of this, the housing market social engineers were unable to suspend the law of unintended consequences. Bartenders became would be real estate moguls, and the lenders played along collecting fees secure in the knowledge that when it all went south, they wouldn't be left holding the bag. Speculative bubbles thrive on someone making a quick buck, drawing others into trying to do the same. Freddie and Fannie fueled the bonfire of greed and ignorance.
The ultimate blame lies not with the lenders, but rather with those who created the perverse incentives.
Sadly, similar economic myths have been promoted in the past, and still afflict us to this day. As a university student, I was fed the story of how the Great Depression proved the ultimate failure of free-markets, and how the administration of Franklin Roosevelt heroically saved the nation from crisis.
This version of history is also very much at odds with the truth. Research by Milton Friedman and others has firmly established that the Stock Market Crash of 1929 played only a limited role in creating the Great Depression. Rather, a series of policy errors by Congress, the Hoover Administration (creating a global trade war), the Federal Reserve (tightening monetary policy during a contraction) and the Roosevelt Administration (too many errors to list) prolonged the downturn.
The United States had suffered plenty of stock market crashes, and economic downturns. What stands out about the Great Depression is not that it happened, but rather that it lasted so long due to a series of tragic missteps.
This too provides a lesson for today: the main thing we should fear are not bank failures or stock market declines, but rather the rushed and foolish actions of politicians. The only thing we have to fear is not fear itself, but rather fear and reckless government mistakes.
Congressman Frank, who defended Freddie and Fannie from attempts to reign them in after scandals emerged, was even so brazen as to dismissively put this crisis back to Ronald Reagan, when at his inauguration he said, Government is not the answer to our problems; government is the problem.
Sorry Congressman: Reagan got it exactly right, and you have it precisely wrong.