October 12, 2011

Wallison at the WSJ on ‘Wall Street’s Gullible Occupiers’

Filed under: Business Moves,Economy,Taxes & Government — Tom @ 8:29 am

Really, if the Occupy Wall Street crowd is going to start picketing millionaires’ houses, they should go where Chris Dodd and Barney Frank live.

In a read-the-whole-thing Wednesday Wall Street Journal op-ed, Peter Wallison lays the blame for the lousy economy and what has been characterized as the Wall Street mess where it belongs — on the federal government.

I’ll pick up where Wallison identifies the relative exposure:

Wall Street’s Gullible Occupiers
The protesters have been sold a bill of goods. Reckless government policies, not private greed, brought about the housing bubble and resulting financial crisis.

… Research by Edward Pinto, a former chief credit officer of Fannie Mae (now a colleague of mine at the American Enterprise Institute) has shown that 27 million loans—half of all mortgages in the U.S.—were subprime or otherwise weak by 2008. That is, the loans were made to borrowers with blemished credit, or were loans with no or low down payments, no documentation, or required only interest payments.

Of these, over 70% were held or guaranteed by Fannie and Freddie or some other government agency or government-regulated institution. Thus it is clear where the demand for these deficient mortgages came from.

… by the mid-2000s, investors had begun to notice that securities based on subprime mortgages were producing the high yields, but not showing the large number of defaults, that are usually associated with subprime loans. This triggered strong investor demand for these securities, causing the growth of the first significant private market for MBS based on subprime and other risky mortgages.

By 2008, Mr. Pinto has shown, this market consisted of about 7.8 million subprime loans, somewhat less than one-third of the 27 million that were then outstanding. The private financial sector must certainly share some blame for the financial crisis, but it cannot fairly be accused of causing that crisis when only a small minority of subprime and other risky mortgages outstanding in 2008 were the result of that private activity.

… When the bubble deflated in 2007, an unprecedented number of weak mortgages went into default, driving down housing prices throughout the U.S. and throwing Fannie and Freddie into insolvency. Seeing these sudden losses, investors fled from the market for privately issued MBS, and mark-to-market accounting required banks and others to write down the value of their mortgage-backed assets to the distress levels in a market that now had few buyers. This raised questions about the solvency and liquidity of the largest financial institutions and began a period of great investor anxiety.

The government’s rescue of Bear Stearns in March 2008 temporarily calmed the market. But it created significant moral hazard: Market participants were led to believe that the government would rescue all large financial institutions. When Lehman Brothers was allowed to fail in September, investors panicked.

… The narrative that came out of these events—largely propagated by government officials and accepted by a credulous media—was that the private sector’s greed and risk-taking caused the financial crisis and the government’s policies were not responsible. This narrative stimulated the punitive Dodd-Frank Act—fittingly named after Congress’s two key supporters of the government’s destructive housing policies. It also gave us the occupiers of Wall Street.

And along came TARP — leaving open the following question: “Was Lehman ‘allowed to fail’ because of incompetence, or to create the panic that would bring on the ‘need’ for TARP?” Given Hank Paulson’s “gun to the head” approach in the immediate aftermath of TARP’s passage and the presence of soon-to-be Obama Treasury Secretary Tim Geithner as head of the Federal Reserve’s New York branch which let Lehman die, I lean towards the latter.


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