Monday, October 31, 2011

Reckless Endangerment


Gretchen Morgenson and Joshua Rosner have written a devastating critique of the public-private partnership that was aimed at putting Americans, including unqualified Americans, into their own homes.  This government-sponsored, corporation-endorsed alliance lays at the root of the financial crisis.

Their book is timely as the hallowed notion of public-private partnerships--the goodness of which is beyond question in government, academic, policy and even some corporate circles--represents policy makers' ideal for achieving social and political objectives in contemporaryAmerica.

Noman says caveat emptor!


The story traverses similar territory to that covered by Peter Schweizer's "Architects of Ruin," and Thomas Sowell's "The Housing Boom and Bust."  It provides much more detail concerning the role played by Fannie Mae, especially by it's long-time chieftain Jim Johnson, than either of those two books, however.  

Additionally, the book heaps blame upon investment banks, ratings agencies and predatory lenders for succumbing to blatant conflicts of interest, if not outright fraud.  Politicians also receive censure for their indispensable contributions to the crisis.

Peggy Noonan commented favorably upon the book in a recent opinion piece:
If [Occupy Wall Street] want[s] to make a serious economic and political critique, they should make the one Gretchen Morgenson and Joshua Rosner make in "Reckless Endangerment": that real elites in Washington rigged the system for themselves and their friends, became rich and powerful, caused the great cratering, and then "slipped quietly from the scene." 
It is a blow-by-blow recounting of how politicians—Democrats and Republicans—passed the laws that encouraged the banks to make the loans that would never be repaid, and that would result in your lost job. Specifically it is the story of Fannie Mae and Freddie Mac, the mortgage insurers, and how their politically connected CEOs, especially Fannie's Franklin Raines and James Johnson, took actions that tanked the American economy and walked away rich. It began in the early 1990s, in the Clinton administration, and continued under the Bush administration, with the help of an entrenched Congress that wanted only two things: to receive campaign contributions and to be re-elected. 
The story is a scandal, and the book should be the bible of Occupy Wall Street...  
What differentiates this book from others is that it originates on the Left.  Morgenson is a Pulitzer Prize winning columnist for the New York Times who achieved journalistic superstardom by assailing Enron and WorldCom.

Back-cover blurbs of praise come from Kurt Eichenwald at the New York Times, Bill Moyers of public television fame, Bryan Burrough, the author of "Barbarians at the Gate,"  and Charles Feguson, the director of "Inside Job."

The book nevertheless eschews the Democratic Party's preferred narrative of events, which now passes for conventional wisdom, i.e., that the crisis was caused by Reaganite free-market ideology, Republican insistence on deregulation, and Republican inattention to Wall Street transgressions.

"Reckless Endangerment" dwells rather on historical facts that lay much of the blame at the feet of those in government, or tied to government.

It slays a number of Liberal sacred cows, none more sacrosanct than Democratic Party mogul James A. Johnson.  In addition to service in both the public and private sectors, Johnson has served as a confidante to Democratic Presidential candidates from Walter Mondale to John Kerry to Barack Obama.  


David Brooks' review of "Reckless Endangerment" explains Johnson's modus operandi:
The story centers around James Johnson, a Democratic sage with a raft of prestigious connections. Appointed as chief executive of Fannie Mae in 1991, Johnson started an aggressive effort to expand home ownership. 
Back then, Fannie Mae could raise money at low interest rates because the federal government implicitly guaranteed its debt. In 1995, according to the Congressional Budget Office, this implied guarantee netted the agency $7 billion. Instead of using that money to help buyers, Johnson and other executives kept $2.1 billion for themselves and their shareholders. They used it to further the cause — expanding their clout, their salaries and their bonuses. They did the things that every special interest group does to advance its interests. 
Fannie Mae co-opted relevant activist groups, handing out money to ACORN, the Congressional Black Caucus, the Congressional Hispanic Caucus and other groups that it might need on its side. 
In 2000, a bill was introduced that threatened Fannie's special status. The Coalition for Homeownership was formed and letters poured into congressional offices opposing the bill. Many signatories of the letter had no idea their names had been used. 
Fannie lavished campaign contributions on members of Congress. Time and again experts would go before a committee to warn that Fannie was lowering borrowing standards and posing an enormous risk to taxpayers. Phalanxes of congressmen would be mobilized to bludgeon the experts and kill unfriendly legislation. 

Fannie executives ginned up academic studies. They created a foundation that spent tens of millions in advertising. They spent enormous amounts of time and money capturing the regulators who were supposed to police them.
[O]nly two of the characters in this tale come off as egregiously immoral. Johnson made $100 million while supposedly helping the poor. Rep. Barney Frank, whose partner at the time worked for Fannie, was arrogantly dismissive when anybody raised doubts about the stability of the whole arrangement. 
[J]ohnson roped in some of the most respected establishment names: Bill Daley, Tom Donilan, Joseph Stiglitz, Dianne Feinstein, Kit Bond, Franklin Raines, Larry Summers, Robert Zoellick, Ken Starr and so on.
In addition to the nine-figure remuneration that Johnson garnered running quasi-governmental Fannie Mae, his severance called for annual consulting contracts paying roughly $400,000 per year, a car and driver for himself and his wife, an office, and two subordinates at shareholder expense.

After leaving Fannie, Johnson ran the Kennedy Center for Performing Arts in DC, the Brookings Institution, and the compensation committee on Goldman Sachs board of directors where he set the pay of future Treasury Secretary Hank Paulson.  Johnson occupied a number of other prestige perches in both the profit (Target, United Healthcare, KB Home, Perseus Partners private equity) and non-profit sectors (American Friends of Bilderberg, the Hamilton Project, the Business Council, the Council on Foreign Relations, and the Trilateral Commission).


Johnson's November 2007 initiative with the Brookings Institution, "A Blueprint for American Prosperity," aimed to form a public-private partnership to rejuvenate America's cities, just as his "Showing America A New Way Home: Expanding Opportunities for Home Ownership" had forged a public-private partnership to expand home-ownership to unqualified buyers. 

Quoting from the Brookings Blueprint:
[The blueprint is] a multi-year initiative aimed at creating a new Federal partnership with state and local leaders and with the private sector to advance American prosperity...
The ability of the United States to compete globally and to meet the great environmental and social challenges of the 21st century rests largely on the health, vitality and prosperity of the nation's major cities and metropolitan areas.
The Obama Administration has adopted the spirit of Johnson's blueprint, and undoubtedly more of its substance through the 2009 trillion-dollar stimulus bill and subsequent actions than Brookings could have imagined.

More importantly, Democratic hegemony in Washington DC has enabled deflection of criticism from the Blueprint's conceptual thrust: the desirability and advisability of public-private partnerships.  

Though Morgenson and Rosner don't explicitly make the accusation, the shaping of economic decisions in financial markets by public actors pursuing social objectives through the actions of private actors is what caused the economy to crater.

The authors end on a somber note.  In the aftermath of the credit crisis of 2008, Congress has failed to address the too-big-too-fail problem.

Fifteen-hundred pages of financial reform legislation bear the names of Fannie Mae's two most strident defenders, Representative Barney Frank and Senator Chris Dodd, and does nothing to address them.  In fact, Dodd-Frank exempted them from the legislation.


Many if not most of the key players that gave us the financial crisis still remain in positions of power. Notable among them are: 
  • Andrew Cuomo: former HUD director who pushed Fannie and Freddie to package more low-quality mortgages for sale to investors the world over is currently the Governor of New York
  • Barney Frank: congressional patron of Fannie and Freddie still represents the Fourth District of Massachusetts in Congress and is currently the ranking Democrat on the House Banking Committee, which he chaired between 2006 and 2010
  • Stephen Friedman: former chairman of Goldman Sachs, former director of Fannie Mae, former chairman of the Federal Reserve Bank of New York is currently chairman of the President's Intelligence Oversight Board
  • Timothy Geithner: former president of the Federal Reserve Bank of New York, and friend to banks and brokerage firms is currently the U.S. Treasury secretary
  • Peter Orszag: author of an apologia minimizing Fannie Mae's potential costs to U.S. taxpayers resigned as President Obama's Office of Management and Budget is currently vice-chairman at Citigroup
  • Robert Peach and John McCarthy: Federal Reserve Bank of New York economists who wrote a 2006 study concluding that there was no housing bubble are still in their positions
  • Robert Rubin: former CEO of Goldman Sachs who became the U.S. Treasury Secretary under President Clinton helped to kill the Glass-Steagall Act, which separated investment from commercial banking in 1933 and prevented firms from becoming too big to fail; he left to join Citigroup as a vice-chairman, the merged firm that occasioned Glass-Steagall's repeal; he is currently a trustee of the Brookings Institution and counselor to Centerview Partners, a hedge fund 
  • Robert Zoellick: former Fannie Mae enforcer has been President of the World Bank since July 2007.
This book is worth a serious read by anyone desiring to understand the crisis, and continuing threats to our economy.  Because it comes from the Left, the Left is obliged to respond to the critique rather than simply dismiss it as the Financial Crisis Inquiry Commission did, for example.

One response comes from Jeff Madrick and Frank Partnoy in the New York Review of Books:
We are not defending GSEs: at its core, the GSE model is flawed. GSEs are charged with serving two masters: to keep the mortgage market working but also to maximize profits with the enormous help of an implied government guarantee on their debt. They ignored regulatory requests to raise more capital, instead borrowing at low rates to invest aggressively at the height of the market. As a result, they lost enormous amounts of money once housing prices collapsed, and they are now being bailed out by the federal government to the tune of $150 billion. 
But they did not lead the crisis; their collapse followed it. Had Morgenson and Rosner written a more cogent, analytical and detached book, they would have provided a needed service supporting GSE reform. Fannie and Freddie had basically become enmeshed in the culture of greed of the 1990s and 2000s, with Presidential and Congressional approval. But the government had also been facilitating abuses by Wall Street and the private sector and new regulations are not yet in place to stop this. What is disturbing about the currency being given the Morgenson-Rosner argument is that it is supplying ammunition to those who believe government involvement of almost any kind in the markets is bad, and that without a mismanaged Fannie and Freddie all would have been fine. 
A new and serious debate is needed about how to reform and reconstitute the GSEs. But it cannot be informed by misleading analysis and over-the-top rhetoric.
A thorough response to the Madrick/Partnoy rebuttal would require a war of statistics that Noman will allow others using the data in Morgenson's book and its sources to engage in elsewhere.  Suffice it for purposes of this post to make two observations.

First, if they want to dispel the criticism that big government, and more specifically the party of big government is largely (not exclusively) to blame for the crisis, they will need to address the umbilical connection between Wall Street, Congress (e.g., Dodd, Frank, the Congressional Black Caucus, the Congressional Hispanic Caucus) and the Democratic luminaries that paraded through the GSE's as if it were their birthright, e.g., Jamie Gorelick, Jim Johnson, Franklin Raines, Rahm Emanuel and Bill Daly.


Secondly, they will need to recognize that rejection in principle of public-private partnerships--the making of economic-financial decisions on the basis of political-social criteria--is a far cry from believing that "government involvement of almost any kind in the markets is bad."

The test is the ends that government involvement is meant to pursue.  If the end of legislation or regulation is to preserve the integrity of markets and the economic functioning of economic systems, then it is necessary and welcome.  Anti-fraud law is of this type, as was Glass-Steagall.

If the end of law or political suasion is to advance social or political goals through economic decision-making, then government involvement is neither necessary nor welcome as it appropriates and obliges an economic entity to produce results contrary to its nature.

The inevitable outcome is corruption, inefficiency, misallocation of capital and, as in the instant case, financial calamity.

That is not to say that economic decision-making is closed to ethical considerations.  All decisions, including economic decisions are always the result of human freedom--decision is the final act of prudence--and as such are always open to the domain of ethics.  Ethics always involves the exercise of human freedom, and vice-versa.

But moral decision-making is always new.  Moral decisions cannot be made in advance by others.  If they could, the decision-maker would not be free.

The connection to the broader range of considerations than merely economic ones is localized to decision-makers, and to the decision-makers that impose conditions on them for the organization.

This dynamic is not the province of social avatars systemically meddling in contextualized decision-making so as to prescribe ends deemed good in the splendid isolation of faraway places.

Examples of such "politically correct" ends would be that everyone should own a home whether they can afford to or not, or that every public employee should enjoy fulsome pay, benefits and job security whether the public can afford to pay for them or not.

Liberal politicos will have to be prevented from imposing their good intentions onto economic actors decision-making for the good of the economy, the common good, and human dignity insofar as it is shaped by moral development from free decisions.

Moreover, they will need to be constrained to pursuing their ends by private means through voluntary, intermediate associations including private companies--but not public (shareholder owned) or government-incentivized ones.

Taxpayers are alarmed at the accumulation of public debt, and revolted by the waste of precious tax revenues on Leftist boondoggles.  The tea parties have served notice, which no number of Occupy protests is likely to alter.

Regardless of what it is called, government involvement in the private sector has a very poor track record, witness Morgenson and Rosner's book, and augurs poorly for the future.


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