Obama Votes “Present” On Mortgage Reform

In the Wall St. Journal,, Peter J. Wallison, a senior fellow at the American Enterprise Institute, argues that Senator Obama voted “Present” on mortgage reform when it counted:

In each of the first two presidential debates, Barack Obama claimed that “Republican deregulation” is responsible for the financial crisis. Most viewers probably accepted this idea, especially because Republicans generally do favor deregulation.

But one essential fact was missing from the senator’s narrative: While there has been significant deregulation in the U.S. economy during the last 30 years, none of it has occurred in the financial sector…

If Sen. Obama had been asked for an example of “Republican deregulation,” he would probably have cited the Gramm-Leach-Bliley Act of 1999 (GLBA), which has become a popular target for Democrats searching for something to pin on the GOP. This is puzzling. The bill’s key sponsors were indeed Republicans, but the bill was supported by the Clinton administration and signed by President Clinton. The GLBA’s “repeal” of a portion of the Glass-Steagall Act of 1933 is said to have somehow contributed to the current financial meltdown. Nonsense.

Adopted early in the New Deal, the Glass-Steagall Act separated investment and commercial banking. It prohibited commercial banks from underwriting or dealing in securities, and from affiliating with firms that engaged principally in that business. The GLBA repealed only the second of these provisions, allowing banks and securities firms to be affiliated under the same holding company. Thus J.P. Morgan Chase was able to acquire Bear Stearns, and Bank of America could acquire Merrill Lynch. Nevertheless, banks themselves were and still are prohibited from underwriting or dealing in securities.

Our resident economics expert, LD* agrees:

The repeal of Glass-Steagall (GLBA) is a total non-event in the midst of the current economic turmoil. What this repeal did was allow commercial banks to get more deeply involved with investment banking activities. Thus, JP Morgan, Citigroup, Bank of America were able to utilize their significant balance sheets and capital bases to become a force on Wall St. Fast forward ten years and it is those institutions that are now thankfully supporting and bailing out our system.

I asked Mr. Doyle to elaborate, to help make sense of the current situation regarding Fannie Mae and Freddie Mac (“F/F”). This also serves to clarify Senator Obama’s ‘non-role’ in working to get us out of this mess and makes clear that John McCain actually stood up when he said he did:

Throughout the 90s and into the early part of this century, F/F were utilizing their significant lobbying power to gain an ever increasing portion of the overall U.S. mortgage market. They had the enormous advantage of being able to borrow at just marginally over U.S, government rates given the “implied” but not explicit backing of Uncle Sam. I mean come on that worst case scenario could never come to pass!!

While F/F were designed to provide liquidity to the market in the form of bundling mortgages into securities, charging a guarantee fee for return of principal to the investors in these Mortgage Backed Securities (“MBS”), and then selling the MBS into the private market, they decided to take a different path. What path was that? Given their ability to borrow at very cheap rates they decided to effectively grow their own internal portfolios. This business model was nothing more than a massively levered hedge fund under the guise of “helping the homeowner”.

In order to grow these portfolios, though, they needed more mortgages. Thus they went directly to the mortgage originators and worked with them to increase the mortgage terms and types that they would buy.

As Freddie and Fannie were executing this strategy, there were 3 groups that stood up and said that this activity was getting out of control. Who were they?? On Capitol Hill, Senator Richard Baker (R-LA) carried the torch. There were actually a number of large banks including Chase and Citi that formed a group called FM Watch that complained that Freddie and Fannie were taking market share from them in their own mortgage origination business. This group was conflicted because the investment banking arms of these institutions were pressured by Freddie and Fannie to quell their complaints or they would refrain from doing business with them. Lastly, the Wall St. Journal was vociferous in their complaints that these entities were getting out of control. Freddie and Fannie responded that they were merely trying to fulfill their mission of providing affordable rates to potential homeowners.

Well how was the impact of Freddie and Fannie on the overall mortgage rates that passed through to the consumer? A number of private studies put the “benefit” of Freddie and Fannie to the American homeowner at between 2 and 4 basis points. In layman’s terms, if a homeowner would have gotten a 6.75% rate then having Fannie/Freddie on the scene helped them get a 6.72% rate.

Now wait a minute, you mean the system was taking all that risk and F/F grew their internal “hedge fund” portfolios of north of 1.5 trillion for a benefit of 3bps. How does that work? Well, the benefits accrued to the shareholders and the executives including Franklin Raines and Jim Johnson.

And as we know, these two gentlemen have been linked to Barack Obama. More good judgment?

As this scenario played out, Senator Baker and then Senator McCain and other Republicans started to get up in arms about the enormous “systemic” risk that was developing. To be fair, Freddie Mac did work to root out the most egregious “predatory lending” that had been undertaken. That said, Freddie was the buyer of the bulk of sub-prime product in the market and without their bid the “overly aggressive” lending would not have taken place to the extent that it did. Fannie was the buyer primarily of Alt-A product which included a lot of the loans without full documentation.

Both F/F were effectively cooking their books. Freddie actually made more money than they were reporting (putting revenue away for future years) while Fannie had truly pathetic risk management and grossly overstated earnings. Both firms reporting of earnings were totally driven by “maximizing” executive bonus packages. Very simply, heads I win, tails you (meaning Uncle Sam and taxpayers) LOSE!!

Even in the midst of this, while Baker, McCain, the WSJ and others were railing on how these agencies were managed, regrettably the necessary regulations and oversights never got out of committee because the Democrats, primarily Sen. Chris Dodd, Sen. Chuck Schumer, and Rep. Barney Frank crushed it.

At this juncture, Barack Obama votes present. He was not willing to stand up to his party because he was in bed with Fannie/Freddie and was well on his way to being the second greatest beneficiary of their largesse only after Chris Dodd. To think that this crowd is now going to hold hearings to “review” this crisis is akin to the “inmates running the asylum!!

While Franklin Raines, Jim Johnson, and Tim Howard were ushered out at Fannie and Leland Brendsel was pushed out at Freddie there were no real dramatic changes. Their regulator OFHEO was given some greater oversights but F/F knew that they had their “friends on the Hill” in their back pocket to stymie real regulation.

The American homeowner got their 3bps but is now stuck with a multiple hundred billion dollar price tag along with the price of the systemic risk that went along with it.

One may ask, why did this happen at F/F and not Ginnie Mae? Well, Ginnie does not run a big internal hedge fund and merely bundles FHA and VA insured mortgages, takes a guarantee fee for return of principal to the investor and then lets the securities go into the private market. It works just fine.

Mr. Wallison of WSJ concurs:

Allowing banks and securities firms to affiliate under the same holding company has had no effect on the current financial crisis. None of the investment banks that have gotten into trouble — Bear, Lehman, Merrill, Goldman or Morgan Stanley — were affiliated with commercial banks. And none of the banks that have major securities affiliates — Citibank, Bank of America, and J.P. Morgan Chase, to name a few — are among the banks that have thus far encountered serious financial problems. Indeed, the ability of these banks to diversify into non-banking activities has been a source of their strength.

Most important, the banks that have succumbed to financial problems — Wachovia, Washington Mutual and IndyMac, among others — got into trouble by investing in bad mortgages or mortgage-backed securities, not because of the securities activities of an affiliated securities firm. Federal Reserve regulations significantly restrict transactions between banks and their affiliates.

Most significantly,

[O]n the matter of deregulation and the financial crisis, Sen. Obama should consider his own complicity in the failure of Congress to adopt legislation that might have prevented the subprime meltdown.

In the summer of 2005, a bill emerged from the Senate Banking Committee that considerably tightened regulations on Fannie and Freddie, including controls over their capital and their ability to hold portfolios of mortgages or mortgage-backed securities. All the Republicans voted for the bill in committee; all the Democrats voted against it. To get the bill to a vote in the Senate, a few Democratic votes were necessary to limit debate. This was a time for the leadership Sen. Obama says he can offer, but neither he nor any other Democrat stepped forward.

Instead, by his own account, Mr. Obama wrote a letter to the Treasury Secretary, allegedly putting himself on record that subprime loans were dangerous and had to be dealt with. This is revealing; if true, it indicates Sen. Obama knew there was a problem with subprime lending — but was unwilling to confront his own party by pressing for legislation to control it.

As a demonstration of character and leadership capacity, it bears a strong resemblance to something else in Sen. Obama’s past: voting present.

Once again Senator Obama uses an effective sound bite in the debates without the facts to back it up. We have seen consistently that Rep. Barney Frank, Senator Chris Dodd, Rep. Maxine Waters, et al, were shouting that no tighter regulations were needed.

Since Obama seems so eager to promise he will build consensus and reach across the aisle, and that Republicans are the party of good ideas – where was his leadership when we needed him? What has he done to show anyone that he has the spine and willingness to make the tough decisions or take a stand? Or the knowledge to lead this nation in a crisis such as the ones we now face both at home and abroad?

Senator Obama once again votes “present.”

Both Mr. Wallison and Mr. Doyle called this one exactly right.

[*LD was an institutional trader of mortgage securities at First Boston and Bear Stearns for 15 yrs in the ’80s and ’90s and then was the national sales manager for mortgage products at JP Morgan Chase from 2000-2006. He is currently a private investor and involved in a variety of not-for-profit activities.]