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Monday, September 22, 2008

Financial Meltdown: Where Does The Buck Stop?

That's a good question. Where does it stop? And what can we do to make sure that something like this doesn't happen again?

Well, we need to find out where this all started and how. Without doing so, all the debate will be meaningless and the current efforts at a bailout will simply result in more crises down the line.

So, where did it start? Sheldon Richman, editor of The Freeman and an economist with the Foundation for Economic Education has the answer to this. According to Cybercast News Service:

“The biggest culprit, I think, is the implicit guarantee the government has always issued to Fannie Mae and Freddie Mac,” Richman said. “Something like 80% of the mortgages these days are held or backed by Fannie Mae or Freddie Mac,” he said, and “they get special treatment from the government like no other lender gets.”

Okay, there was a big bailout of these two earlier this year. What do they have to do with anything and why?

“[T]he financial industry is regulated all over the place.” In Richman’s analysis, it is precisely the government guarantee of Fannie and Freddie that is “short-circuiting” the market.”


Providing context, Richman said government policy laid the foundation of this crisis more than 30 years ago when Congress passed the Community Reinvestment Act of 1977. This law forced banks to loan money to low-income borrowers as a way to ensure that financial institutions would “meet the credit needs of the local community.”

Under the Clinton administration, federal regulators began using the act to combat “red-lining,” a practice by which banks loaned money to some communities but not to others, based on economic status. “No loan is exempt, no bank is immune,” warned then-Attorney General Janet Reno. “For those who thumb their nose at us, I promise vigorous enforcement.”

Now we are getting to the meat of the problem. Government had been forcing lending institutions to make high-risk loans and Freddie Mac and Fannie Mae have been buying up those loans. When the defaults on these loans began to pile up, the collapse of Freddie and Fannie happened and the need for the bailout soon followed.

Further, it wasn't that banks wanted to make (or even encouraged the making of) these loans. They were forced to.

The Clinton-Reno threat of “vigorous enforcement” pushed banks to make the now infamous loans that many blame for the current meltdown, Richman said. “Banks, in order to not get in trouble with the regulators, had to make loans to people who shouldn’t have been getting mortgage loans.”

This threat combined with the government backing of Fannie and Freddie set the stage for the current uncertainty, because the “banks could just sell the loans off to Fannie or Freddie,” who could buy them with little regard for negative financial outcomes, Richman said.

The problem is that the government's policy of requiring private institutions to make these bad loans is still in place. The failures of Freddie and Fannie and the bailouts of AIG and Bear Stearns are just symptoms. The disease of government intervention is still on the books.

One of the conditions for enacting a bailout should be to remove the ridiculous high-risk loan requirements put in place by the Carter and Clinton Administrations.

You can access the complete column on-line here:

Financial Meltdown: Where Does The Buck Stop?
Matt Cover
September 22, 2008

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