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.