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by Paul R. Hollrah, ©2012

Has the Securities and Exchange Commission done its job properly? Has it gone too far?

(Jan. 3, 2012) — Wall Street melt-downs?  Banking industry bailouts?  Hedge fund hanky-panky?  Multi-million dollar Wall Street bonuses?  Collapse of the dollar?  National debt default?  Economic collapse?  Who can possibly make sense of it all?  How did it happen, and who’s to blame?  Did George W. Bush create the mess and leave it for Obama to clean up, or were Democrats to blame all along and Obama was just too incompetent to know what to do about it?  What is the truth of all this?

Now that the Securities & Exchange Commission is finally pursuing wrongdoing at Fannie Mae and Freddie Mac, it’s time the American people knew the root causes of our current economic difficulties.  We all need to have a basic understanding of the mess… one that will allow us to explain it to our Democrat friends in terms that even they can understand.

First, it must be said that the Community Reinvestment Act (CRA), a Carter administration initiative, was not a totally bad idea.  It encouraged lenders to make loans to qualified borrowers who had previously been denied solely on the basis of the color of their skin.   The CRA was intended to reduce or eliminate a practice known as “redlining,” in which realtors and lenders discriminated against potential buyers in low-income and depressed neighborhoods, approving home loans for lower-income whites but not for middle or upper-income blacks.

Throughout the Reagan and Bush (41) years, between 1981 and 1993, the CRA was enforced in a straightforward manner.  Lenders were encouraged to abandon the “redlining” practice and to meet the credit needs of all members of the community, consistent with sound lending practices.

However, when Democrats regained control of the White House in 1993, in the person of Bill Clinton, Democrats began to act like Democrats.  They decided that the CRA, if strategically enforced with a political end in mind, provided a unique opportunity to purchase the votes of those at the lower end of the economic ladder.

Under the Clinton administration, regulators paid particularly close attention to the lending practices of banks and savings & loan associations.  In other words, were lenders meeting the credit needs of all borrowers in their local communities, regardless of borrowers’ ability to repay their loans?  Accordingly, they began to use the results of those examinations to determine whether or not to approve mergers and acquisitions, and whether or not to approve applications for new branch banks.  Lenders soon found that the CRA was more stick than carrot.

As a result, lenders abandoned traditional lending criteria and made mortgage loans to almost anyone who applied, regardless of their income level or credit worthiness.  Under normal circumstances, no prudent lender would ever lend money to those with little or no ability to repay, but these were not normal circumstances.  Two of the Democratic Party’s favorite patronage cesspools… Fannie Mae and Freddie Mac… were standing ready to buy up any and all mortgages.  And why should Fannie and Freddie worry about the quality of the mortgages they bought?  They had no reason to worry because, as quasi-public institutions, they had the cash assets of the American taxpayer… the U.S. Treasury… at their disposal.

Here’s how it worked.  When a home buyer took out a home loan from a bank or a savings & loan association, the mortgage was then sold to what was known as a Government Sponsored Enterprise (GSE), i.e. Fannie Mae or Freddie Mac.  Fannie and Freddie then bundled the loan with other sub-prime mortgages and sold the bundle to private investors… promising not only attractive returns, but a high degree of security as well.  By year end 2010, Fannie and Freddie had acquired more than half of the $11 trillion mortgage loan market in the United States.

However, the sale of mortgages to private investors was not a totally arms-length proposition because, even though Fannie and Freddie had sold the bundled mortgages, they continued to have a financial interest in them.  They guaranteed the securities for the investors, promising to continue making payments on the mortgages even if the homeowner stopped paying.  In 2008, when the overheated real estate market collapsed and a great many homeowners stopped paying all at once, the cash reserves of Fannie and Freddie were soon depleted, forcing them to default on their guarantees and precipitating a major economic crisis.

One might ask, how could something like this happen directly under the noses of our political leaders without anyone taking notice?  The fact is, shortly after taking office in 2001, the Bush administration did notice and took steps to reform Fannie Mae and Freddie Mac.  What they apparently failed to understand was that Fannie and Freddie existed in a world of their own, a world in which Democrats who were either owed big favors, or who were being paid to keep their mouths shut for one reason or another were well taken care of.

Among these was Franklin Raines, former Clinton White House budget director, who served as chairman and chief executive officer of Fannie Mae.  Raines took “early retirement” from Fannie Mae on December 21, 2004 after the Office of Federal Housing Enterprise Oversight (OFHEO) accused him of participating in widespread accounting irregularities, including the shifting of losses so that senior Fannie Mae executives could earn large bonuses.  Some $90 million was paid to Raines based on overstated earnings… earnings initially reported at $9 billion but later found to be in the neighborhood of $6.3 billion.

Tim Howard, Chief Financial Officer under Raines, is a former Senior Economic Advisor to Barack Obama.  When Howard was terminated at Fannie Mae he walked away with a “golden parachute” reported to be worth approximately $20 million.

Jim Johnson, a former Lehman Brothers executive who headed Obama’s vice presidential search committee, is also a former Fannie Mae CEO who was forced to resign.  Johnson’s 1998 Fannie Mae compensation was reported at between $6-7 million.  In truth, it was $21 million.

And last, but not least, we have former Deputy Attorney General in the Clinton administration, Jamie Gorelick, the woman who erected the infamous “Gorelick Wall” which prevented the CIA and the FBI from sharing intelligence that could have prevented the 9/11 attacks on the World Trade Center and the Pentagon.  After leaving the Justice Department she resurfaced as Vice Chairman of Fannie Mae from 1997 to 2003.  And although she had no training or experience in finance, whatsoever, during the six years she worked at Fannie Mae she earned over $26 million.

While serving as Vice Chairman of Fannie Mae, Gorelick participated in the development of an accounting scheme which allowed Fannie’s Mae’s top executives – whose bonuses were tied to earnings-per-share – to meet the target for maximum bonus payouts.  For example, in 1998 the target earnings for maximum bonus payout at Fannie Mae was $3.23 per share.  Fannie Mae reported earnings of exactly $3.2309.  (Don’t you just hate it when that happens?)

So how was this arranged?  Because of lower interest rates in 1998, Fannie Mae found itself facing an extraordinary expense estimated at $400 million.  Johnson, Franklin, and Gorelick decided to recognize only $200 million of the $400 million expense, deferring the remainder to the next fiscal year.  This fortuitous “coincidence” resulted in maximum bonus payouts: $1.932 million to then-CEO Jim Johnson, $1.19 million to CEO-designate Franklin Raines, and $779,625 to accounting whiz Jamie Gorelick.

Democrats do have an uncanny way of taking care of their own.

In the 2 years and 11 months that Barack Obama has been in office, Democrats have waged an uninterrupted and unabashed attack on George W. Bush, insisting that he did nothing to forestall the Fannie and Freddie disasters that we now face.  However, the facts are these: The Bush administration warned Congress of impending insolvency at Fannie Mae and Freddie Mac in April 2001, May 2002, November 2003, February 2004, August 2007, December 2007, March 2008, April 2008, May 2008, and June 2008.  In addition, officials of the Bush administration testified before Congress, calling for reform of Fannie and Freddie, in September 2003, June 2004, April 2005, and February 2008.

In each instance, their warnings were either ignored or were subjected to strong push-back from leading Democrats, who charged Republicans with opposing home ownership by the poor and minorities.  In each instance, the principal push-back came from Senator Chris Dodd (D-CT), Chairman of the Securities and Investment Subcommittee of the Senate Banking Committee, the recipient of major “sweetheart” loans from now-defunct Countrywide Financial Corporation; and Rep. Barney Frank (D-MA), Ranking Member of the Housing and Community Opportunity Subcommittee of the House Financial Services Committee.

In short, the financial crisis that our country now faces is exclusively the product of Democratic political excess.  It is further proof that, when government interferes in the private economy in order to guarantee what liberals and Democrats see as “fairness” and “equal outcomes,” the unintended consequences are always predictable, but never pretty.  What would be pretty would be to see Christopher Dodd, Barney Frank, Franklin Raines, Jim Johnson, Jamie Gorelick, and other Obama cronies being led away in handcuffs.  The current charges being investigated by the Securities & Exchange Commission are a good beginning.

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  1. An often overlooked part of the story about the CRA, was how the government regulators managed to coerce the banks into make those bad loans in the first place. While there was a good deal of fee income to be made by writing those loans (points and other mortgage origination fees), the main reason why the banks acquiesced was that they were threatened with the removal of their FDIC membership, without which, their depositors wouldn’t be insured, and would have taken their business elsewhere.

    In the private sector that kind of behavior is referred to as extortion and racketeering.


  2. The truly disgusting aspect of what the above named Democrats did is that they did it in public, as if to say “You can look at us but you can’t touch us.”