Crazy Talk

This article contains a correction.

It’s pretty much undeniable that the Bush administration was asleep at the switch as it allowed the current financial crisis to occur. The top economic officials had the duty to know what was going on in the economy and the power to do something about it. There were certainly warnings that there were big problems and, besides, it would hardly be an excuse for the top economic officials in the country to say they didn’t know what was going on in the economy. That’s their job.

They also had every opportunity to do something about the problem. There were many missed opportunities and specific failures along the way. But beyond those, the economic apparatus of the federal government had the ongoing opportunity to blow the whistle at any time and say to the financial industry: “Hey, there is a huge problem in the mortgage and mortgage-backed securities market, many of the loans are iffy and when house prices stop shooting up the whole thing is going to fall apart and it could undermine the entire financial system—so stop it.”

Saying this behind the scenes to those on Wall Street would probably have been effective. But the fall back would have been to make such a declaration public—spooking the markets into better behavior long before the Armageddon we face now. It might have caused a mild panic—but nothing compared to what has happened. And the problems wouldn’t have spread as widely and disastrously, sparing us bankrupt investment banks and insurance companies, and a $700 billion “rescue.”

Against this background, those whose mission in life is to set us free of government economic regulators are having a rough slog of it. After all, in the face of what is happening, it’s once again been made abundantly clear that financial markets can get out of hand and get into a psychology where they are extremely self-destructive and end up taking everyone else down with them. “Irrational exuberance” gets the best of the market makers. They lose sight of risks and underlying asset values, get giddy with success, feel competitive pressure to make bigger profits, and get greedy. Finally the big bet that underlies everything comes up snake eyes and it all collapses under its speculative weight.

When the market fails, those chiefly responsible usually end up in fairly cushy circumstances (millions of dollars gone but other millions still safe). In fact, one factor in the willingness to roll the dice is that they know that they’ll end up OK no matter what happens. It’s everyone else who experiences the real pain. It’s to avoid these outcomes that we ask our elected leaders and their appointees to keep an eye on things.

There are two rational responses that those who oppose interventions in private markets could have to the utter failure of government supervision that has brought us to this turn. One is that this is all OK. We have booms and busts and it averages out better than if the market were more heavily regulated. This is an intellectually defensible position. There is such a thing as overregulation of an economy. People are free to argue that we have too much regulation and that we shouldn’t worry about the current financial market bust because, on average, we’re better off than if government had prevented it from happening.

Of course, there are problems with this position. The first is that too many Americans get a large portion of their lives torn away from them with unemployment, lost savings, lousy wages, and dismal retirements when there are busts. They can’t afford college for their children or health coverage. The busts have lasting consequences in people’s lives for which the booms never compensate. A second problem with this argument is that a bolder hand in sheperding of the economy can turn out stronger growth than a hands-off approach. Having a basic set of confidences in the market—that assets aren’t worth half what their sellers say they are, that stock prices aren’t set by insider trading, etc.—can attract greater investment and stronger economic growth. These things need not come at the cost of innovation—and can in fact spur it.

The other rational response those ideologically opposed to government involvement in the economy might have to the financial meltdown would be to make the very modest admission that there is some role for government in regulating economic markets, define it very modestly, acknowledge the failure in this particular case, and then go on a rant against all the other circumstances where they think government overregulates.

An alarming number of the antigovernment ideologues appear, however, to be forgoing either of these arguments. One can understand this. The first seems cold-hearted and the second is a concession. But what they choose instead to deflect attention from the train wreck that has been Bush administration supervision of the economy are some claims that are completely divorced from the truth. The three claims that have come across our view screen are:

  • It’s the fault of the Community Reinvestment Act
  • It’s the fault of Fannie Mae and Freddie Mac
  • It’s the fault of immigrants

These have been responded to very effectively in a number of places. Here we will just offer the top-line talking points and with references to the more thorough responses.

Community Reinvestment Act

The Community Reinvestment Act is a law that was designed to end the practice of commercial banks of refusing to extend credit to entire, usually minority, neighborhoods—a practice called “redlining.” The CRA imposes a duty on banks to lend to borrowers in neighborhoods in which it takes deposits. The claim is that CRA forced banks into making foolish loans to risky borrowers. There are two fundamental problems with that claim:

  • The CRA was passed in 1977—over 25 years before subprime loans came into vogue. So the timing is wrong.
  • The CRA only covers commercial banks and savings-and-loan institutions—not other forms of mortgage-offering enterprises. Fact is, most subprime loans weren’t made by the lenders subject to CRA.

There has been much written proving CRA’s innocence in myriad ways (see links to additional resources at the end of this column). That, unfortunately, hasn’t stopped those who can’t face up to the facts from claiming, and claiming, and claiming that CRA is the root of it all.

Fannie and Freddie

Fannie Mae and Freddie Mac are private institutions that were set up by Congress. Their primary job is to be a secondary market for mortgages. That is, a lender originates a mortgage and then sells it to Fannie or Freddie. The idea is that by providing a secondary market for mortgages, mortgage originators can originate more loans. They sell them, which gives them the capital to loan again. The essential claim of the ideologues is that these institutions led the way into the mortgage crisis by lending money to those who couldn’t afford it. They blame a law that requires Fannie and Freddie to support affordable housing and then jump to the fact that Fannie and Freddie ended up going bust and are now in conservatorship under the U.S. Treasury.

These facts do not, however, add up to any causal nexus with the mortgage crisis. This too has been rebutted thoroughly, but to touch on the most important points:

  • Fannie and Freddie did not guarantee and securitize substantial quantities of subprime loans. They had more Alt-A loans but these were still a relatively small portion of their overall business. In fact, as the subprime market was building, Fannie and Freddie lost market share because they weren’t participating. Their involvement in the secondary market was far from the driving force in the creation of the subprime market.*
  • It’s true, however, that Fannie and Freddie were damaged by the subprime crisis because everyone in the housing sector was damaged by falling home prices and, more significantly, the two companies branched out into a broader investment portfolio. In that portfolio were included mortgage-backed securities that hurt all of those who purchased them. Fannie and Freddie weren’t the biggest players in this and, most importantly, started this practice very late in the game. In fact, the subprime market had already started to go bad when they started their purchases (which speaks poorly for Fannie and Freddie’s decision making, but precludes them from responsibility for the crisis).
  • Fannie and Freddie were supposed to be more closely supervised than other lenders—with their own regulator, which was supposed to keep a special eye on them because they are important institutions. Those regulators, who were part of the Bush administration, failed along with the rest of the Bush regulatory apparatus to stop the problem.

Illegal immigration

Finally, there’s this idea that it’s all the fault of illegal immigrants (Hispanic illegal immigrants to be specific). The Center’s David Abromowitz takes this one on deftly. The bottom line: Facts show that Hispanics received only about 20 percent of subprime loans. And, needless to say, most of them are not in the country without documentation.


I’d like to say “nice try” to those who are attempting to shift the blame for the mess we’re in to whatever programs, institutions, or people they find handy. But, really, they’re so far off the mark that one can’t even give them points for cleverness. All they have going for them is bombast—they say it confidently and often and hope it sticks even if it is dishonest. It would really serve the debate better for them to stick to their ideological guns. It would be an excellent time to have serious discussion over the appropriate level of supervision over the various markets that comprise our economy.

Michael Ettlinger is Vice President for Economic Policy at the Center For American Progress.

Additional resources: Community Reinvestment Act

Additional resources: Subprime lending