The Affordable Housing Scam

Raking over the politicians, regulators, brokers, and bankers who caused the financial crisis


Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon, by Gretchen Morgenson and Joshua Rosner, Henry Holt & Co., 315 pages, $30

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.

On the mortgage origination side, the most prominent villain was the flamboyant Angelo Mozilo of Countrywide Financial. But there were plenty of others, including many in the higher suites of Wall Street's most prestigious investment banks.

There were also some white knights, men and women who saw where all this was headed and tried to get it under control. They include Bush's first treasury secretary, John Snow; regulators Bill Taylor (Federal Reserve), Armando Falcon (Housing and Urban Development), and Don Nicolaisen (SEC); Congressional Budget Office Director June O' Neill; and several less visible lawyers and analysts whose warnings were beaten down by Fannie Mae's powerhouse lobbying.

Reckless Endangerment is not, at least directly, about the role of the Federal Reserve Board. The Fed, however, was an enormous enabler, with its shockingly promiscuous money creation and shockingly low interest rate policy from 2001 to 2003. Year-over-year growth of the money aggregate M2 ranged from 8 percent to 10 percent, while the Fed lowered its target for the federal funds rate, the rate at which banks borrow from the Fed to maintain their reserve requirements, from 6.25 percent in 2001 to 1 percent in 2003. This policy produced a negative real rate of interest and an enormous incentive for investors to seek out riskier, more lucrative debt—such as Fannie Mae's mortgage-backed securities. Morgenson and Rosner do not fault Federal Reserve Chairman Alan Greenspan and Ben Bernanke, then a member of the Fed's board, for their wrong-headed monetary performance and ambivalent pronouncements. But it is hard to see how anything like the housing bubble could have happened had there been a stable 2 percent monetary growth rate and a 6 percent federal funds rate.

For students of financial regulatory policy, Reckless Endangerment is valuable in identifying key decisions that led to unhappy results. For instance, a little-noticed provision in the Federal Deposit Insurance Corporation Improvement Act of 1991 authorized the Fed to bail out not just commercial banks but also investment banks and insurance companies. In November 2001 all four federal bank regulators agreed that AAA- and AA-rated mortgage-backed securities needed to carry only a 20 percent risk weight, down from the conventional 50 percent—drastically reducing the amount of reserves banks were required to hold against loan defaults. This change fueled investor confidence in the securities, which all too often contained a large component of subprime and Alt-A mortgages ("liar loans").

The authors do not give enough attention to the Community Reinvestment Act (CRA), first enacted in 1977 to require banks to report the distribution of their mortgage loans. By 1995 the CRA had become a powerful tool in the hands of ACORN and allied activist organizations. Unless a bank could silence their protests by making (and passing on to Fannie Mae) the demanded amount of subprime loans, it faced serious difficulties in obtaining regulatory approval for branching, merging, and other corporate decisions.

The book is also marred by superficial criticism of the "repeal" of the 1933 Glass-Steagall Act, which prohibited deposit-taking commercial banks from underwriting or dealing in securities. As former Treasury Department General Counsel Peter Wallison has shown, the reformist 1999 Gramm-Leach-Bliley Act actually left this prohibition intact. Gramm-Leach-Bliley merely allowed a bank holding company that owned a deposit-taking commercial bank to also own other affiliated financial firms, such as insurance companies or stock brokerages. This change, Wallison persuasively argues, enhanced competition, preserved the protection against banks draining their depositors' accounts to speculate, and in fact buffered the financial crash in 2008.

One other shortcoming of the book—perhaps understandable—is its decision to begin the story in 1991, when Johnson took the reins at Fannie Mae. The Housing Act of 1968, the law that created the modern Fannie Mae, contained an ominous provision replacing the "economic soundness" underwriting standard of the Federal Housing Administration (FHA) with a weaker "acceptable risk" standard. This practice inevitably spread throughout the industry.

The Housing Act also spawned the Section 235 program, under which the FHA insured 40-year home mortgages at 1 percent interest with a $250 down payment, in order to finance President Lyndon Johnson's projected 6 million new units of subsidized housing over 10 years. That program produced every feature of the subprime loan scandals of the last 20 years: enormous default rates, liar loans, exploited purchasers, quick-buck profits, foreclosures, vandalism, fraud, and taxpayer losses. Reviewing the wreckage, Housing and Urban Development Secretary George Romney later reported to Congress in harrowing detail the failure of an idealistic proposal gone very, very wrong. How the architects of the most recent 20 years of disaster could have so rapidly forgotten that searing experience remains a mystery.

Those interested in this shameful topic would do well to read additional accounts by Jeffrey Friedman, Peter Ferrara, Richard Rahn, and Peter Wallison, among others. But all in all, Reckless Endangerment is an informative, understandable, and balanced account of the great homeownership madness. It is especially good in illuminating the scheming of actors in and out of government who made it worse, and a useful epilogue tells us what became of the key figures.

The authors stop short of offering an explicit reform agenda, but it's not hard to infer their preferred model: more and better regulation by dedicated and courageous public servants. A market-disciplined system—with full and honest disclosure, no government risk taking, and no hope of bailouts—might have been a far better path.

Contributing Editor John McClaughry recently retired as president of the Ethan Allen Institute in Vermont.

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  1. You libertarian city-STATISTS have been building houses for far too long on landed enTITLEments that are used to restrict the free movements of peoples about forest and plain.
    Officer, am I free to gambol?

    1. …or work for one of the big government enTITLEd owners of this country.

      NAP in action!

      1. Putting the food under lock and key is the cornerstone of our economy, because if the food wasn’t under lock and key, who would work?

        1. …our right to starve out people who don’t want to work for us, and kill people who want to eat food on this planet without working for us.

    2. That’s friggin’ funny every time!

    3. Please go out in the woods and gambol. The land belongs to me and I could use a snack.

  2. …loves that sort of city-STATISM.

    1. Barf! Barf!

      1. We love you Barfman
        Oh yes we do
        We love you Barfman
        And we’ll be true
        When you’re not barfing
        We’re blue
        Oh barfman, we love you

  3. If they ever allow the bust to complete its natural course, poor people will really be able to buy homes without a bunch of government financial gymnastics.

    1. There are two other groups who got rich off this thing and will never let that happen. Real estate agents, who get a percentage of every sale, and local governments, who get to raise their property tax assessments with the market, never want housing to return to normal values.

      1. The third group is politicians getting kickbacks.

        1. The real estate agents are providing some of those kickbacks. Google national association of realtors sometime. They are a huge player in Congress.

          1. …unless you’re a true believer in Pure Communism and its sister city-State brand, Pure Capitalism.

            1. …communism, not capitalism.

          2. I fucking hate “professional” organizations as much as or more than unions.

            1. Karl Marx also breathed oxygen. Do you really wanna breathe the same substance as a dirty commie??

      2. Maybe I should have bolded and italicizationed the If in that.

      3. I don’t know how much the local governments really rely on it for property taxes. At least where I live, they set their rates so that they get the revenue they need regardless of actual property values. When an assessment is much higher than the previous one, the rates generally go down quite a bit.
        There is still an advantage to local governments, though. People who can afford more expensive houses generally use fewer government services.

    2. I think there is about as much chance of that as WI going the way of the Comanche.

      1. …fair and square in the realm of the mind.

      2. Psh, Native Americans were way smarter than WI. They realized the value that the europeans brought to their society, and willfully traded for the goods we provided.

  4. “There were also some white knights, men and women who saw where all this was headed and tried to get it under control. They include Bush’s first treasury secretary, John Snow… ”

    ‘You don’t know nothing Jon Snow!”

  5. [Standard & Poor’s, Fitch’s, and Moody’s] 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

    Is this a great system, or what?

    1. Well the ratings agencies are a government monopoly so of course.

  6. Someone could write a fucking phone book of this stuff, starting around 1929 and earlier.

    Have scientists and engineers figured out how to make foreseeable consequences unintended, yet?

  7. Everyone must own a home. Everyone must have a college degree. Everyone must have total access to all medical services.

    Bubbles, how do they work?

    1. Those are all rights. I mean HUMAN RIGHTS!

      1. Which is why pricing for risk in all of those is bad, m’kay?

      2. aggression for:

        ? The right to starve people into submission so they’ll be eager to work for the capitalists.

        ? Kill people who want to eat food on humankind’s home planet without working for the capitalists.

        Sounds just like the communists!

        That’s why I call it the Mises-Marx Axis of Evil.

  8. Gambol!

    1. …nonsense inside of the prison walls of the City-STATE.

      All this Conservative/Libertarian Free Market bullshit is pedantic debate about whether prisoners should be able to sell cigarettes without too much interference from the wardens, while studiously ignoring the prison walls.

  9. “The Roosevelt administration created and capitalized Fannie Mae in 1938…”

    And just 70 short years later it created the housing bubble and financial crisis.

    1. …the mighty oak does grow.

    2. Not quite, Barney Frank and Chris Dodd wrote a bill that Have a cigar Bill Clinton signed into LAW in the 90’s is what caused the “bubble” to rise and break.

      1. You don’t know anything about this except some key phrases you learned watching GOP apologists on teevee rewrite history.

        1. Please, enlighten us Tony. I’m guessing your argument will have something to do with how government is the best and everyone that wasn’t educated at Haaaaaaaaaaavad simply doesn’t understand and should stfu.

          Prove me wrong.

          1. Although, I guess I should recognize your retort against this situation for what it actually is: projection of your own ignorance of the subject on to those that do understand the subject being discussed.

        2. Housing and mortgage policy are the interventions that created a structural weakness or place to aneurysm, but artificially low interest rates/credit inflation was what provided the pressure to blow it.

          In order to have a bubble you have to have policy that creates an artificially attractive place for money, and an increase in that supply. IE hypothetically if we had a completely flat and uniform tax policy, and a completely closed system (which of course we don’t) there wouldn’t be a weak point for credit inflation to go to. Of course even pure inflation is always still bad because it redistributes from labor to finance.

          Here’s a bone. Reagan’s economic growth was built on a bubble, that’s how he was able to lower taxes a bit and increase tax revenue. Of course Clinton did the same, and Bush did the same. (and I don’t blame the presidents so much individually, but it’s a convenient way to speak of it)

          So if you’re even in a mood to bash Reagan there’s another arrow for your quiver. Bubblenomics pretty much started under Reagan.

          Of course the jig is up, and the Fed under Obama keeps trying to inflate a limp condom. It can’t work anymore. His solution is to borrow, and that is going to end very very badly.

        3. Little Boy Blue….Have a read


          Focus on the changes in 1994 and 1999 Those are the ones that started the inflation of the bubble.

          Like it or not Fony it is the truth.

      2. Not exactly the use I had in mind when I wrote “Have a Cigar.”

    3. Yeah, Roosevelt stopped all bubbles. Nothing happened until 2005-present.

    4. Actually, Fannie and Freddie were given their “unique” (read, an open invitation to moral hazard) status in 1969.

  10. #OccupyReason

    Sadly, winter won’t be the end of it for us.

    1. They seem to have gotten less active. Ignoring them definitely helps. After last Saturday I figure it was the end that they would just destroy every thread. But oddly that hasn’t happened.

      1. Unfortunately, there are still some people acknowledging him/her though.

        1. Responding to her and pointing out what she is doing to attack the board with her nonsense is not the same thing.

          1. agree. didn’t mean you

            1. OK. Never mind. One of the name-hoppers attacked me about it yesterday.

          2. nonsense in the realm of the mind.

        2. …yeah, people might respond.

          It’s funny how the Libertards are relying on PEER ENFORCED IGNORANCE.

          Da, comrade Zampolit.

          1. ….was not merely a joke.

  11. I can afford housing if you guys will pay for it.

    1. Sure thing. I hereby request that my federal tax dollars be allocated to Aresen and not to whatever nonsense the government planned to waste my money on.

  12. John Snow is actually kind of a usual piece of shit politician and crony in the private sector.

    1. MAybe so, but he apparently tried to do the right thing here.

    2. He’s also a character in Game of Thrones!

  13. OK, I am officially SICK of the gambolling idiot trolls. If you want primitivism so badly, STOP USING THE DAMNED INTERNET AND GO GAMBOL WITH THE BEARS IN GOVERNMENT PARKS. The bears will get a good meal and we’ll get some small chance to have adult discussions of reality. GEEEZ

    1. You’re feeding the trolls by posting about it. Just don’t read their inane bullshit.

    2. OK, I am officially SICK of the gambolling idiot trolls.

      Obviously, their trolling works on some. They got to *you*. Learn to ignore them.

    3. I like gambolling idiot trolls. They’re delicious!

    4. why should I gambol on marginal “park” ground?

      Shouldn’t all the land be free of government regulations meant to restrict free movement?

      1. “why should I gambol on marginal “park” ground?”

        It isn’t the government restrictions that you should worry about. Gambol on my turf and you’ll be eaten. Meow!

  14. I don’t think that word means what you think it means. I found a copy of the Encyclopedia Prehistorica painted on a cave wall and it indicated that ancient gambolling involved bison and “bad touch”. Then again, maybe you do know what it means…

  15. I worked at a bank in the early 1990s. We had a Community Reinvestment Act officer. Care to guess his skin color? Thanks to the war on poverty, inner city blacks were unable to buy homes, as they had little incentive to improve themselves and save a down payment. Jimmy Carter saw that as racism, so the CRA was born. That’s the dumbest thing about liberals – they have no idea how capitalism works. It’s color blind, other than green. Has a salesman ever turned down a sale to a minority? I highly doubt it. The market will provide anything and everything, but liberals hate it with a burning passion.

  16. I’m certainly no expert in the subject, but I find it quite curious that the majority of discussions I’ve read on the topic seem to ignore that there are at least two parties to a mortgage (contract). Surely the maker of a mortgage obligation (the borrower,) bears some responsibility for actions they have taken. I don’t recall hearing of any situation where someone was forced against their will to enter into a contract to borrow money with respect to this debacle.

    There must be a personal responsibility component brought into this discussion… else everything is always someone else’s fault.

    1. On both sides. The Borrower should not even try “max’ out the loan AND the Bank should be looking a little more closely at the totals and keeping the loans more realistic.

      But the provisions in the 1999 part of the CRA forced banks to lend to sub par folks with little income to avoid being “racist”….Money was easy and Banks got rich as did realty people.

  17. thank you a lotsssssssssssssssssss

  18. I don’t read Peter Wallison because he’s a clueless idiot… but most of this article is outright garbage as well… why not do yourself a favor and read Bailout Nation or Griftopia instead?

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