Needed: A National ‘We Told You’ Tour on GSEs, Financial Crisis

By September 23, 2008Economy

Statement No. 196, AEI’s Shadow Financial Regulatory  Committee, “Legislation on Fannie Mae and Freddie Mac,” September 22, 2003:

The central question raised by the quasi-public status of Fannie and Freddie is whether the taxpayers and the economy itself can be adequately protected, by regulation alone, against the risks these two government-sponsored enterprises (GSEs) create. Not only have Fannie and Freddie now issued over $1.5 trillion in debt obligations–for which the US government is perceived by many to be the implicit backer–but the very fact that there are only two GSEs, and that they completely dominate the residential real estate finance, adds other dimensions of risk. A major mistake by the management of either company could seriously impair the housing finance process and, through the housing market, adversely affect the economy as a whole. Moreover, if either should suffer substantial losses, the taxpayers could be called upon to make good on their debt obligations. It is important to recall that Fannie and Freddie are receiving a lot of attention today because of a major error of judgment by the management of Freddie Mac. Fortunately, that error will not have systemic consequences, but there is no reason to assume that future errors will be so inconsequential.

We cite the above passage — written five years ago! — to sing the praises of those who got it right, those scholars and political observers who consistently warned of the dangers posed by weakly regulated, politically powerful housing GSEs, the immediate cause of Wall Street’s current financial troubles. If these critics were right then, odds seem pretty good they’re right now, and the public should pay attention to their current analyses of the financial crisis.

We suggest they undertake a national “We Told You” tour, not to boast or to mock but to educate the public, in the process demanding accountability for the elected officials who now claim special wisdom in addressing America’s financial and economic troubles.

Two of these honorable Cassandras have an op-ed in today’s Wall Street Journal, “Blame Fannie Mae and Congress For the Credit Mess.” Charles Calomiris of the Columbia Business School and Peter Wallison, former general counsel at Treasury and now a senior fellow at the American Enterprise Institute, have spent years cautioning against GSE risks as members of AEI’s Shadow Financial Regulatory Committee. In today’s column they chart the legislative history of GSE regulation, noting a strong  measure introduced in 2005 that could have prevented much of today’s troubles. 

Wallison and Calomiris points to the Democratic politicians who blocked the legislation, suggesting a lack of credibility today. And they debunk one line of political attack, the argument that blame for today’s financial crisis rests with “deregulation.”

This is a canard. There has indeed been deregulation in our economy — in long-distance telephone rates, airline fares, securities brokerage and trucking, to name just a few — and this has produced much innovation and lower consumer prices. But the primary “deregulation” in the financial world in the last 30 years permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable in this storm.

As a result, U.S. commercial banks have been able to attract more than $100 billion of new capital in the past year to replace most of their subprime-related write-downs. Deregulation of branching restrictions and limitations on bank product offerings also made possible bank acquisition of Bear Stearns and Merrill Lynch, saving billions in likely resolution costs for taxpayers.

If the Democrats had let the 2005 legislation come to a vote, the huge growth in the subprime and Alt-A loan portfolios of Fannie and Freddie could not have occurred, and the scale of the financial meltdown would have been substantially less. The same politicians who today decry the lack of intervention to stop excess risk taking in 2005-2006 were the ones who blocked the only legislative effort that could have stopped it.

Having followed these developments during a career stop in the financial regulatory world, we’d spread the accountability a little bit further across partisan lines than they do. Congress was, after all, controlled by Republicans during most of the decade. And yes, the White House and Treasury repeatedly put forward GSE reform proposals, but they  always seemed perfunctory, designed not to become legislation but just to provide cover. The Administration expended little political capital.

But in any case, the Shadow Financial Regulatory Committee got things right then. Their members’ counsel should be heeded now, certainly more than the advice from the suddenly insightful.

Let’s see that national tour, the “We Told You Express.” Former Rep. Richard Baker can be the master of ceremonies.


Shadow Financial Regulatory Committee
September 15, 2008 Press Briefing





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