There will probably never be an Oxford Companion to the 2008 American Financial Disaster. Those interested in this baneful topic, however, would do well to read Reckless Endangerment. Veteran New York Times business reporter Gretchen Morgenson and financial analyst Joshua Rosner (who, Morgenson says, “has seen every trick there is”) acknowledge that their book about the events that led up to the financial crisis is not the last word on this sorry episode. But it is, they promise, a work that names names and smokes out 20 years of key incidents that produced the crash and its trillion-dollar aftermath. In this they deliver.
The thesis of Reckless Endangerment is simple: In a rush to orchestrate affordable home ownership—and generate enormous profits—politicians, government-sponsored enterprises, pusillanimous regulators, greedy mortgage brokers, and profit-chasing Wall Street investment bankers combined to drive the American economy into its worst crisis in 70 years, saddling taxpayers with trillions of dollars of debt and leaving the financial landscape littered with the wreckage of ruined lenders, borrowers, and taxpayers.
Morgenson and Rosner begin this ugly tale in 1991, following the savings and loan crisis and subsequent taxpayer bailout. “In just a few short years,” they write, “all of the venerable rules governing the relationship between borrower and lender went out the window, starting with the elimination of the requirements that a borrower put down a substantial amount of cash on a property, verify his income, and demonstrate an ability to service his debts.”
The poster boy for this narrative is Federal National Mortgage Association (“Fannie Mae”) CEO James A. Johnson, an ambitious Minnesota lad who worked his way up in Washington via connections with Walter Mondale, Bill Clinton (his roommate at a 1969 anti–Vietnam war conference), and other Democratic luminaries.
The Roosevelt administration created and capitalized Fannie Mae in 1938 when no private group came forward to charter a national mortgage association. Its purpose was to provide a secondary market for mortgages issued by bank lenders, thus replenishing their loan capital.
In the 1950s Congress pressed Fannie Mae into becoming the purchaser of otherwise unmarketable government-insured mortgages with below-market interest rates. In 1968 Congress created a federal corporation, the Government National Mortgage Association (Ginnie Mae), to purchase government-insured mortgages, and spun Fannie Mae off as a pseudo-private corporation to buy private mortgage paper from banks and other loan originators. Although it was now owned by private stockholders, Fannie Mae retained an exemption from securities laws, an exemption from D.C. real estate taxes, and the right to draw ultimately $2.5 billion from the U.S. Treasury. It was not explicitly backed by the full faith and credit of the government, but investors quickly leaped to the conclusion that it was. That perception allowed Fannie Mae (and its smaller savings-and-loan counterpart Freddie Mac) to borrow money at a significantly lower rate than most financial institutions.
In 1991 retiring Fannie Mae Chairman David Maxwell recruited James Johnson as his successor, mainly for his connections and political skills. Johnson, Morgenson and Rosner write, soon became “the financial industry’s leader in buying off Congress, manipulating regulators, and neutralizing critics.…Johnson’s manipulation of regulators provided a blueprint for the financial industry, showing them how to control their controllers and produce the outcome they desired: lax regulation and freedom from any restraints that might hamper their risk taking and curb their personal wealth creation.”
Throughout the 1990s, Fannie Mae recurrently faced the threat of congressionally spurred privatization. To protect the lender from the horrors of losing its competitive advantage, Johnson set out to make Fannie Mae so popular with Congress that its privileges would remain intact, keeping its money machine running at full throttle. His strategy was to produce millions of happy new homeowners, people whose credit history, income, or down payments were inadequate by traditional home loan standards. Community organizations, subsidized by the Fannie Mae Foundation, would generate applicants from groups believing themselves to be victims of a heartless capitalist system. Banks and other lenders would originate these loans with an agreement that Fannie Mae would buy the loan paper, leaving them with attractive servicing fees and political approval. Activist organizations such as the left-wing Association of Community Organizations for Reform Now (ACORN) and home buyers would become a political claque pressing their members of Congress to defeat any threat to their benefactor.
Johnson’s playbook for blocking privatization and troublesome regulations became a blueprint for any large institution seeking freedom or favor. When one courageous Congressional Budget Office analyst, Marvin Phaup, produced a report in 1995 measuring the value of Fannie Mae’s implied government guarantee and the equally startling amounts that found their way into Fannie Mae’s executive pay packets, Johnson’s lobbyists spread the rumor that Phaup suffered from mental illness. Fannie Mae’s political contributions became enormous.
Fannie Mae not only played defense in Congress; it also seized on the practice of securitizing mortgage loans for sale to the country’s leading financial institutions. Wall Street—notably Goldman Sachs—in turn made huge profits selling these securities to investors.
This superstructure all came crashing down in 2007, and in late 2008 former Goldman Sachs CEO Henry Paulson, serving as George W. Bush’s treasury secretary, presided over the Troubled Asset Relief Program bailout and the disappearance of firms such as Bear Stearns and Lehman Brothers. A year later Fannie Mae and its smaller counterpart, Freddie Mac, went into government “conservatorship.” (Amusingly, the conservators are now suing the larger banks for selling Fannie Mae and Freddie Mac the toxic mortgages that the buyers eagerly solicited.) James Johnson made it out the door unscathed in 1999, going on to chair the compensation committee of Goldman Sachs, Fannie Mae’s go-to collaborator, then headed by Henry Paulson.
Morgenson and Rosner turn over a lot of rocks, doing a good job of explaining the incentives and motivations of various actors, including those few who sounded the alarm, usually in vain. The most infamous of the bad boys are, in addition to Johnson, Rep. Barney Frank (D-Mass.), Sen. Chris Dodd (D-Conn.), Clinton administration Treasury Secretary Robert Rubin and his deputy Larry Summers, and Fannie Mae officials Franklin Raines and Robert Zoellick.
President Bill Clinton was an enthusiastic enabler. In 1994 he launched the Johnson-conceived National Partners in Homeownership program, a public-private partnership booster club aimed at encouraging greater home ownership financing. President George W. Bush foolishly took a plunge into affordable home ownership in 2002 by announcing expanded support for home buyers from the Department of Housing and Urban Development, but made at least two efforts to get Congress to put the brakes on Fannie Mae’s runaway express. His most serious effort, in 2005, died when Bush capitulated to a united front of Democratic senators, including the Fannie Mae–financed Sen. Barack Obama (D-Ill.), who vowed to filibuster a Republican-authored regulatory reform bill. To the end of his presidency Bush seemed not to grasp the awful consequences of his passion for irresponsibly expanding home ownership.
Also notable among the villains were the three securities rating agencies: Standard & Poor’s, Fitch’s, and Moody’s. A 1975 Securities and Exchange Commission (SEC) ruling conferred a shared monopoly on the three, and each learned that asking for too much information about a pool of loans was bad for its business. Since the rating agencies only offered opinions, they were not subject to civil action by investors who discovered that they had paid too much for junk.