Confidence, Credit and Growth

By Dean Riesen

As a free-market bank director and commercial real estate investor, I find these challenging times.  We face a massively complex problem that is the result of human nature, the acceleration in the past ten years of extremely complex financial engineering, and significant government interference in markets.

The core problem was a residential real estate ‘bubble’ like no other we have ever experienced.  This was facilitated by the easy money strategy of the Federal Reserve under Alan Greenspan, who largely ignored asset inflation as an economic problem.  The government magnified the easy money problem with its mistaken social engineering policy of making housing more “affordable” by weakening traditional lending standards through its government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, egged on by Democrats Barney Frank, Charles Schumer, and Christopher Dodd. 

The GSEs created massive demand for a product (sub-prime debt) that didn’t really exist. This led the “free market” of mortgage originators, home builders, and home buyers to an orgy of construction and expansion.  These mortgages were then ‘engineered’ into all sorts of very new and complex vehicles that were then sold and traded around the world in a way that has caused the inevitable bubble busting to infect the entire global financial system with a very serious disease which has all but shut off global growth.  Adding insult to injury, this is happening in the middle of a very contentious Presidential election making it very difficult to sort out reality from fiction.

The reality is that Democrats led the charge to expand the mortgage purchases of GSEs, criticizing Republican attempts to regulate these public-private monsters.  

● On September 10, 2003, Rep. Barney Frank told a hearing of the House Financial Services Committee:  “The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see.  I think we see entities that are fundamentally sound financially . . . .”

● Two weeks later, Congressman Frank, who now chairs the Financial Services committee, said:  “I do not want the same kind of focus on safety and soundness that we have in the OCC [Office of the Comptroller of the Currency] and OTC [Office of Thrift Supervision].  I want to roll the dice a little bit more in this situation towards subsidized housing . . . .”

In 2005, Republicans (now in control of the Senate), passed a strong reform bill out of the Senate Banking Committee that could have prevented much of the financial disaster, only to have Democrats prevent it from coming to a floor vote.  Sen. Barack Obama did not support the bill or oppose his party’s efforts to keep it from coming to a vote.  Sen. John McCain said at the time: “If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system and the economy as a whole.”

So in somewhat of a role reversal, we had Republicans trying increase regulation and Democrats opposed.  Of course Republicans were trying to regulate government in the form of GSEs and prevent it from distorting the market.  Democrats were trying to protect a piggy bank that made massive contributions to their favorite groups like ACRON and Jessie Jackson’s organizations as well as their political campaigns. (Senators Obama, Schumer, and Christopher Dodd and Representative Frank are among the top four recipients of political contributions from GSEs.)  Senator Obama still lists Franklin Raines, former CEO of Fannie Mae and someone who should probably be sitting in a federal prison for massive accounting fraud, as an adviser to his presidential campaign.

So from my perspective the government had a major role in creating the mess we find ourselves in and, therefore, must be part of the solution.  The crisis has reached the stage where banks are afraid of each other.  Credit is becoming difficult to find, which means there won’t be economic growth and in reality economic contraction is more and more likely. 

There is no market for many securities because there are no buyers.  It doesn’t mean they aren’t worth anything.  The government will now be involved in helping to create a “market” for the distressed securities allowing banks to rebuild their balance sheets which, in turn, will lead to confidence to lend money which can then lead to economic growth.  There is clearly a risk that government will create additional problems in the functioning of the free market but it’s a risk we must take since the market has gone on strike.  We must watch closely to ensure it does the least amount of damage to the functioning of future free markets.

October 10, 2008