Daily Archives: February 4, 2010

Who is Responsible for the Recession? The Role of Democrats and the Federal Reserve by Gregory Hilton

Many Democrats want to blame Republicans for the mortgage meltdown which greatly contributed to the recession. The start of the problem goes back to the “Community Reinvestment Act” of the Jimmy Carter administration which lowered bank lending standards. Another major step was the Gramm-Leach-Bliley Act which allowed commercial banks, investment banks, and insurers to merge. The legislation passed the Senate 90-8, and the House 362-57, and it was signed into law by President Bill Clinton on November 12, 1999. It would have violated antitrust laws under Glass-Steagall.
Democrats blocked GOP efforts to get control of Fannie Mae and Freddie Mac. The boards and senior management of both of these organizations were filled with political operatives of the Democratic Party. Clinton’s nominee to oversee Fannie Mae was able to scrape off $90 million in bonuses, while the organization was sinking. A popular Youtube video shows Sen. John McCain (R-AZ) warning Rep. Barney Frank (D-MA), the current Chairman of the Banking Committee, to reign in Fannie and Freddie. Frank almly responds “I do not see any potential problem.”
Another element was the creation of credit derivative swaps (CDS). Swaps are financial instruments traded over the counter between banks, insurance companies or other funds. This is how bad loans were securitized and on bank books as investments. The CDS market grew enormously with little oversight and regulation, and it made the financial crisis much deeper and more pervasive than it otherwise would have been. Brooksley Born was the Chairman of the Commodity Futures Trading Commission in the later half of the Clinton Administration. She was one of the first to see the CDS problem but her effort to bring these swaps under the CFTC umbrella was shot down by Clinton Treasury Secretaries Robert Rubin and Larry Summers.
The securities which back up a “securitized loan” are mortgages and deeds of trust. If the quality of the notes and deeds were good, there would have been no collapse of the securities in the first place. The quality of the notes and deeds were bad, and the blame for that is on the Democrats who forced banks to make bad loans.
Many people are blaming the Federal Reserve for the recession. They say the Fed did not do a good job as a regulator of financial markets and this caused the rise of subprime mortgages, adn the Fed’s easy credit policy inflated the housing “bubble.” These issues were addressed by economic journalist Robert Samuelson:

China and other developing countries became major trading nations. From the fall of the Berlin Wall to 2005, the number of workers engaged in global trade rose by 500 million. Competition suppressed inflation. Interest rates around the world declined; as this occurred, housing prices rose in many countries (not just the United States) because borrowers could afford to pay more.
Second, the Fed’s easy credit didn’t cause the housing bubble because home prices are affected by long-term mortgage rates, not the short-term rates that the Fed influences. From early 2001 to June 2003, the Fed cut the overnight Fed funds rate from 6.5 percent to 1 percent. The idea was to prevent a brutal recession following the “tech bubble” — a policy Greenspan still supports. The trouble arose when the Fed started raising the Fed funds rate in mid-2004 and mortgage rates didn’t follow, as they usually did. What unexpectedly kept rates down, Greenspan says, were huge flows of foreign money, generated partially by trade surpluses, into U.S. bonds and mortgages. It was not the end of the Cold War, as (former Fed Chairman Alan ) Greenspan asserts, that triggered the economic boom. It was the Fed’s defeat of double-digit inflation in the early 1980s. Since the late 1960s, high inflation had destabilized the economy. Once it fell — from 14 percent in 1980 to 3 percent in 1983 — interest rates slowly dropped. This promoted economic expansion and boosted stocks and housing prices. By 1988, a year before the fall of the Berlin Wall, mortgage rates had already dropped from 15 percent in 1982 to 9 percent. By 1991, the year the Soviet Union collapsed, the stock market had already tripled since 1982. . . Greenspan’s complicity in the financial crisis stemmed from succeeding too much, not doing too little. Recessions were infrequent and mild. The 1987 stock market crash, the 1997-98 Asian financial crisis and the burst “tech bubble” did not lead to deep slumps. The notion spread that the Fed could counteract almost any economic upset. Greenspan, once a critic of “fine-tuning” the business cycle, effectively became a convert. The world seemed less risky.