A Nation of Moochers (20 page)

Clinton also subtly shifted the focus of the law from poor neighborhoods to low-income individuals, significantly expanding its mandate and ultimately its effect on lending. For Husock, however, the new culture was personified by one activist in particular: Bruce Marks, the CEO of the Neighborhood Assistance Corporation of America. “Bruce Marks has set out to become the Wal-Mart of home mortgages for lower-income households,” wrote Husock, with offices in twenty-one states, an annual budget of more than $10 million, and delegated underwriting authority from banks. A self-described “bank terrorist,” Marks openly recruited homeowners as activists for his political agenda.

Years before the housing meltdown, Husock predicted that activists like Marks “may well reshape urban and suburban neighborhoods,” because they pushed the envelope on the sorts of loans they issued. Because Marks believed that low-income borrowers were oppressed, disadvantaged victims, he regarded requiring down payments from low-income minority buyers as “patronizing and almost racist.’”
¹⁶

An Open Checkbook

So the political stars were aligned for a transformation of the home mortgage industry. Even before the Bush-era “ownership society,” Democrat Bill Clinton pushed to expand the number of Americans who owned homes, and the CRA and Fannie and Freddie were key weapons in the battle. In 1995 the Clinton administration gave a green light to Fannie and Freddie to start buying subprime securities, including those backed by mortgages given to low-income borrowers. By 1996 the feds required that fully 40 percent of the loans backed by Fannie and Freddie had to come from buyers with “below median incomes.”
¹⁷

“We began to stress homeownership as an explicit goal for this period of American history,” Henry Cisneros, then Secretary of Housing and Urban Development, later told
The Washington Post.
“Fannie and Freddie became part of that equation.” Noted the
Post
: “The result was a period of unrestrained growth for the companies.… The companies increasingly were seen as the engine of the housing boom. They were increasingly impervious to calls for even modest reforms.”
¹⁸

Critics lacked the clout to restrain the mortgage giants or their rush to financial recklessness. Defenders like Congressman Barney Frank insisted that the companies with their virtually limitless checkbook served a public purpose because they made mortgages cheaper.
¹⁹

Fannie and Freddie effectively wrapped themselves in the cloak of homeownership, which was recast as an indispensable part of the American Dream, as indeed it was. But a key distinction was overlooked: The
opportunity
to one day own a home was a far cry from a mad rush to provide everyone—even those who couldn’t afford one—the means to purchase a sprawling suburban ranch
right now.
Once seen as the end result of a series of choices, sacrifices, and prudent decisions, homeowners now had to be instantly gratified. Artificially cheap loans were what economists call “signal noise,” distorting the market and blinding politicians and investors alike to the peril of the expansion of the unaffordable loans.

As long as the music played—and the housing market continued to go up—the game worked: Homeowners got their bigger homes; the originators got their fees; Wall Street was able to reap fat yields; and taxpayers were assured they would never have to pay a nickel for any of this. Fannie and Freddie lubricated friendly politicians with generous campaign donations and kept fueling the subprime market even after it was caught cooking its own books. But when the music did, in fact, stop, the realization set in that the housing bubble had been fueled by funny money and that the dubious mortgages had been quickly shuffled from one hand to another, like a stick of dynamite with a slowly burning wick.

In September 2008, the federal government seized control of Fannie and Freddie and the taxpayer bailouts could amount to hundreds of billions of dollars.
*
The total price tag for bailing out the financial system could run into the trillions of dollars.

Chapter 11

BAILOUTS FOR IDIOTS (HOW TO MAKE OUT BIG BY SCREWING UP)

The Great Bailout of 2008–09 can be summed up simply:

Never have so few mooched so much off so many.
*

The numbers are mind-bending—tens of billions of dollars for badly run car companies; hundreds of billions for reckless financiers; trillions to bail out the mortgage insanity of the previous decade. Spurred by dire warnings of financial Armageddon, the bailouts rewrote the rules of finance, exemplified crony capitalism, and transformed the landscape of the free market. Losing large amounts of money is the essence of market discipline; the prospect of failure is precisely what deters businesses from running imprudent risks. But in the Great Bailout the laws of financial gravity were suspended, if not repealed: Some well-connected companies were protected from their losses by the generosity of taxpayers, many of whom were watching their life savings devastated by the financial turmoil.

As shocking as the bailouts seemed at the time, history is likely to be far less kind. The Congressional Oversight Panel’s review of the bailout of supermoocher AIG is a withering critique of cronyism, conflicts of interest, favoritism, and profligacy.

The government’s actions in rescuing AIG continue to have a poisonous effect on the marketplace. By providing a complete rescue that called for no shared sacrifice among AIG’s creditors, the Federal Reserve and Treasury fundamentally changed the relationship between the government and the country’s most sophisticated financial players.… Even more significantly, markets have interpreted the government’s willingness to rescue AIG as a sign of a broader implicit guarantee of “too big to fail” firms. That is, the AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America’s largest financial institutions, and to assure repayment to the creditors doing business with them. So long as this remains the case, the worst effects of AIG’s rescue on the marketplace will linger.
¹

Even though taxpayers will recoup some of the original cost of the bailouts, the consequences as well as the costs will be paid not over years, but over generations.

Bailouts, like corporate welfare, are not new. The federal government bailed out Chrysler in 1980, the S&Ls in the 1990s, Penn Central in 1974, and Lockheed in 1971. The Lockheed bailout set a precedent, but even so, that taxpayer rescue cost a mere $250 million, a small fraction of the money laid out to save Wall Street firms like Bear Stearns, Goldman Sachs, Citigroup, and AIG from their own excesses.

Beginning with the rescue of Bear Stearns for $29 billion, the $700 billion Troubled Asset Relief Program (TARP), the takeover of Fannie Mae and Freddie Mac (which put taxpayers on the hook for $5.5 trillion in debt), the loan guarantees for Citigroup and injection of cash into Bank of America, the $182 billion rescue of insurance giant AIG, and the tens of billions of dollars for Chrysler and General Motors, the bailouts marked a massive transfer of wealth from productive America to a new class of supermoochers.

As details have emerged, questions have multiplied: Were the bailouts really necessary? Were there alternatives to government takeovers? And was there any pattern to the winners and losers? The randomness of the bailouts is perhaps the most puzzling. Bear Stearns was rescued; Lehman Brothers was allowed to die; Citigroup got a stunningly generous bailout. Referring to Citi’s sweet deal, author Barry Ritholtz in
Bailout Nation
wrote: “One might assume the government would cut a hard bargain with the biggest, stupidest, most irresponsible bank in the country.… Instead, the Treasury essentially handed over the keys to the kingdom for a mere song.”
²
By guaranteeing nearly $250 billion in toxic assets, “the liabilities for a full decade of terrible decision making were transferred from Citi’s bond-shareholders to the taxpayers—a terrible deal for Uncle Sam, but a fantastic score for Citi.”
*

The taxpayers were essentially required to underwrite a decade of recklessness made possible by a mad fever of Wall Street greed abetted by misguided deregulation. A caveat here: On balance I support freeing markets from unnecessary rules, mandates, and forest-killing make-work regulations. But some libertarians (and I use this word respectfully) took a Panglossian attitude that sound ethics and prudent common sense would prevent the worst abuses if the government simply got out of the way. As it turned out, they were naïve in assuming that “deregulation” itself would make markets more efficient. As Richard Posner and others have noted, it is one thing to ease the burden of dysfunctional overregulation; it is quite another to use it as a cover for Wall Street to invent bogus new securities that were so lacking in transparency and so fragilely connected to reality that they bordered on the fraudulent. “If you’re worried that lions are eating too many zebras, you don’t say to the lions, ‘You’re eating too many zebras,’” said Posner. “You have to build a fence around the lions. They’re not going to build it.”
³

Regulators, including Congress, not only failed to build the fences, but they turned out to be as clueless as many of the investors who bought the exotic and highly leveraged securities. The country’s biggest firms simply poured fuel on the conflagration.

Casino

In 2004 the Securities and Exchange Commission waived its leverage rules that had limited firms to a maximum debt-capital ratio of 12 to 1. The exemption freed five firms—Goldman Sachs, Bear Stearns, Merrill Lynch, Lehman Brothers, and Morgan Stanley—to leverage their bets up as high as 30 or even 40 to 1.

These were casino-like wagers that would be considered certifiably insane, except for the belief that the value of real estate would continue to rise, as the banks apparently assumed. Here’s a simplified version (offered for demonstration purposes only) of the power and perils of leverage at this altitude: At a ratio of 40 to 1, a firm could buy $100 worth of subprime mortgages, for example, with just $2.50 of its own money. Here’s the upside: If the value of the investment rose by 5 percent to $105, the firm makes $5 on an investment of just $2.50—a profit of 100 percent, minus any interest payments. Brilliant.

Here’s the downside: If our investment of $100 drops in value by 5 percent, it will be worth only $95—and the $2.50 cash investment is transformed into a $5 loss—a loss twice the original investment. If the value drops by 10 percent, the loss becomes four times the original investment. Multiply these numbers by billions of dollars and you realize the panic that began to sweep through Wall Street’s high-flying casinos in 2007 and 2008.

As the Great Bailout began, the pattern of determining winners and losers shifted from the roulette wheel of the housing market to the halls of government. But the randomness remained: Some lenders were pressured by the feds to make concessions and take losses on their risky bets in exchange for bailouts; others were paid 100 cents on the dollar with taxpayer cash. But while there was no consistency, there were some discernible patterns. Foremost among them: It’s good to be Goldman Sachs.

Government Sachs

Before the Fall, American International Group (AIG) was a AAA-rated monolith with $1 trillion in assets, boasting 76 million customers around the globe. But it became the symbol of the reckless exuberance of the mortgage bubble. Among its many products, AIG’s soon-to-be notorious Financial Products subsidiary peddled insurance policies for exotic financial instruments that fueled the explosion of subprime lending. The insurance policies, known as credit default swaps or CDS, underwrote much of the wheeling and dealing of firms like Goldman Sachs. By late 2008 AIG was on the hook for more than $2.7 trillion worth of swap contracts. The swaps were such sure things, the company boasted, that its computers predicted that the odds of never having to pay out any money on the credit swaps was 99.85 percent.
⁴
AIG’s Financial Products unit believed that the CDS were so ironclad that the entire economy would have to descend into a full-scale meltdown before the company would have to pay out a penny to cover the defaulting bonds. As it turned out, billions of dollars in those swaps were held by Goldman Sachs.

Even in an era of crony capitalism, Goldman Sachs stands out. “Goldman, more than any other company,” wrote journalist Timothy P. Carney, “pulls the levers of government.”
⁵

Both the Bush and Obama administrations were packed with Goldman Sachs alumni; and the revolving door between government and the firm became so well established that Goldman won the moniker “Government Sachs.” So incestuous was the relationship between Goldman’s insiders and the government that the firm was able to orchestrate the Great Bailout to its maximum advantage. At key moments, the interlocking interests blurred distinctions between what was good for Goldman and what was good for everyone else.

For years, Goldman had packaged and marketed subprime mortgages to its clients, but more recently it had reversed its position, actively betting against the housing market by buying credit default swaps that would pay off if the housing bubble burst. Goldman was counting on AIG to pay it billions of dollars if, as it expected, the housing market began to implode. In any case, AIG and its sure-thing credit swaps were crucial for Goldman’s bottom line. As
The New York Times
later noted, “Without the insurer to provide credit insurance, the investment bank could not have generated some of its enormous profits betting against the mortgage market. And when that market went south, AIG became its biggest casualty—and Goldman became one of its biggest beneficiaries.”
⁶