Big Bailout Part 2: Arrogance & Lost Opportunities

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Yesterday, House Speaker Nancy Pelosi, in effort to escape accountability for financial chaos caused by Fannie May and Freddie Mac, said the Bush Administration should have been “way in front of this.”

Ms. Pelosi apparently forgot that in 2003 Bush Administration submitted to Congress proposed legislation to impose a new regulatory regime that could have kept Fannie  and Freddie from approving poor quality mortgage loans.  But Congress, under heavy lobbying by Fannie  and Freddie, decided to keep the party going.

Yesterday Barack Obama, as always, blamed John McCain:

For eight years, Bush-McCain economic policies have favored reckless deregulation and huge tax loopholes for big corporations. Now, as these corporations crumble, American taxpayers are facing costly bailouts.  More of the same failed ideas are not going to solve our economic problems…I’ll end the “anything goes” culture on Wall Street with real regulation.

As we reported in the first post in this series the problem is definitely not a lack of regulation.  The financial sector is over-burdened with counter-productive regulations, including Sarbanes-Oxley and perverse accounting rules, that aggravated losses from investments in mortgage debt, much of it issued by Fannie Mae and Freddie Mac, the two public-private hybrids created by government to control most of the mortgage lending in America.

As it turns out, John McCain did try to head off the crisis.  Here are excerpts from a speech Senator McCain gave on the Senate floor 28 months ago:

Mr. President, this week Fannie Mae’s regulator reported that the company’s quarterly reports of profit growth over the past few years were “illusions deliberately and systematically created” by the company’s senior management, which resulted in a $10.6 billion accounting scandal.

The Office of Federal Housing Enterprise Oversight’s report goes on to say that Fannie Mae employees deliberately and intentionally manipulated financial reports to hit earnings targets in order to trigger bonuses for senior executives. In the case of Franklin Raines, Fannie Mae’s former chief executive officer, OFHEO’s report shows that over half of Mr. Raines’ compensation for the 6 years through 2003 was directly tied to meeting earnings targets.

The report of financial misconduct at Fannie Mae echoes the deeply troubling $5 billion profit restatement at Freddie Mac.

The OFHEO report also states that Fannie Mae used its political power to lobby Congress in an effort to interfere with the regulator’s examination of the company’s accounting problems. This report comes some weeks after Freddie Mac paid a record $3.8 million fine in a settlement with the Federal Election Commission and restated lobbying disclosure reports from 2004 to 2005. These are entities that have demonstrated over and over again that they are deeply in need of reform.

For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac–known as Government-sponsored entities or GSEs–and the sheer magnitude of these companies and the role they play in the housing market. OFHEO’s report this week does nothing to ease these concerns. In fact, the report does quite the contrary. OFHEO’s report solidifies my view that the Government Sponsored Enterprisess need to be reformed without delay.

I join as a cosponsor of the Federal Housing Enterprise Regulatory Reform Act of 2005to underscore my support for quick passage of GSE regulatory reform legislation. If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.

The text of the proposed reform act is here. It would have established a new regulatory regime and a new regulatory agency to oversee Fannie and Freddie.  Of course there’s no guarantee that these proposed changes would have prevented any future problems.  But the point is that John McCain was one of the few in Congress who recognized a gathering storm and attempted to contain it.  The proposed reform never came to a vote in either the House or the Senate.

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