Cash Cows and Scapegoats

Now that Bank of America has settled with DOJ for an unprecedented $16 billion, it is time to reflect on the pervasive corruption that led to the housing bubble. The settlement is for sins committed by Countrywide Financial and Merril Lynch, which BofA bought after the crash, under pressure from the government.

The majority of the mortgage securities at the heart of the Justice investigation are the product of Countrywide and Merrill Lynch.

BofA now tops the list of settlements sans verdicts or, as The Economist calls them, “an extortion racket.”  If you are one of those who blame the banks for the housing bubble, you might wonder why the DOJ never insists on a trial.

Bank Fines

American housing policy was insane to begin with, and still is. Mortgage interest is tax deductible, encouraging home buyers to overextend themselves. On the other side of the transaction, lenders are backed up by Fannie Mae, encouraging them to overextend as well. This means that our mortgage market is, at all times, bigger and riskier than it would be without policy intervention.

Starting in the Clinton administration, we added 1) the Community Reinvestment Act and 2) regulatory pressure for lending to underprivileged buyers, plus 3) the repeal of Glass Steagall, and 4) a suppressed Fed funds rate. These policies caused mortgage risk to be further underpriced, and directly resulted in the housing bubble.

Anyone with any knowledge of economics saw it coming. Offhand, we can recall Taleb, Schiller, Rajan, and that guy from Goldman Sachs. Look up “predicted the housing crisis,” and investigate some of the claims. Here is an article from City Journal, warning about the impending crisis – in 2000. All the participants knew exactly what would happen, and how they would profit from it.

The cash cow was the government backed mortgage agency, Fannie Mae. When the housing bubble burst, the taxpayers were left holding most of the bad debt – and the guy running Fannie Mae got a fat bonus.

Johnson spotted a golden opportunity to use a popular cause—increasing home ownership—as a means of building Fannie’s power in Washington, and also feather his and his fellow executives’ nests along the way.

Fannie Mae CEO James Johnson had a lead role in the policies that created the bubble. He organized various advocacy groups to push for the failed policies, and bribed Congress with campaign donations. If you really want to raise your blood pressure, read the New York Times account of this scam – or the book, Reckless Endangerment.

Fannie Mae co-opted relevant activist groups, handing out money to Acorn, the Congressional Black Caucus, the Congressional Hispanic Caucus and other groups that it might need on its side.

There was something in it for everyone. The politicians would look good because there would be a temporary boom, led by housing activity. Underprivileged buyers would finally get homes. The boom might run for years, and the bust would be on someone else’s watch. Meantime, everybody would get rich. The bankers just needed to get the bad loans off their books before the music stopped.

Securitizing mortgage loans was not new. Banks had been routinely packaging loans and reselling them, to Fannie and to each other. The innovation was bundling loans of varying risk classes into inscrutable “collateralized debt obligations.” These were inscrutable in the sense that, when the bubble popped, no one knew who was holding the bad mortgages. Banks stopped lending to each other, and the financial system locked up.

This brings us to the various interventions of Sec. Paulsen and Chairman Bernanke, and brings our story back to Bank of America. Paulsen prevailed upon BofA to buy the assets of Countrywide and Merrill Lynch. The CEO, Ken Lewis, knew this was a bad deal, but gave in to pressure from Paulsen. They made a handshake deal that BofA would be protected from liability.

Wall Street was crumbling and BofA faced intense government pressure to buy Merrill to keep the crisis from spreading.

Countrywide had escaped scrutiny by giving generous mortgage deals to members of Congress. One beneficiary was Sen. Chris Dodd. That’s right – he of the Dodd-Frank “Wall Street Reform Act.” Rep. Barney Frank (you have to ask) was in a relationship with a Fannie Mae employee.

Countrywide … bought influence on Capitol Hill by issuing hundreds of sweetheart loans for members of Congress, their staffs and other government employees

So, the Clinton administration made political hay by inflating a housing bubble, the Bush administration ordered BofA to take a share of the fallout, and now the Obama administration turns around and prosecutes them for it. Along the way, lots of people got rich. James Johnson’s haul is estimated at $100 million. This revolving corruption and scapegoating is so flagrant it’s comical, and the really funny part is –it’s called Bank of America.


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