Don't Know Much About History, Anniversary Edition: Everything You Need to Know About American History but Never Learned (Don't Know Much About®) (97 page)

In the language of economics, real estate, and banking, “underwater” describes a house that is worth less than the amount it is mortgaged for. During an incredible boom time in America, such an idea was far removed from the minds of most people, including many of the world’s economists and central bankers, such as Alan Greenspan. For more than a decade, skyrocketing housing values continued to propel the American economy, aided by increasingly elaborate mortgage products that promised to put millions of Americans in reach of a “McMansion” of their own. Housing, for obvious reasons, is a major driver of the economy and for a time in America, there was only one way for house prices to go—
up.

But if mortgage debt was rain, and the banks that held those mortgages and the investment houses that bought and sold mortgage-backed securities were the canals holding in the water, the levees were about to break. Soon, millions of Americans found themselves with houses that were “underwater”—and banks began to foreclose on those houses in an effort to avoid their own bankruptcies. The vastly inflated “bubble” in housing prices had been pricked. And as the bubble deflated, it threatened to bring America back to the hopeless days of the Great Depression.

The “subprime” crisis. The credit crisis. The Great Recession. It was an economic downturn unlike anything most living Americans had ever seen. And for a while, the nation teetered on the edge of another Great Depression. Would the financial system, now intricately linked across borders, actually hold? Would the financial levees hold? Or would a financial flood of debt come washing over the country, inundating homes and businesses just as the waters had drowned New Orleans in 2005?

As the nation prepared to elect a new president in 2008, the deluge certainly seemed to be coming. For months, the country had teetered at the edge of economic disaster. Slumping housing sales. Plummeting retail sales. Personal and corporate bankruptcy filings on the rise. Employers slashing payrolls at the fastest pace in decades. One of the most visible of American retailers, Circuit City—home of the electronic playthings that had become as American as two cars in the garage and a chicken in every pot—shut its doors.

The immediate crisis had begun in early 2007 with the deepening troubles of a number of Wall Street investment firms whose risky bets in mortgage-backed securities—a financial invention of the previous decades that had proved extremely profitable while housing prices were going up—came crashing down as a recession burst the bubble in American housing prices.

Many of those mortgages were underwritten and held by two agencies, known widely as Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Association). Fannie Mae was created in the Depression era to purchase mortgages, allowing lenders to free up money to make more mortgages. In 1968, Fannie Mae was converted into a private, shareholder-owned corporation. At the same time, Freddie Mac was created to compete with Fannie Mae in order to create an efficient secondary mortgage market. In the 1980s, Fannie Mae created the mortgage-backed security. Over the years, the two corporations had also been politically pressured to ease loan requirements to low-income and middle-income earners. This meant greater risks for corporations that were responsible to their shareholders to make a profit yet still were exposed to political pressure. By 1999, Steven Holmes of the
New York Times
warned, “Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s.” A series of accounting scandals then hit Fannie Mae as well, and the troubled agency was taking water.

By 2007, Holmes’s prediction came true. As more subprime loans went into default, the two mortgage giants teetered. Although they were not legally backed by the federal government, most investors believed that the government would not let them fail. In 2008, the two companies were placed in “conservatorship” inside another federal agency. Shareholders, many of whom believed that Fannie and Freddie were “guaranteed” by the federal government, now held nearly worthless shares in the two mortgage giants, which together held more than half of all U.S. mortgages in 2008.

The Bush administration, already badly damaged by the political fallout from the failing war in Iraq and the president’s response to Hurricane Katrina, suddenly had to deal with a new levee about to burst—the entire American banking system seemed unable to hold back the floodtide, largely begun by underwater mortgages and the inability of a growing number of Americans to meet their monthly mortgage payments, especially in the case of adjustable-rate mortgages, which increased as interest rates climbed. By the time Barack Obama was elected president, the insurance giant AIG announced that it had lost $24.5 billion in the summer of 2008, and the Bush administration announced a plan to save it. In November, the ailing financial giant Citigroup, once the standard-setter for global bankers, reached a rescue agreement with the Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC). It would mean that the government was about to become a major shareholder in the bank. Also in November, Bush’s secretary of the treasury, Henry Paulson, announced that the $700 billion bank bailout plan known as the Troubled Asset Relief Program (TARP) would be used to stabilize and stimulate credit markets.

Then two of Detroit’s “big three” automakers—General Motors and Chrysler, the backbone of American manufacturing for a century—asked Congress for a taxpayer-financed rescue.

It was a series of extraordinary events, a cataclysm of failing financial dominoes that had not been seen in America since the time of the Great Depression—and the fear of another Great Depression was not exaggerated. In his book
The Big Short
, the financial writer Michael Lewis wrote, “Every major firm on Wall Street was either bankrupt or fatally intertwined with a bankrupt system.”

In
Too Big to Fail
, his exhaustive history of the crisis, the financial columnist Andrew Ross Sorkin described it this way:

In the span of a few months, the shape of Wall Street and the global financial system changed almost beyond recognition. Each of the former Big Five investment banks failed, was sold, or was converted into a bank holding company. Two mortgage-lending giants and the world’s largest insurer were placed under government control. And in early October [2008], with a stroke of the president’s pen, the Treasury—and by extension, American taxpayers—became part-owners in what were once the nation’s proudest financial institutions, a rescue that would have seemed unthinkable only months earlier.

Once in place in January 2009, the Obama administration basically had to continue a jerry-rigged rescue plan begun by the Treasury Department and Federal Reserve under the outgoing Bush administration while also trying to battle a long, deep recession that was pushing unemployment higher. The job losses were adding to the crisis, as the unemployed were unable to pay their mortgages and consumer spending ground to a near-halt. In February 2009, the American Recovery and Investment Act (the “stimulus”) was passed, intended to boost the nation’s struggling economy, with a combination of tax cuts and spending. (No Republicans in the House and only three Republican senators supported the legislation.)

A year later, the levees seemed to have held, but at enormous cost to taxpayers. The notion that Americans were bailing out wealthy bankers and investment firms while millions of average Americans lost their homes and their jobs helped fuel rage against Washington and Wall Street. Some of this rage emerged in the Tea Party movement, which attracted Americans angry over the size of government and its intrusion into the free market. And as Andrew Ross Sorkin put it:

That of course raises a more pointed question. Once the crisis was unavoidable, did the government’s response mitigate it or make it worse? To be sure, if the government had stood aside and done nothing as a parade of financial giants filed for bankruptcy, the rest would have been a market cataclysm far worse than the one that actually took place. On the other hand, it cannot be denied that federal officials—including Paulson, Bernanke and Geithner—contributed to the market turmoil through a series of inconsistent decisions. They offered a safety net to Bear Stearns and backstopped Fannie Mae and Freddie Mac but allowed Lehman to fall into Chapter 11, only to rescue AIG soon after. What was the pattern? What were the rules? There didn’t appear to be any, and when investors grew confused—wondering whether a given firm might be saved, allowed to fail, or even nationalized—they not surprisingly began to panic.

A
MERICAN
V
OICES

CONGRESSMAN BARNEY FRANK
, discussing the financial crisis on
60 Minutes
, December 11, 2008:

The problem in politics is this: You don’t get any credit for disaster averted. Going to the voters and saying, “Boy, things really suck, but you know what? If it wasn’t for me, they would suck worse.” That is not a platform on which anybody has ever gotten elected in the history of the world.

How did America elect its first black president?

In mid-October 2008, a few weeks before the presidential election pitting the one-term Democratic senator Barack Obama of Illinois against Arizona’s veteran Republican senator, the Vietnam War hero John McCain, NBC News and the
Wall Street Journal
released a poll taken among registered voters. Of the respondents, 2 percent said race made them more likely to vote for Barack Obama, 4 percent said it made them less likely to vote for Barack Obama, 2 percent said they were not sure how it swayed them, and 92 percent said race was not a major factor.

Those numbers may reflect people saying what they thought the pollsters wanted to hear. But even so, the fact that more than nine out of ten people would claim that race was not a factor was still extraordinary. In a country where racial politics, racial relations, the history of slavery, and the civil rights movement have been such an emotionally scarring part of the national debate for such a long time, the idea that a very large majority said race was not a factor in their vote was nothing short of a shock.

What surprised a good many veteran political observers just as much was that this young, little-known senator from Illinois had burst onto the scene and defeated the Democratic powerhouse Hillary Clinton in a primary race that the senator from New York and former first lady thought was her prize—a step to becoming America’s first female president.

Just as they would be in the presidential campaign, the policies of the outgoing president George W. Bush and Americans’ desire for change were key issues throughout the primary campaign. Bush was unpopular. Polls consistently showed that only 20 to 30 percent of the American public approved of his job performance.

On that count, Barack Obama held a distinct advantage. As the war in Iraq became increasingly unpopular, it was Obama who could campaign as the Democrat who had opposed the war. As a senator, he had voted against the measure authorizing the war; Hillary Clinton had voted for it. Apart from that crucial difference, there were few serious policy disagreements between the two Democrats. (Days after his election, Obama offered the post of secretary of state to Senator Clinton, his bitter primary rival, who accepted the job.)

Obama’s primary victory was fueled largely by that discontent, along with a desire for “change.”

During the general election campaign, the major party candidates ran on a platform of change and reform in Washington. Domestic policy and the economy eventually emerged as the main themes in the last few months of the election campaign after the onset of the 2008 economic crisis.

But the unpopular war in Iraq was a key issue during the campaign before the economic crisis. When John McCain said the United States could be in Iraq for as long as the next 50 to 100 years, his remark proved costly. Running against George Bush as much as against John McCain, Obama linked McCain, a stalwart supporter of the war in Iraq, to the unpopular President Bush; this was not difficult, since McCain himself said he supported Bush 90 percent of the time that the president was in office.

McCain attempted to depict Obama as inexperienced, but the desire for “change” seemed more important to Americans than “experience.” It seemed there was an awful lot of experience behind the Bush team, and many Americans thought that this team had made a mess of things. Of what value was experience?

McCain also undercut his own argument for experience with the historic selection of the first woman to run for vice president on the Republican ticket, Governor Sarah Palin of Alaska, who quickly became a lightning rod of controversy in the election. Palin had been governor only since 2006, and before that had been a council member and mayor of the small Alaskan town of Wasilla. When several media interviews suggested that Palin lacked basic knowledge on certain key issues, serious doubts were raised about her qualifications to be vice president or president.

But the war and experience—Obama’s or Palin’s—soon took a backseat to the economic crisis engulfing the country. The campaign played out against the recession and the credit crisis. McCain’s prospects suffered as he made some costly misjudgments about the economy and was once again linked to the Republican administration that was being blamed for the crisis. It didn’t help when he told an interviewer that he didn’t know how many houses he and his wife owned. (The answer was seven.) His out-of-touch image took another hit when, on September 15, the day of the Lehman Brothers bankruptcy, McCain declared that “the fundamentals of our economy are strong.”