The Magazine

Guilty Men

The political origins of the meltdown.

Jul 25, 2011, Vol. 16, No. 42 • By CHRISTOPHER CALDWELL
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To have served as the intellectual architect of the stalest presidential campaign of the modern-media era, to have lost a record number of states, to have gained a reputation for ruthlessness and secrecy in the process—only in Washington is that a recipe for success. Running the 1984 effort of his fellow Minnesotan, Walter Mondale, turned out to be the perfect entrée for James A. Johnson: He wound up a director of the Kennedy Center, chairman of the Brookings Institution, a board member of Goldman Sachs, an adviser to John Kerry in 2004, and—until derailed by scandal—the head of Barack Obama’s vice-presidential search team in 2008. 

Barack Obama points to Barney Frank while Christopher Dodd looks on.

Barack Obama points to Barney Frank while Christopher Dodd looks on, 2010

OwenDB / Black Star / Newscom

But if Johnson’s name winds up in history books, it will be for something else. It was he who transformed Fannie Mae (formerly the Federal National Mortgage Association) in the course of the 1990s. Fannie had been a sleepy vestige of the New Deal bureaucracy, meant to deepen the market for middle-class mortgages by purchasing qualifying loans from banks. Under the leadership of Johnson and his successor, former Clinton budget director Franklin Raines, it became the flagship of the subprime mortgage industry. Its executives earned eight-figure salaries. It held as much debt as the U.S. Treasury in 2005. It had a massive, ferocious lobbying organization. It proclaimed itself to be leading a righteous mission to spread affordable housing to minorities, poor people, and other “underserved” parts of the population. And in 2008, it had to be bailed out by the U.S. taxpayer, at a cost, so far, of several hundred billion dollars.

The upshot of Reckless Endangerment, by New York Times business journalist Gretchen Morgenson and economist Joshua Rosner, is that Johnson has as much claim as anyone to be the main villain of the financial crisis.

Fannie Mae was a funny company. Privatized in the 1960s, it maintained a lot of government perks. Its board was partly appointed by the president. It was exempt from taxes in the District of Columbia, from certain conflict-of-interest laws, and from regulations governing financial disclosure, including disclosure of executive salaries. It benefited from the perception—correct, alas—that it had the backing of the U.S. government. This backing allowed Fannie to borrow more cheaply than its competitors. Fannie claimed that these savings were all passed along to homebuyers, but a 2003 study by the Federal Reserve found that Fannie lowered mortgage costs by less than one percent.

Fannie’s mission kept changing. Rather belatedly, it became an arm of the War on Poverty. “More than any other single act,” the authors write, Congress’s decision to equip Fannie with an affordable-housing mission in 1992 would lead, decades on, to the financial collapse. That same year, the Federal Reserve Bank of Boston, led by the economist Alicia Munnell, did a study of lending patterns purporting to show “redlining,” or discrimination against blacks. The study had obvious flaws. It did not control for creditworthiness in the most elementary way. Munnell admitted to Forbes that “there was no relationship between the racial composition of the tract and the default rate.” Had there been discrimination against blacks in lending decisions, blacks’ default rate would have been lower than that of whites. The ridicule that greeted the report did nothing to dampen the Clinton administration’s insistence on using home lending as a tool of poverty-fighting and race relations.

This required what the authors call “a completely new approach to lending”—a politicized one. This is where Johnson’s lobbying expertise was crucial: If the new affordable-housing mandate did not make Fannie more economically sound, it had the potential to make it politically unassailable. Fannie started a foundation that funneled money to the Congressional Hispanic Caucus and to all the community organizing groups that could possibly resist its plans for expansion. It formed an advisory council and invited a number of housing advocacy groups to join it—La Raza, the National Low Income Housing Coalition, and the Association of Community Organizations for Reform Now (ACORN). One of the great revelations of Reckless Endangerment is that the role of ACORN in shaping U.S. housing policy is not just a figment of the right-wing TV-watchers’ imagination. ACORN helped devise Congress’s affordable housing goals.

Fannie Mae opened “partnership offices” across the country which a later HUD investigation concluded were “primarily designed to obtain access to or influence members of Congress.” Rather like a tobacco company, Fannie also paid for academic research—including a 2002 paper by Nobel Prize-winner Joseph Stiglitz and future White House budget director Peter Orszag—that showed its role in the industry to be benign and its risks of a bailout negligible. 

The preferred method of the Clinton administration for meeting these goals was the public-private partnership. When they work well, such partnerships spread the costs of government to those who most benefit from it, and they lower taxes. But the experience of the past 20 years is that they don’t work well. Mostly they give plutocrats the power to make law. Johnson wound up with unseemly links to certain private companies. Since 1999, he has been on the board of Goldman Sachs, which, back in the 1990s, designed an investment vehicle that would allow Fannie’s executives to shift income from year to year to meet bonus targets for earnings per share.

That is part of the reason why, according to Morgenson and Rosner, “[y]ou could predict what Fannie’s earnings-per-share would be at year-end, almost to the penny, if you knew the maximum earnings-per-share bonus payout target set by management at the beginning of each year.” Between 1998 and 2003, Johnson’s successor Franklin Raines made $90 million, $52 million of which was tied to these incentive targets.

Angelo Mozilo, the aggressive CEO of Countrywide Financial, the mortgage giant that swooned, bankrupt, into the waiting arms of Bank of America in 2008, called Johnson a man who “could cut off your balls and you’d still be wearing your pants”—doubtless a compliment in Mozilo’s book. By 2007, Countrywide was supplying 28 percent of Fannie’s loans. It was for having taken a friends-of-Angelo loan from Countrywide at a preferential rate that Johnson had to leave the Obama campaign in the summer of 2008. Others who got these loans included the late Richard Holbrooke (Johnson’s former lobbying partner), senators Christopher Dodd, Kent Conrad, and Barbara Boxer, former Health and Human Services secretary Donna Shalala, and George W. Bush’s Housing and Urban Development secretary, Alfonso Jackson. 

There is certainly plenty of blame for both political parties in the finance crisis that grew out of the subprimes. But Johnson was an extremely partisan Democrat and for that reason, the unraveling of Fannie is largely a Democratic scandal. Fannie’s most strident defenders were Democrats, and they include the two authors of the most recent financial reform bill, Dodd and Rep. Barney Frank, whose ex-boyfriend Herb Moses Fannie hired while they were dating. Almost all of Fannie’s foes were Republicans. There were a couple of exceptions: Sen. Christopher Bond of Missouri was a ferocious defender of Fannie Mae, and former Utah senator Robert Bennett was one of the main beneficiaries of its favors. (You may applaud or deplore the ouster of Bennett by Tea Party Republicans last year, but they had their reasons.)

Johnson’s priorities survived him, and Fannie was not alone in using housing policy as a means of social engineering. Housing and Urban Development secretary Andrew Cuomo pressured Fannie to buy more subprime mortgages. A 1999 HUD study faulted Fannie for disqualifying borrowers with “low incomes, limited wealth, and poor credit histories; applicants with these characteristics are disproportionately minorities.” Cuomo threatened fines if such borrowers were not given more loans. In 2003, California representative Maxine Waters called for eliminating down payments from mortgages altogether. What sounded insane in 2003 was industry practice in 2005.

Gretchen Morgenson’s columns are as bold and well-informed as anything in American financial journalism, and Joshua Rosner is one of the rare analysts who saw, a decade ago, where subprime shenanigans would take us. But one wishes this book were better. The two authors’ contributions do not mesh. There is a hundred pages on Johnson, a hundred pages on Fannie Mae after Johnson, and then a hundred pages about topics, interesting in their own right, that the authors never manage to slot into an overarching narrative: the history of rating agencies’ role in mortgage securitization, the story of the disreputable mortgage originators NovaStar and Fremont, the shocking account of how Johnson, Mozilo, and former HUD secretary Henry Cisneros colluded to build a lot of moderate-income housing with zero-money-down loans in San Antonio.

James Johnson provides a useful device for launching us into this narrative, and he is well chosen as a villain. It was, indeed, unfortunate that such a capable political schemer—one, moreover, with enough of the self-righteous Midwestern moralizer in him not to care much for the counsel of others—should have wound up at the head of such a powerful agency. When you are earning one of the largest salaries in the world while haranguing the country on behalf of the downtrodden, you might see any attempt to hold you accountable as an assault on the country itself.

But there is no shortage of shrewd, driven, ruthless, capable bleeding-heart liberals across whose mind not a hint of self-doubt has ever passed. If Johnson had never been born, the mortgage crisis would have unrolled just as it did. The direction in which he took Fannie Mae was the direction in which Bill Clinton, the economists at the Boston Fed, Andrew Cuomo, and the mortgage industry were pushing him. We were bound to wind up with the system we have, in which the rich, in the name of the poor, avail themselves of the assets of the middle class.

Christopher Caldwell is a senior editor at The Weekly Standard.