In The Semisovereign People, political scientist E. E. Schatt-schneider argues that “political conflict is not like an intercollegiate debate in which the opponents agree in advance on a definition of the issues. As a matter of fact, the definition of the alternatives is the supreme instrument of power. . . . He who determines what politics is about runs the country.” Schattschneider calls the organized effort to ensure that some alternatives remain illegitimate “the mobilization of bias.”
Peter J. Wallison must be quite familiar with this idea. A longtime critic of Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSE) tasked with injecting liquidity into the secondary mortgage market, he has offered warnings about these agencies that have fallen on deaf ears for over a decade. When he and Edward Pinto, his colleague at the American Enterprise Institute, correctly pointed out that Fannie and Freddie were loaded up with the subprime mortgages that contributed to the financial collapse of 2008, and that maybe—just maybe—this had something to do with the mess, they were greeted with accusations of Hitlerism. “The Big Lie” is what Joe Nocera of the New York Times accused Wallison and Pinto of propagating.
There are some ideas that simply cannot gain mainstream acceptance because they challenge essential priorities of the ruling elite. Accordingly, any connection drawn from Fannie and Freddie to the financial collapse must be squashed, because distributing federally subsidized credit to low- and middle-income (LMI) borrowers has been a backbone of the nation’s housing policy for nearly 20 years. All of this makes Wallison’s work intriguing to anybody inclined to question the status quo—even more so because he has written this excellent book in defense of his thesis.
Wallison argues that the existing explanations for the crisis are either wrong (overregulation) or insufficient (monetary policy in violation of the Taylor rule). This is easy pickings. Most accounts focus on the investment practices of the banks, to the exclusion of what they were actually invested in. It is almost as if they could have invested in anything and produced the same result, because they were so greedy, leveraged, unregulated—whatever. Wallison points out that the troubled institutions were all tangled up in the same sort of investment—mortgage-backed securities (MBS)—and while he avers that part of the crisis has to do with how these were traded, he places the MBS at the center of his analysis.
This approach is straightforward and intuitive, and if it did not lead inexorably to a damning critique of a quarter-century’s worth of federal housing policy, it would probably be widely accepted. Wallison contends that the MBS market was dangerous because mortgage-lending standards had steadily declined since the mid-1990s. He traces this to the Department of Housing and Urban Development (HUD), which, after 1992, was empowered to create affordable housing goals for the GSEs. HUD did this with gusto, insisting that low- and moderate-income buyers become an ever-greater share of Fannie’s and Freddie’s books. In response to this, the GSEs lowered their lending standards; and because they were such a huge part of the market, everybody’s standards were lowered.
This had two powerful effects. First, it facilitated a housing market bubble that, as Wallison notes, was substantially larger and longer than any of its predecessors. Second, it increased the potential for defaults. Wallison demonstrates the commonsensical notion that as mortgage lending abandons “prime” standards, default rates rise. So long as the bubble was expanding, this was not a problem, as borrowers could refinance because of rising home values. But when the market turned, as it did in 2006, defaults rose, and banks that had invested in mortgage-backed securities were on the hook.
This alone should not have been catastrophic, because (as Wallison notes) the housing market is a relatively small share of the domestic economy. Calamity arrived because of mistakes at the top: The Basel Accords lowered capital requirements for holding MBSs; the federal government was too slow to suspend mark-to-market rules, forcing firms to report huge accounting losses; the federal government’s response was ill-considered and unpredictable, especially its decision to bail out Bear Stearns while letting the much larger Lehman Brothers fall into bankruptcy.