By Joe Boyles
“Reckless Endangerment” is a 2011 best-seller by Gretchen Morgenson and Joshua Rosner. The subtitle – “How outsized ambition, greed, and corruption led to economic Armageddon” – best describes what this important book is about. The authors, a business writer for the New York Times and a mortgage researcher respectively, have tackled a complex subject – explaining how the economic meltdown of late 2008 (which stills plagues us today) occurred over time.
Unlike many books on this subject, Morgenson takes us back nearly two decades to the early 1990s to demonstrate how early studies and decisions set us on a path toward economic ruin. Let’s be clear about the cause of this mess – it has everything to do with housing and a mortgage market that went over the cliff, not suddenly but in stages.
Key to the foundation of the economic crash were the government sponsored enterprises (GSE) of the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac). These public-private corporations were designed to buy mortgages from banks to free-up capital so the lenders had money to generate new loans. Frequently, the two GSEs were used as a financial incentive to enrich political appoin- tees. So a Clinton Administration secretary like Frank Raines could leave his cabinet post and take the reigns of Fannie Mae and bank millions in bonuses and stock options in a few short years. As a result, politicians took a particular interest in not only lining their pockets, but protecting the GSEs when more prudent whistlebowers sounded warning.
My son, who worked at Fannie for several years, told me that the number of politicians of both parties who were courted by the GSE were dozens. Whenever Fannie or Freddie would come under scrutiny, their political cronies were all too eager to run interference.
An important ingredient to a cascading economic demise was the repeal of the Glass-Steagall Act in 1999. Glass-Steagall was an important part of early New Deal legislation by the Roosevelt Administration to address problems which led to so many bank failures in the first years of the Great Depression. The important provision was to separate bank investors from those accepting deposits. Sixty-six years later, a bi-partisan Congress and the Clinton Administration felt comfortable with dissolving these safeguards. Nine years later, we saw and felt the results when too-big-to-fail banks came crashing down, with and without government bailouts.
A general theme for this economic catastrophe is that the natural conservatism that characterizes bankers and mortgage lenders went out the window. Egged on by politicians and community activists and thirsting for more profits, they threw caution to the wind. The method to capture more homeowners was the “subprime” mortgage, designed to permit homeownership among those who had no savings to afford either a down payment or closing costs. Lenders could now offer mortgages that featured no down payment; no upfront closing costs; teaser interest rates; and exotic, non-traditional mortgages. In many cases, the only way a subprime borrower could hope to pay off the loan was to flip the house. Such a strategy only works in an escalating real estate market. As with all bubbles, sooner or later, the balloon will burst.
The result was a witches-brew of toxic mortgages that Fannie and Freddie bundled into mortgage backed securities and collateral debt obligations and sold to investors … with the guarantee of full faith and credit of the federal government (i.e. taxpayers).
To summarize, like many ideas, this was a project which started with good intentions and gradually went awry. Along the way, politicians put their finger on the scale and money in their pockets. Lenders tried to outdo each other and became trapped in an economic whirlwind. Rating agencies failed to investigate financial soundness, and investors were lulled to sleep with an eye on quick, unrealistic profits. It was a perfect financial storm.
Unlike many books of this genre, the authors name names. While the list is non-partisan, it is overly stocked with Democrats. This shouldn’t be surprising since the underlying theme for the original initiative was to extend homeownership to the poor and minorities, traditional Democrat constituencies. Unfortunately, these very groups were taken advantage of in the process and are suffering abnormally to this day.
This is not an easy book to digest … or an easy column to write. While I think the authors have done a masterful job, it is a complex and difficult subject. Economics is neither an easy nor exciting subject – trust me. Still, I believe it is important to read, particularly for anyone in the financial services industry – bankers, lenders, investors, insurers, etc. Collectively, we created the mother-of-all bubbles, and the deflation impacted … and still impacts – every sector of not only our economy, but the world’s as well. We must take these lessons to heart to insure they are not repeated.
Can this contagion happen again? I’m afraid so. No one has really been held accountable for their part in the meltdown. Supposedly last year’s Dodd-Frank financial regulatory reform was to correct this, but the authors (Senator Chris Dodd and Congressman Barney Frank) were two of the most culpable politicians in this mess and the reform left Fannie and Freddie, now under federal receivership, untouched. The scenario isn’t rosy.