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Conservatives counter that commercial banks actually weathered the storm better than investment banks. Bear Stearns, Lehman and Merrill Lynch folded, not Chase or Citi. What dragged the system down, they say, was the crusade by Fannie and Freddie, New Deal holdovers beloved by Democrats, to peddle risky mortgages to people who couldn’t afford them.
Both stories are partly true and partly false. Deregulation began under Democrat Jimmy Carter, not Reagan. The critical 1999 bank deregulation, known as Gramm-Leach-Bliley after its three Republican sponsors, passed in both houses of Congress by strong bipartisan majorities and was signed into law by Bill Clinton. Only a handful of Democrats voted no, including Barney Frank.
Bank deregulation wasn’t the only blow. Arguably worse was a rule quietly adopted in late 2000, barring the little-known Commodity Futures Trading Commission from regulating the new, exotic, barely understood financial instruments known as derivatives.
One key derivative was the Mortgage-Backed Security. It’s a bundle of individual mortgages bought from the original lenders that are thrown into a pot, chopped up into shares and sold off to investors, who now owned tiny pieces of hundreds of mortgages and receive a share of all those homeowners’ mortgage payments. As long as folks kept buying homes and making their monthly payments, everyone was happy.
But many families were suddenly having trouble, and therein lies our tale. Millions had bought homes with something called an adjustable-rate mortgage. This offered the borrower a very low starting interest rate, which then rose or (rarely) fell in sync with industry rates. Usually, the rate was tied to the so-called London Inter-Bank Offer Rate, or LIBOR.
Popular in Europe, adjustable mortgages were first approved by Congress in 1982 as a vehicle for sophisticated investors. By the 1990s, however, they were being sold to lower-income borrowers eager to get in the door. The practice exploded following deregulation. By 2004, about one-fifth of all American mortgages were adjustable. The vast majority — 90%, according to government figures — were characterized as sub-prime loans, meaning the borrowers didn’t qualify for credit by normal standards.
The assault on Barney Frank is largely over his role as opposition leader on the financial services committee in the early 2000s. He says he was pushing for better regulation of lenders but faced a hostile Republican majority. The Bush administration’s priority was a new body to oversee Fannie Mae and Freddie Mac, which together underwrote about half of all mortgages in the country and were seriously undercapitalized. Democrats feared that was a ploy to undercut the organizations’ role in affordable housing.
In the midst of this came a disastrous decision by the SEC: a change in the biggest investment banks’ leverage requirements. Leverage is the cash kept on hand to cover current debts and future bets. The banks were required to have $1 in cash for every $12 they owed. In April 2004, the commissioners voted to increase the ratio to 1-to-30. The five banks could now double their indebtedness. Some observers call that the worst decision of all.
But the most fateful decision was taken in Europe. Beginning in 2004, the continent’s central banks began raising their base interest rates in a bid to head off inflation. Consequently, the LIBOR soared from 1.21% in January 2004 to 5.64% in June 2006. This caused a sudden spike in mortgage bills for millions of American sub-prime homeowners. You know the rest.
In November 2006, a wave of voter anger swept the Democrats back into control of Congress. Frank, now chairing the banking committee, quickly took the lead in a multipart rescue operation — trying to halt evictions, restore regulation, then save the banks as they began to tumble, so the whole economy didn’t collapse. It was a daunting, terrifying sprint when he had a cowed Republican minority and a broken president to work with. When Barack Obama became president and Republicans declared war, it became an agonizing slog. Since the Republicans regained the House last January, he’s become a piñata. At a certain point, you had to wonder how much longer he could take it. Now we know.
Contact J.J. Goldberg at email@example.com