In their September 23 Wall Street Journal article, Charles Calomiris and Peter Wallison opined the vast accumulation of toxic mortgage debt that poisoned the global financial system was driven by the aggressive buying of subprime and Alt-A mortgages, and mortgage-backed securities, by Fannie Mae and Freddie Mac. The poor choices of these two government-sponsored enterprises (GSEs) — and their sponsors in Washington — are largely to blame for our current mess.

Well, sure. But, as I wrote yesterday, Fannie and Freddie chose that path because they were pressured by the Clinton administration to loosen loan requirements for minorities and others unable to qualify for conventional financing. And, as Ben commented, Clinton relied on the Community Reinvestment Act (CRA), passed under Carter in 1977, for authority.

Didn’t anyone realize what was happening and sound the alarm? Sure, many. And in the wake of Freddie’s 2003 accounting scandal, even Fed Chairman Alan Greenspan became a powerful opponent, calling for stricter regulation of the GSEs and limitations on the growth of their risky retained portfolios. But by presenting themselves to Congress as the champions of affordable housing, Fannie and Freddie retained the support of many in Congress, particularly Democrats, and they were allowed to continue unrestrained.

…Rep. Barney Frank (D., Mass), for example, now the chair of the House Financial Services Committee, openly described the “arrangement” with the GSEs at a committee hearing on GSE reform in 2003: “Fannie Mae and Freddie Mac have played a very useful role in helping to make housing more affordable … a mission that this Congress has given them in return for some of the arrangements which are of some benefit to them to focus on affordable housing.” The hint to Fannie and Freddie was obvious: Concentrate on affordable housing and, despite your problems, your congressional support is secure.

Eventually, of course, the bubble burst just as Alan Greenspan and others had predicted. Now Congress is trying to get out from under the weight of responsibility by pointing at everyone else while the Bush Administration is working with the Fed to propose a way for Congress to repair the damage with the least negative impact on American taxpayers.

And what were our current presidential candidates doing while all this was going on?

In light of the collapse of Fannie and Freddie, both John McCain and Barack Obama now criticize the risk-tolerant regulatory regime that produced the current crisis. But Sen. McCain’s criticisms are at least credible, since he has been pointing to systemic risks in the mortgage market and trying to do something about them for years. In contrast, Sen. Obama’s conversion as a financial reformer marks a reversal from his actions in previous years, when he did nothing to disturb the status quo. [Empahsis added] The first head of Mr. Obama’s vice-presidential search committee, Jim Johnson, a former chairman of Fannie Mae, was the one who announced Fannie’s original affordable-housing program in 1991 — just as Congress was taking up the first GSE regulatory legislation.

But here’s the crux of the matter. While Democrats point their fingers at everything and everyone else, you need to know the real reason nothing was done to prevent the huge increase of high risk, declining quality, loans — from less than 8% of all mortgages in 2003 to over 20% in 2006 — being bought up by Fannie and Freddie:

In 2005, the Senate Banking Committee, then under Republican control, adopted a strong reform bill, introduced by Republican Sens. Elizabeth Dole, John Sununu and Chuck Hagel, and supported by then chairman Richard Shelby. The bill prohibited the GSEs from holding portfolios, and gave their regulator prudential authority (such as setting capital requirements) roughly equivalent to a bank regulator. In light of the current financial crisis, this bill was probably the most important piece of financial regulation before Congress in 2005 and 2006. All the Republicans on the Committee supported the bill, and all the Democrats voted against it. Mr. McCain endorsed the legislation in a speech on the Senate floor. Mr. Obama, like all other Democrats, remained silent. [Emphasis added]

Now the Democrats are blaming the financial crisis on “deregulation.” This is a canard. There has indeed been deregulation in our economy — in long-distance telephone rates, airline fares, securities brokerage and trucking, to name just a few — and this has produced much innovation and lower consumer prices. But the primary “deregulation” in the financial world in the last 30 years permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable in this storm.

As a result, U.S. commercial banks have been able to attract more than $100 billion of new capital in the past year to replace most of their subprime-related write-downs. Deregulation of branching restrictions and limitations on bank product offerings also made possible bank acquisition of Bear Stearns and Merrill Lynch, saving billions in likely resolution costs for taxpayers.

Here’s the bottom line:

If the Democrats had let the 2005 legislation come to a vote, the huge growth in the subprime and Alt-A loan portfolios of Fannie and Freddie could not have occurred, and the scale of the financial meltdown would have been substantially less. The same politicians who today decry the lack of intervention to stop excess risk taking in 2005-2006 were the ones who blocked the only legislative effort that could have stopped it. [Emphasis added]

Carter laid the foundation with the CRA, Clinton used it to pressure Fannie Mae to make more loans to poor folks, especially minorities, who couldn’t otherwise qualify, and Democrats in Congress like Barney Frank not only ignored the warnings but encouraged Fannie and Freddie to continue their practices, implying that the government was behind them all the way. The Bush Administration is trying to head off a serious recession (or worse) while Congressional Democrats are posturing and casting blame elsewhere.

And what’s hitting the news? The President asked for a round table to help solve the problem and invited, among others, Senators McCain and Obama. McCain postponed his campaign and headed for D.C. while Obama continues campaigning for face time claiming he can do “more than one thing at once.” Says a lot.

Continued…