A Review of Hidden in Plain Sight by Peter Wallison
Peter Wallison’s new book, Hidden in Plain Sight, is a detailed, disciplined argument for the prosecution, with the U.S. government as the defendant in the dock. The government is charged with principal responsibility for causing the financial crisis of 2007-09 through its sovereign forcing of millions of low credit quality, risky mortgage loans into the system, using its government-sponsored enterprise servitors, Fannie Mae and Freddie Mac. What will the jury say? “Guilty, Your Honor!”
Fannie and Freddie were and are, thanks solely to their “too big to fail” government backing, big enough to affect the whole housing finance sector—they hold an amazing $5 trillion in mortgage credit risk. Wallison carefully marshals the evidence of their major role in loading American housing finance with dubious credit. This credit, it turned out, was hyper-leveraged to the fall in house prices from their bubble highs, a fall which was inevitable. This concentration of credit risk could not have been created if investors had not assumed that the U.S. Treasury was on the hook for Fannie and Freddie, no matter what. About this they were entirely right, of course.
In sum, Fannie and Freddie were about half the $10 trillion U.S. mortgage market, and the government required them to have more than half of their business in lower quality loans. This was a regulatory requirement imposed by the government—in both the Clinton and the G.W. Bush administrations, as Wallison points out. It was not deregulation, but its exact opposite: increased regulation, explicitly requiring a great number of riskier loans in the name of so-called “affordable housing goals.” Fannie and Freddie, Wallison reports, ended up with about 12 million of these non-prime, or “non-traditional” mortgages. And how about those private subprime mortgage-backed securities? Fannie and Freddie were among the biggest buyers of them in order to meet their regulatory requirements. As for the government as a whole, as a JPMorgan investment strategist later concluded, “Government agencies now look to have guaranteed, originated or underwritten 60% of all non-traditional mortgages.”
The prosecutor summarizes: “There is compelling evidence that the financial crisis was the result of the government’s own housing policies.” For “Fannie and Freddie were the dominant players in the housing finance system and were subject to [government] regulations that required them to reduce their underwriting standards.” Further: “The conventional narrative about the crisis—that it was caused by lax government regulation–is false.”
Of course, the government was not intending to create a financial collapse. Its required lower lending standards were rather, as Wallison says, “intended to assist low-income borrowers.” Perhaps these were good, but they were certainly foolish, intentions. A permanent financial truth is that you are not doing people a favor by making them loans they cannot afford—just the opposite.
To his credit, even that erstwhile political promoter of Fannie and Freddie, former Congressman Barney Frank of the Dodd-Frank Act, came to see that, when looking back. With “intellectual honesty,” as Wallsion says, Frank rightly concluded, “It was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.”
Part, but only part, of this lesson got reflected in President Obama’s speech on housing on January 8. “Don’t buy what you can’t afford,” the President counseled his audience in Phoenix. That is not a new idea, to say the least, but it is a sound one. While recalling this wise adage, which is the opposite of the government behavior Wallison documents, the President continued, “We’re not going down the road again of financing folks buying things they can’t afford. We’re going to be cracking down on that.” Unlike Frank, however, the President did not confess that the government’s own policies and regulations had been committed to speeding down the road “of financing folks buying things they can’t afford.”
An important part of Wallison’s history is that Fannie and Freddie did not disclose in their financial reports the remarkable buildup of credit risk they were creating under regulatory pressure. Thus, the amount of riskier mortgage loans in the financial sector was far greater than almost anybody thought.
It was certainly a lot greater than what economist Paul Krugman confidently pronounced in July, 2008. Fannie and Freddie “didn’t do any subprime lending, because they can’t,” he pontificated. That was two months before they collapsed under the weight of bad loans. By 2011, the SEC was suing for misleading reporting by Fannie and Freddie. Both of them, Wallison relates, “admitted that they had recognized the inherent riskiness of some mortgages…that they had kept track of these loans separately…and that they had never disclosed them.”
“I hope by next year we’ll have abolished Fannie and Freddie,” said Barney Frank in 2010. We haven’t, of course—they live on, now as government-owned enterprises, possibly more vulnerable to political manipulation than before. Therefore Wallison worries, and we should too, that the colossal government mistakes of the past are likely to be repeated. Reducing credit standards “to meet the political goals of the current administration” looks like it is under way with both Fannie and Freddie, under the tutelage of their political master, the Federal Housing Finance Agency.
