Bernanke's Finger Pointing

by John M. Curtis
(310) 204-8700

Copyright Jan.. 7, 2010
All Rights Reserved.                    

             Blaming the housing bubble on lax regulation, Federal Reserve Board Chairman Ben S. Bernanke pointed at the wrong culprit, insisting that permissive lending practices caused the last housing bubble.  Bernanke forgets that Fannie Mae and Freddie Mac, the government-backed agencies commissioned by Congress to make homeownership more affordable, relaxed lending guidelines in 1997.  Supported by former President Bill Clinton and passed by Congress, the 1997 Community Reinvestment Act mandated changes to discriminatory lending practices, preventing the poor and minorities from home ownership.  When translated to Fannie Mae and Freddie Mac, the agencies relaxed the bias toward W-2 or company-employed borrowers typically requiring income verification.  CRA ended discrimination against self-employed borrowers, requiring less employer-based income verification.

            U.S. lenders selling mortgages to Freddie Mac and Fannie Mae in the so-called secondary market, no longer required the old rigorous income verification documentation, instead relying on property appraisals measuring home equity and FICO or credit scores.  When the housing bubble burst two years ago, some experts blamed former Fed Chairman Alan Greenspan for loosening monetary policy, namely, lowering short-term interest rates, causing real estate inflation.  “All efforts should be made to strengthen our regulatory system to prevent a recurrence of the crisis, and to cushion the effects, if another crisis occurs,” said Bernanke, asking Congress to expand the Fed’s regulatory powers.  What Bernanke forgets is that only two years after passing CRA, the Congress passed the 1999 Gramm-Leach-Bliley Act, essentially repealing the 1933 Depression Era Glass-Steagall Act.

            After the stock market Crash of 1929, the 1933 Glass-Steagall Act protected bank depositors by restricting banks from risky stock market investments.   In exchange for regulating banks, Congress funded the Federal Deposit Insurance Corporation, insuring bank deposits against a future stock market crash or economic calamity.  While Bernanke blames loose lending practices and unqualified borrowers, he forgets that Clinton and the Congress permitted banks under Gramm-Leach Bliley to restart risky stock market investing.  That’s when investment banks like Goldman Sachs created abstract mortgage-backed securities known as “derivatives” to trade like stocks in domestic and foreign exchanges.  With more people qualifying under CRA for mortgages, it caused real estate prices to rise, escalating derivative prices.  By the end 2000, the Dow hit 12,500 and Nasdaq 5,000, generating massive profits for financial institutions trading mortgage- backed.securities.

            Unlike the stock market where few investments get insurance, banks insured derivatives through “credit-default-swaps,” complex insurance policies primarily sold by American International Group [AIG] to insure derivative investments.  When defaults and foreclosures began to rise, the derivative market collapsed, causing AIG to go broke, unable to reimburse banks for failed investments.  Credit markets began to seize, causing a  liquidity crisis, prompting the Bush Administration, Fed and Congress to pass the $687 billion Toxic Assets Relief Program [TARP] to provide emergency capital to banks on the threshold of insolvency.  Blaming the collapse on unqualified borrowers only tells part of the story, where banks abandoned all common sense and invested heavily in the risky derivative market.  Bernanke’s finger-pointing at residential mortgage borrowers misses the point.

            When Bernanke talks of reforms, he’s not talking about repealing Gramm-Leach-Bliley, restoring Glass-Steagall and restricting banks from the risky stock market investing that seized up credit markets.  He’s referring to restricting specific kinds of mortgage products known in the lending business as negative-amortization loans, allowing borrowers to pay interest only or a small fraction of the principle-and-interest.  Instead of butting into the lending business, Bernanke would be better served working on more regulations for banks to prevent reckless derivative investing.  Bernanke knows that raising short-term interest rates, namely, the Federal Funds rate, has only minimal effect on long-term rates like T-bills and 30-year mortgages.  Bernanke warned that if the Fed didn’t get more regulatory authority, he’d have to use monetary policy to prevent future bubbles.

            Bernanke should focus his efforts on repealing Gramm-Leach-Bliley, restoring elements of Glass-Steagall and assuring optimal monetary policy designed to maintain a strong dollar and stable money supply.  Today’s cheap dollar policy has eroded faith in the U.S. economy and driven foreign T-bill investors like China to have reservations about making more investments.  Instead of pointing fingers at residential mortgage borrowers, the Fed should look at current reckless bank investing policies that caused credit markets to seize and lending to stop.  Banning banks from investing in derivatives would be a good first step in restoring fiscal sanity in an otherwise speculative investment bubble.  Bernanke must reconsider the necessity of the 1997 Community Reinvestment Act to assure the American Dream of homeownership.   Today’s harsh lending standards hurt real estate and the overall economy.

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news.  He’s editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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