Putting Principle First

By: Mr. Curmudgeon
mrcurmudgeon@inthepublicsquare.com

On Christmas Day of 1991, a dejected Mikhail Gorbachev – last dictator of the Soviet Union – signed a letter informing anyone who cared that he was resigning as leader of the Evil Empire. Gorbachev’s last official signature, after seventy years of communist denial, resigned himself and his country to reality. The world’s first experiment in government-enforced utopia ended not with a bang but a whimper; brought down, not by war but economic reality. Simply stated, Gorbachev discovered that there is no such thing as a free lunch.

Today, the U.S. banking system and economy is teetering on the brink of collapse for the same reason. Government policies and the agencies that carried them out have brought this nation dangerously close to extinction. Now, ironically, the American people are looking to the same social engineers of this disaster to cook up a plan to save them from loosing everything they have worked a lifetime to build. The future looks very grim indeed.

This disaster began innocently enough during the Carter administration. In 1977, the Democratically controlled Congress passed the Community Reinvestment Act, which mandated that banks make loans to low-income borrowers without regard for ability to repay. The quasi-governmental agencies Freddie Mac and Fannie Mae bought the mortgages back from the banks, converting them into Mortgage Backed Securities (MBS). Some of these securities were sold on the secondary market, bringing a tidy profit for some of the appointed officials at Freddie and Fannie. According to the New York Times, the two agencies hold $5.2 trillion in mortgages.

As the adjustable rate on many subprime loans began to rise, so did the number of defaults. As the red ink on subprime increased, Freddie and Fannie officials cooked the books to hide the losses, which also shielded their congressional allies. It’s estimated that Freddie and Fannie have suffered $217 billion in losses because of subprime. The Congress eventually stepped in and took control of the mortgage giants, infusing the institutions with $200 billion.

But there is another market most people have never heard of; it’s called the credit default swap market. In it, policies insure bonds and other debt instruments against loss to investors. This market totals a whopping $62 trillion. One of the largest issuers of these policies is American International Group (AIG). The problem with a number of these instruments is that the assets, namely real estate, that back them are declining in value. The more subprime borrowers default, the more homes enter the market. The more homes on the market, the greater the downward pressure on the overall market value of housing in general.

The reason the U.S. Treasury Department is urging congress to bailout AIG (calling it “too big to fail”) is that it insures investors against trillions of dollars in losses should a large number of U.S. banks collapse. The number of banks currently on the verge of collapse could drive AIG into bankruptcy. Surviving banks, in this scenario, are less likely to lend money to other banks, seizing up the international credit market and leading to a global economic collapse. Treasury says the bailout will cost American taxpayers $700 billion. But many experts say it will be over $1 trillion – a mere fraction of the capital needed should a banking catastrophe actually occur.

Rep. Barney Frank, Chairman of the House Financial Services Committee said with a straight face, “The conservative philosophy of…don’t regulate, let the market do what they want, don’t have any supervision of these risky decisions…that’s brought us into this situation.”

Rep. Frank is banking on the short-term memory of the American people. In an interview with The Nightly Business Report, conducted shortly after he was named chairman of the Financial Services Committee in 2006, Rep. Frank said: “If you are African-American or Hispanic, you have less chance of getting a mortgage. …I think that has got to be a very high priority.” In other words, the Democrats were committed to continue pressuring Freddie and Fannie to issue more bad loans.

In fact, after the recent Freddie and Fannie takeover by the government Frank said, “I want [Freddie Mac and Fannie Mae] to help with affordable housing, to help low-income families get loans and to help clean up this subprime mess. Otherwise, why should they exist?” In other words, that these risky subprime loans threaten to destroy the financial wellbeing of 300 million Americans is no reason to suspend issuing loans as long as they buy Democrats more votes.

In fact, Senate and House Democrats insist that a bailout of AIG also include tax money to help subprime mortgage holders meet their obligations. The Bush administration has acquiesced to this as well as many Senate and House Republicans. This crisis truly exemplifies the very real danger inherent in the Republican tendency to “reach across the aisle.”

Republicans conveniently forget that their party controlled both houses of Congress for thirteen years. During this time, many of the dangerous programs that now threaten our country were never overturned. In fact, a 2005 Republican sponsored bill to tighten regulatory oversight of Freddie and Fannie never made it into law. And, again, this failure occurred while Republicans controlled both houses of Congress and had a President in the White House.

It is clear that whatever legislation Congress enacts to deal with our financial crisis won’t reform the legislative or bureaucratic excesses that brought about this tangled mess. Instead, the bipartisan plan will throw good money after bad, further deepening the crisis.

Sen. McCain suspended his presidential campaign and rushed to Washington to be part of the legislative negations. “There are times for politics and there are times to rise above them…” said McCain. “[We must] do what is right for the country…This is one of those times.”

This precisely explains the bipartisan mindset that led us to the edge of this cliff in the first place. “Country First” is a nice campaign slogan for Sen. McCain and his Republicans, but putting principle first would have served his party far better, and in the process, saved his country.

--Mr. Curmudgeon