How Capitalism Will Save Us (25 page)

Fannie and Freddie fueled the trend toward securitization, the bundling of home loans into mortgage-backed securities that were bought and sold on Wall Street. In and of itself, securitization was a very positive financial innovation. The pool of money available for mortgages was now the entire financial system—instead of just local banks. Securitization spread the risk; if a mortgage went bad, one bank wouldn’t take the whole hit. The impact would be spread all over the country and throughout the world. Lower risks meant lower, more affordable mortgage rates. But unfortunately, like many essentially positive innovations, securitization could be misused and abused.

We mentioned in
chapter 2
that Freddie and Fannie began as federal agencies. They were later spun off by the government so that they could sell shares to the public and generate more mortgage money. But they weren’t truly privatized. Noted economist Alan Reynolds explains that Fannie and Freddie were vastly different from other private-sector corporations:

Fannie and Freddie had been created to serve as helpful resources in the housing market. Instead, the two giants virtually became the market. They recklessly expanded their indebtedness. Who cared? Uncle Sam stood behind them.

During the administration of Bill Clinton, Fannie and Freddie became true behemoths. As Terry Jones recalled in
Investor’s Business Daily
in September 2008,

By the mid-2000s, some people were warning of the enormous risk to the economy Fannie and Freddie had created. A report from the Heritage Foundation warned in 2005: “Fannie Mae and Freddie Mac have abused their generous federal privileges to the point that they now control as much as half of the nation’s residential mortgage market. Their commanding presence exposes U.S. financial markets to excessive risk and instability.”
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Calls to rein in Fannie and Freddie went unheeded. Enriched by their government ties and special privileges, these government-sponsored monsters had enormous lobbying power. Between the late 1990s and 2008, the two spent some $200 million to buy political influence. Fannie and Freddie made themselves the most potent lobby in Washington—more powerful than any corporate interest from the private sector. Political contributions flowed everywhere. “Affordable housing” charities with ties to Fannie and Freddie had a presence in virtually every congressional district. Relatives of influential politicos could often find a cushy perch in these organizations.

Fannie and Freddie were a favorite landing place for ex-officials and staffers from Congress seeking lucrative jobs after government careers. The hours were easy. And the pay was lavish. Fannie and Freddie soon had more million-dollar executives than virtually any company in America. In 2004, Fannie Mae’s then CEO Franklin Raines was seventy-seventh on
Forbes
list of most highly paid executives, with an annual compensation of $11.6 million.

Fannie and Freddie didn’t even have to make the financial disclosures required of every other publicly held company in America. This gravy train began to slow in 2004, when Raines and his executives were accused of manipulating Fannie’s books, overstating earnings and understating risk in an obvious ploy to inflate their bonuses. After an SEC review, Fannie had to cut its dividend to bolster its shaky finances. Raines and others were made to resign. Did they go to jail, as they would have in the private sector? Not a chance.

While Fannie and Freddie were building their government-sponsored mortgage empires, Washington politicians were working to lower lending standards to homeowners. Lenders were pressed to abandon the standard they had developed based on decades of market experience, which had proved effective in filtering out too-risky borrowers—requiring homeowners to put 20 percent down. Why put 20 percent down? Why not 3 percent? That’s what Washington started to do in the 1970s. By the 2000s, President George W. Bush’s administration was urging lenders to write mortgages requiring no down payment.

People who blame Wall Street for the subprime crisis conveniently forget that in the 1970s, banks were demonized for “redlining”—failing to lend to low-income neighborhoods. Congress, in 1977, during the Carter administration, responded by passing the Community Reinvestment Act, designed to pressure banks to make more loans. Banks could not get government approval to merge unless they had a CRA rating that showed they were in compliance with the law. Critics at the time warned that the act would lead to unsound lending and distort markets.

The Community Reinvestment Act did not create today’s crisis, but it established a critical government priority that influenced lending for the ensuing decades, increasing pressure on banks to make loans they would not have made under normal circumstances. Thus, Uncle Sam institutionalized the very practices that are today labeled “predatory.”

Government pressure on banks to lower lending standards and the creation of Fannie and Freddie were just two of the unfortunate interventions that helped inflate the subprime bubble. As we explained in
chapter 2
, misguided Federal Reserve policies of too much money and low interest rates also helped to fuel the lending mania.

Clearly, no one in either government or the private sector could have foreseen that such a perfect storm could occur. There was plenty of blame to go around. But the Real World truth is that the subprime meltdown and its corruption was not caused by a private sector looking to get rich at the expense of the poor, but by government efforts to influence markets in the name of well-meaning social policies.

T
he era of 1982–2007 may well go down in history as a golden age of growth produced by a succession of promarket government reforms—most notably, the tax cuts of Ronald Reagan and George W. Bush, as well as the capital gains tax cut of Bill Clinton. A boom in high technology, finance, and other sectors created numerous newly rich individuals. This wealth was not at the expense of the poor. Everyone profited from millions of new jobs, products, and services.

Yet even in good times, despite countless positive economic indicators, critics of capitalism insisted that the longest boom in the nation’s history benefited only “the rich,” while the poor lost ground.

Exhibit A, some say, is the Gini coefficient, a government ratio measuring income distribution. In 2005 it reached its highest level ever according to the U.S. Census Bureau, 0.0462, reflecting a historic level of “income inequality,” an unprecedented gulf between rich and poor. Further proof, they say, is provided by Census Bureau statistics showing that
the percentage of Americans living below the poverty line has remained virtually unchanged since the 1960s—around 12.5 percent.

These numbers supposedly provide irrefutable evidence that the free-market policies of the past three decades simply haven’t worked. In the words of Hillary Clinton, they’ve delivered “trickle-down economics without the trickle.”

The problem is that many experts—on both ends of the political spectrum—say the government’s poverty numbers are frequently misrepresented. Some believe they’re just plain wrong.

Let’s look at those income inequality numbers. Yes, there is a wider gulf between poor and rich incomes today than in years past. But it’s not because the poor are falling behind, but because more low-income people than ever are coming here.

Between 500,000 and more than one million immigrants, many of them poor, are admitted to the United States each year. This does not include the one million to two million illegals who annually enter the United States. (Obviously, in times of recession, particularly a severe one, the number of newcomers temporarily declines.)

According to Brink Lindsey of the Cato Institute, author of
The Age of Abundance: How Prosperity Transformed America’s Politics and Culture
, the portion of the total U.S. population born in foreign countries jumped from 5 percent in 1974 to 12 percent in 2004.
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Today’s top points of origin are not the European nations as they were in years past, but the world’s poorest countries, such as Mexico, Haiti, Cuba, the Dominican Republic, Nicaragua, and El Salvador, among others.