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Tim Geithner Covers for Corruption on Pennsylvania Avenue

Treasury Secretary Timothy Geithner charged in a Wall Street Journal op-ed that those who oppose the Obama Administration’s regulatory regime for the financial services industry “seem to be suffering from amnesia about how close America came to complete financial collapse under the outdated regulatory system we had before Wall Street reform.” Au contraire, Secretary Geithner, it is you who choose to ignore and misrepresent the lessons of the financial crisis by perpetuating the myth that the source of the crisis was a lack of regulation.

First, your essay glosses over the central role the federal government played in creating the crisis. In particular, the government through Fannie Mae and Freddie Mac directed $5.2 trillion (that is trillion with a “t”) of capital to increase the supply of mortgages. In addition, it passed a law that required banks to make billions of dollars in loans to individuals that were unlikely to pay off the loans, in the end with 0% down.

In 1998, Fannie Mae announced it would purchase mortgages with only 3% down. And, in 2001, it offered a program that required no down payment at all. Between 2001 and 2004, subprime mortgages grew from $160 billion to $540 billion. And between 2005 and 2007, Fannie Mae’s acquisition of mortgages with less than 10% down almost tripled.

These loans are now known as “subprime” and “alt A” loans. At the time they were made, Fannie Mae and Freddie Mac encouraged their issuance by lowering their standards and buying them up from the now vilified mortgage brokers, S&Ls, banks and Wall Street investment banks.

This activity was not due to a lack of regulation or oversight as you claim. Both companies are under the direct supervision of a federal regulator and Congress. At the time these loans were being purchased by these two Government Sponsored Enterprises, their actions were defended by many in Congress who, led by Senator Chris Dodd and Congressman Barney Frank, saw such reckless lending as a successful government initiative.

At the same time, the easy money policies of the Federal Open Market Committee, of which you were a voting member, were feeding an asset bubble in residential real estate, providing what proved to be an irresistible lure not only for speculators, but also for American families trying desperately to buy a house before inflation robbed them of their chance for home ownership.

Yes, mortgage brokers and banks encouraged reckless borrowing, though many who borrowed, with a little honest reflection, could have known that they would be unable to meet the financial obligation of paying the mortgage that they were using to buy a house that they could not afford.

Nor does any of this excuse the poor judgment of those on Wall Street who levered their firms’ balance sheets so that even a 4% loss on their investments would leave them either bankrupt or in need of a bailout.

But, the culpability of those in the private sector should not be used to cover up or excuse the irresponsible behaviour of those in the federal government. The self-regulatory check normally provided by markets on activities that are likely to lose money – lenders backing away – was simply blocked by the government’s intervention in the capital markets.

As you must know, six top executives of Fannie Mae and Freddie Mac have been charged by the Securities and Exchange Commission with securities fraud for hiding the size of the purchases of low quality mortgages from the market.

In addition, the normal check on excessive leverage provided by unwilling lenders was overwhelmed by the perception, now validated, that Fannie Mae and Freddie Mac debt were backed by the full faith and credit of the federal government.

This created a willing buyer backed by the federal government with unlimited access to credit markets and a trillion dollar budget. No wonder S&Ls and Wall Street found ways to satisfy the demand. Blaming a lack of regulation for the subsequent losses is political spin meant to cover up the greed and corruption on Pennsylvania Avenue that led to the crisis.

Second, your claim that increased regulatory oversight would have prevented the crisis requires a credulous belief in the wisdom and courage of those in power. Regulators with all of the necessary powers have failed in their most basic task of preventing fraud including Bernie Maddoff’s Ponzi scheme, and now the still unexplained disappearance of $1.6 billion of customer money at MF Global. Yet, you ask us to believe tens of thousands of pages of new regulations will somehow empower you and other elite public servants to prevent another financial crisis?

As we know now, you and the other members of the Federal Open Market Committee in 2006 did not grasp the implications of the then faltering housing market for the general economy or the health of the banking system. As a consequence, you and your colleagues did not use the powers you had to head off the financial crisis when there was still plenty of time to act.

As former Prime Minister Tony Blair writes in his memoir, A Journey of My Political Life, an important contributor to the financial crisis was a failure “of understanding. We didn’t spot it…it wasn’t that we were powerless to prevent it even if we had seen it coming; it wasn’t a failure of regulation in the sense that we lacked the power to intervene.

Had regulators said to the leaders that a huge crisis was about to break, we wouldn’t have said: There’s nothing we can do about it until we get more regulation through. We would have acted. But they didn’t say that.”

Third, the new regulatory regime for the financial industry created by the Dodd-Frank bill – ironically named after two of the perpetrators of the financial crisis – omits any reform of Fannie Mae and Freddie Mac.

Yet, unlike the commercial and investment banks who have repaid the government bailout money, these two state sponsored financial giants have cost taxpayers more than $140 billion and are seeking billions more in bailout funds. At the same time, HUD is moving forward on issuing new rules that would support racial quotas for bank mortgages, which no doubt will again force banks to make loans to individuals who cannot afford them.

In light of this evidence and your own experience, your promise that a new, expansive regulatory regime reduces the risk of financial crisis is not credible. The regulatory maze created by Dodd-Frank not only robs the private sector of real resources that otherwise would be committed to allocating capital to credit worthy borrowers, it also undermines market skepticism essential to preventing systemic risk. In addition, it puts even more power in the hands of a few individuals who, like you, are fallible, rather than dispersing power among market participants.

You conclude your essay by writing: “We cannot afford to forget the lessons of the crisis and the damage it caused to millions of Americans. Amnesia is what causes financial crises.”

With all due respect Mr. Secretary, federal government policies, not amnesia, were at the heart of the financial crisis. The arrogance of power revealed by your selective memory and political spin, and the expansive regulatory regime you support are now the primary source of systemic risk to the US financial system and the economic security of the American people.

Regards,

Charles Kadlec
for The Daily Reckoning Australia

This article originally appeared in The Daily Reckoning USA.

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7 Comments

  1. Ross says:

    Don’t forget the so called ratings agencies and those that shopped for them …

    http://www.bloomberg.com/news/2012-03-30/fitch-blasts-s-p-ratings-on-credit-suisse-mortgage-securities.html

    You know they on the block when they start fingering each other in public. Of coarse Fitch, with their annex on the Aussie bank balance sheets, are the pot calling the kettle black. Credit Suisse should have a crack back at them.

  2. shortchanged says:

    Err, the regulators did it, no no, the banksters did it, or we did it, some body did it, didn’t they? Will any of the real culprits be caught?. Apart from a few sacrificial lambs, no one of importance will go to jail, and the taxpayers will pay and pay and pay.In the meantime Europe is burning, austerity is forced on the people whom can least afford it, and the politicians still draw their massive salaries and expenses. Time for reality, isn’t it?.
    Good article Charles Kadlec, but whats the solution?.

  3. truth and integrity says:

    “What’s the solution?” shortchanged.
    Question what is the relevance of government today?
    What business did they start?
    Did they invent something?
    Austrian economics vies for small government.
    Therefore reduce the government to 5% of the workforce including all commissions and subsidiaries to the government.
    Put 30% of those in the workforce who can not contribute on to social welfare and let the other 65% of people work for our wealth and new provisions without hindrance.
    We would have growth in excess of 10%, sustainability, clean environment and minimal taxes below 15% so that all would be twice as well off every 10 years.

  4. shortchanged says:

    Sounds good, ‘Truth & integrity’ but when it comes time to vote, we are stuffed, to use a technical term. Wouldn’t it be nice if we could not vote for anyone but AGAINST a candidate, thereby not voting for anyone. In the uk for example it is not compulsary to vote, or even turn up to vote, a truly democratic system. Meanwhile back in Oz we are forced to attend a voting booth. Under pain of fines or other government induced penalties. I’m with you, less of government the better. Now…how to start the revolution?.

  5. Garry says:

    Of course the system was/is corrupt, however the only people who could keep the wheels in train after the GFC were the crooks themselves – inside knowledge of the way things really worked – thus they were allowed to remain on board. (Indeed, a bit like Germany’s rocket men post WW2, who were needed for a higher purpose on US soil)

    Though these days Obama seems to sifting through them one by one – at least that’s what the raft of FBI reports and summonses suggest.

  6. RodZone says:

    For a start, since you asked:

    Raise interest rates to force lower RE prices both res and comm. Then prices can go to a more competitive level. Get rid of NG.

    Vote against your current pollie. If everyone does this we’ll get a clean out of all the corrupt and time servers.

    If banks need a bailout, nationalise them, let the bond and shareholders wear the losses, guarantee the depositors, sack and fine all the top tier execs.

    Tax inheritances (estates) over $20m to stop the formation of an ultra rich dynastic aristocaracy.

    Gov’t stay out of all social engineering and reduce the number of civil servants.

    Governor General to get power to dismiss gov’ts which fail to keep their promises.

  7. shortchanged says:

    RodZone, I like it, you are a rebel aren’t you?.
    But joshing aside, it will take something like you say to shake things up. One day it might come about, I hope it does. But not to far away, I would like to see it. Putting the world to rights is the domain of the young, and watching it happen the delight of the old.

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