Has the SEC Charged the Right People with Securities Fraud?

May 28, 2010 09:16

It appears that the age of soft tyranny has ended, so be ready for more taxpayer-funded bailouts due to government-designed economic bubbles, based on unsound economic policy, and justified through social justice — all of which will be followed by major economic collapses.

By Larry N. Smith and C. Gary Moody at American Thinker

As Fannie Mae and Freddie Mac ask for an additional $8.4 billion of U.S. taxpayer dollars to cover their rising mortgage losses, their cumulative total debt to the American public comes to $145 billion. The citizenry hardly notices, and the government quietly writes a check to the two failing institutions. This strategy is in keeping with the American political system’s management of the populace’s collective attention, with the understanding that if an administration can ride out a scandal for six months, then all will be forgotten.

The uncurious press moves on to other events, and the limited public memory replaces old facts with new. This myopic historical memory is exactly what the political class is using to hide its culpability in the national mortgage crisis. Therefore, a quick history lesson is in order.

The 1970s brought the Community Reinvestment Act, followed by the Equal Credit Opportunity Act and the Home Mortgage Disclosure Act. These laws were then used by socio-political activists to pressure banking and lending institutions into making bad loans, which these institutions probably would not have made without the new laws in place. In the name of social justice, the FDIC was further empowered to audit lenders for redlining practices and pressured regulated private lending institutions to make marginal and bad loans. From within Fannie and Freddie, two quasi-political, uninsured, and unregulated government institutions, these bad loans were bought and packaged or securitized as collateralized mortgage obligations (CMO). The bad loans were packaged with a collection of good loans into multi-year tranches so that the entire loan package could receive an investment-grade bond rating. With rating institutions giving good ratings to these volatile, risky CMOs, an artificial, government-created market was born.

The original lending institutions were happy to sell these notes, as they wanted the high-risk loans off their books. As a result of progressive government intervention and regulation, the multi-layered CMOs grew into a massive and lucrative financial instrument. This artificial sub-prime CMO market flourished only because of forced government regulation through bureaucratic agencies and law.

After the Glass-Steagall Act was officially repealed in 1999, every mortgage originator got into the business and legally underwrote marginal loans. This all occurred while the fundamentally unsound practice was being championed by Democrats such as past President Carter, Senators Dodd and Obama, and Congressmen Frank and Rangel, as well as ACORN, the Urban League, and virtually every other progressive political organization in the country.

Fannie and Freddie expanded the CMO market through the 1990s and early 2000s as investment banks realized the trade was lucrative and was not illegal. Such highly rated CMOs began replacing much safer U.S. Treasury notes in the banks’ investment portfolios. Institutions such as Goldman Sachs, Lehman Brothers, and Merrill Lynch did the same, all the while originating, packaging, and selling the sub-prime loans along with a few good loans to keep the CMO highly rated. Again, these practices were all legal and supported by an artificial, government-created and -regulated market.

Countrywide Financial and other mortgage companies were happy to play in this new market of government-mandated social justice. The government had made the risks very low with cheap money, and Fannie and Freddie absorbed the toxic loans by purchasing them from the banks. As a result, housing prices exploded (and lest we forget, even Senator Chris Dodd earned a favorable low-interest loan from Countrywide). Insurer AIG was guaranteeing these securitized loans with the implicit backing of the government, gambling that the Feds would possess the deep pockets of last resort in the event that this social justice experiment failed.


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