How many of us have marveled at our own creativity in producing a soap-derived bubble that was perfectly formed and symmetric, but knowing full well this wondrous creation would soon burst?

This is exactly what we have done in the housing market as we have artificially channeled capital into the American dream known as home ownership. We have created an overpriced bubble in home prices that eventually would bust.

The dream that everyone should own their home, purchased at an affordable price, and then expect 10 percent annual appreciation in the home’s value is laudable but not guaranteed or entitled. Like water always flowing downhill, capital flows to where it has the highest return and lowest risk if left to the marketplace. This prevents large run-ups or large price declines if the government does not get involved and no “bubbles” are created to later burst.

It was the low interest-rate policy of Alan Greenspan in the 1990s that fed the “Tech Wreck” bubble collapse of the stock market early in 2000, and the same easy money policy was followed by Greenspan after this Tech Wreck and 9/11 in the middle 2000s. Bubbles cannot be created unless central banks monetize them.

As in so many aspects and facets of our culture, “government knows best” and has contributed to our slouching toward socialism, and helped to create a bubble in home prices that now has burst. Do not listen to those who blame this financial debacle upon greed, capitalism or deregulation. The fault lies in the federal government force-feeding capital into housing. This is simply socialism at work, and since the government cannot be as smart as markets, financial problems always follow.

Financial purgatory

The chronology of our descent into financial purgatory begins (as does much of our slide into socialism) in the New Deal of the Roosevelt Administration. The New Deal did not cure the Great Depression, World War II did.

Federal National Mortgage Association (FNMA/Fannie Mae) was created in 1938 to help provide liquidity to banks that had made bad home loans. Thus the creation of the first government-sponsored entity (GSE) to transfer some of the home-loan risk to the federal government and eventually the taxpayers. Still implicit in this government involvement in the home-mortgage industry was the fact that the original loans be made in accordance with safe and sound lending practices; i.e., the borrower must have the ability to repay the loan via a job and have positive net worth. Fannie was chartered as a private company in 1968, by the Johnson Administration, to get the company off the federal budget as Johnson’s two wars, poverty and Vietnam, were causing federal spending to balloon.

Federal Home Loan Mortgage Corporation (FHLM/Freddie Mac) was created in 1970 as a stockholder-owned company (just like Fannie) to provide competition for Fannie. By 1970, both Fannie and Freddie are GSEs and removing more risk from the banks that originate the loans and passing the risk to the taxpayer. Again, both the involvement of Fannie/Freddie was still to be in accordance with safe and sound banking principles.

Pandora’s box

The Community Reinvestment Act (CRA) was passed by the Carter Administration in 1977 to force banks to stop “redlining”; i.e., not making loans in poor neighborhoods, many of which are minority. But again, these loans in low-income neighborhoods were supposed to be made according to sound and safe banking principles. This CRA also opened the Pandora’s box of lending based upon skin color and the wretched race card will be played more and more after 1977.

It was the election of Bill Clinton in 1992 where government involvement in home lending really got out of control. Clinton and his Treasury secretary, Robert Rubin (formerly CEO of investment bank Goldman Sachs) rewrote the rules in 1994, just before the GOP took control of the House, for how banks could comply with the onerous burden of the CRA rating that allowed them to expand or merge. If they wanted to get a decent rating, they had to make riskier loans to low-income and minority mortgage seekers. Thus, the nation now had affirmative action in banking. Fannie/Freddie purchased these loans from the banks, since their GSE status assured the investors that purchased their bonds of government backing that Fannie and Freddie securitized the loans for further resale. The risks are again loaded off on the taxpayer. The GOP tried to slow this freight train down, but the damage was done before Newt Gingrich became speaker in 1994. Government-created GSEs had touched 70 percent of the entire mortgage market by early 2008.

The amount of “subprime” loans had increased from $35 billion in 1994 to more than $1 trillion by 2007. In fact, between 1992 and 2004, the infamous community organizing group ACORN, known for voter fraud and where Barack Obama cut his political teeth, had urged the Clinton administration to pressure Fannie/Freddie to make more of their loans to “low-income” borrowers. What a recipe for disaster.

Where was the warning?

Was anyone warning of the potential danger to our financial system if housing prices started to decline, resulting in the collateral that stood behind all those ill-advised mortgage loans to erode and the bubble to burst?

President Clinton’s Treasury secretary, Larry Summers, did warn about Fannie/Freddie but was shot down by Sen. Chris Dodd, D-Conn., and Rep. Barney Franks, D-Mass. President Bush, in 2003, did urge oversight of Frannie/Freddie to be transferred to the Treasury Department, but he was blocked by such financial gurus as Barney Franks in the House, who said: “Frannie/Freddie are not facing crisis and President Bush is creating an artificial issue.”

Franks is now the House member in charge of the banking committee. In 2005, Sen. Hagel, R-Neb., crafted a letter urging that Fannie/Freddie be reformed. Nineteen senators, all Republicans, signed this, including Sen. John McCain. Not a single Democratic senator signed, nor did Missouri Sens. Christopher Bond or Jim Talent. In all, from 2003 to 2008, the Bush Administration made twelve attempts to slow down the rapid expansion of Fannie/Freddie, but was stifled by most of the Democrats and too many Republicans in Congress.

I must add that the Republicans are not without blame in this mess as only 19 of them signed on Hagel’s letter.

Current Senate Majority Leader Harry Reid puts the nail in the coffin of reform: “While I favor improving oversight, we cannot pass legislation that limits home ownership.” Dodd chimes in: “President Bush should reconsider his ill-advised position.” Dodd and Franks are now leading the Torquemada-like inquisition into the causes of this financial meltdown, when they and their party bear much responsibility. Heaven help us.

We should not provide an environment of profit-side capitalism, while guaranteeing loss-side socialism in the existence of Fannie/Freddie as GSEs. We must phase out and totally privatize them without any implicit or explicit guarantees of their debt. We must make loans on the basis of credit history, not skin color. And we must eliminate the moral hazard of ill-advised government policy producing perverse behavior such as creating a giant real-estate bubble by the improper channeling of our nation’s capital into the dream (but not entitlement) of home ownership.

The chances of this happening after the 2008 election are slim to none, as the very political party that did the most to cause this bubble is on the ascendancy and will receive very little blame.

This is our ultimate moral hazard. Be concerned, be very concerned.

Richard La Near is the J.R. Kuhn Distinguished Professor of Finance at Missouri Southern State University.

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