When the Financial Crisis Inquiry Commission (FCIC) reported in January that the 2008 crisis was caused by lax regulation, greed on Wall Street and faulty risk management at banks and other financial firms, few were surprised.
That, after all, was the narrative propagated by government sources since 2008 and widely accepted in the media, in numerous books, and by many commentators. Writing in the New York Times on June 30, for example, Pro-Publica reporter Jesse Eisinger complained that bankers' concerns about excessive regulation under the Dodd-Frank Act did not take account of "the staggering costs of the crisis that the banks led us into."
The notion that the "banks led us into" the financial crisis echoes the narrative of the FCIC's Democratic majority, which placed the blame for the financial crisis on the private sector and dismissed the idea that government housing policy could have been responsible.
According to the FCIC majority report, the government's housing policies--led by the Department of Housing and Urban Development and the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac--contributed only "marginally" to the crisis. Moreover, Fannie and Freddie "followed rather than led Wall Street and other lenders" into the subprime and other risky mortgage lending that ultimately caused the financial crisis.
With the publication of "Reckless Endangerment," a new book about the causes of the crisis, this story is beginning to unravel. The authors, Gretchen Morgenson, a business reporter and commentator for the New York Times, and Josh Rosner, a financial analyst, make clear that it was Fannie Mae and the government housing policies it supported, pursued and exploited that brought the financial system to a halt in 2008.
After James A. Johnson, a Democratic political operative and former aide to Walter Mondale, became chairman of Fannie Mae in 1991, they note, it became a political powerhouse, intimidating and suborning Congress and tying itself closely to the Clinton administration's support for the low-income lending program called "affordable housing."
This program required subprime and other risky lending, but it solidified Fannie's support among Democrats and some Republicans in Congress, and enabled the agency to resist privatization or significant regulation until 2008. "Under Johnson," write Ms. Morgenson and Mr. Rosner, "Fannie Mae led the way in encouraging loose lending practices among banks whose loans the company bought. . . . Johnson led both the private and public sectors down a path that led directly to the financial crisis of 2008."
The authors are correct. Far from being a marginal player, Fannie Mae was the source of the decline in mortgage underwriting standards that eventually brought down the financial system. It led rather than followed Wall Street into risky lending.
This history does not appear in the FCIC majority report, and Mr. Johnson was not among the more than 700 witnesses the commission claims to have interviewed. Edward Pinto (a former chief credit officer of Fannie Mae, and now a colleague at the American Enterprise Institute) presented the evidence to the commission showing that by 2008 half of all mortgages in the U.S. (27 million loans) were subprime or otherwise risky, and that 12 million of these loans were on the books of the GSEs.
The research he gave the commission also showed that two-thirds of these subprime or risky loans were on the books of government agencies or firms subject to government control. But these facts were left out of the majority report. They did not fit with the narrative that the financial crisis was caused by the private sector, and they moved the blame uncomfortably close to the powerful figures in Congress who had supported the GSEs and the affordable housing goals over many years--and of course who appointed the majority of the commission.
If that were the end of the matter, we would be dealing solely with a report distorted by partisan considerations. The commission majority's false narrative, however, buttresses the notion that more regulation of banks and other private-sector financial institutions could have prevented the financial crisis--and might be necessary to prevent another one. This was the rationale for the Dodd-Frank Act.
But if government housing policy, and not Wall Street, caused the financial crisis, what was the basis for Dodd-Frank's extraordinary and growth-suppressing regulation on the financial system? This question is particularly trenchant as the country struggles through a seemingly interminable recession, brought on initially by a mortgage meltdown and a financial crisis but possibly extended by the uncertainties and credit restrictions flowing from the most comprehensive controls of the financial system since the New Deal.
The principal sponsors of that Dodd-Frank Act, former Sen. Chris Dodd and former House Financial Services Committee Chair Barney Frank, were also the principal supporters and political protectors of Fannie Mae and Freddie Mac, and the government housing policies they implemented.
It is little wonder then that legislation named after them would place the blame for the financial crisis solely on the private sector and do nothing to reform a government-backed housing finance system that will increasingly be seen as the primary cause of the devastating events of 2008.
Peter Wallison is the Arthur F. Burns Fellow in financial policy studies at AEI.