By William K. Black
Quito: May 23, 2015
Few people’s efforts at myth-making have been as devastatingly refuted as Peter Wallison. But fables that are designed to make the banksters look less criminal are always welcome by the banksters. Any honest discussion of Wallison’s claims would begin with three points. First, Wallison’s adult life has been devoted, on behalf of the banksters, to pushing the three “de’s” – deregulation, desupervision, and de facto decriminalization. He is therefore as culpable as anyone in the world for the epidemics of accounting control fraud that drove the financial crisis and the Great Recession.
Second, he was appointed by the Republican leadership to the Financial Crisis Inquiry Commission (FCIC) to assure that the banksters would have the benefit of their leading apologist. The chances that he would ascribe any problems to the three “de’s” was always non-existent because he does not have a scholarly instinct in his body. He is rabidly ideological and a willing tool of the banksters.
Third, the Republicans appointed three other members to the FCIC, each of them a highly partisan Republican who was known to oppose effective financial regulation – yet none of them was willing to join Wallison’s dissent. They were unwilling to do so because Wallison’s dissent was discredited so effectively by the FCIC investigation and report. The data destroyed Wallison’s screed – repeatedly.
But the WSJ editorial pages are no fans of data and huge fans of the banksters and anti-governmental dogma. In the WSJ’s alternate history:
“Peter Wallison, a scholar at the American Enterprise Institute, demonstrates in a new book that the subprime housing boom was fostered mainly by federal housing politics and policy, not by the rampant “deregulation” that many have imagined out of whole cloth.
Note the rhetorical game that Wallison and the WSJ editor play from the beginning – they refer to only one of the three “de’s” – ignoring desupervision and de facto decriminalization. The formal rules do not matter if they are not enforced by the banking regulators and the Department of Justice (DOJ). Wallison knows that desupervision and decriminalization of finance were very close to total – and that he and those who shared his dogmas such as Alan Greenspan and Ben Bernanke are all responsible for this result. Tom Frank’s Wrecking Crew captures Bush (II’s) approach to destroying effective regulation, supervision, enforcement, and prosecutions by appointing anti-regulatory leaders dedicated to the self-fulfilling prophecy of regulatory failure.
But Wallison (and the WSJ) also ignores the key act of deregulation that lies at the heart of his thesis (and is fatal to that thesis). The most important act of deregulation was the removal of our loan underwriting rule that we used to drive “liar’s” loans out of the S&L industry beginning in 1991. The rule was destroyed by Bill Clinton and Al Gore’s “Reinventing Government” assault on effective regulation. The underwriting rule was replaced with a deliberately unenforceable “guideline.” The elimination of the rule was not the product of housing goals – it was the product of Clinton and Gore’s “New Democrat” hostility to effective regulation. The elimination of the rule made it far harder for regulators to ban liar’s loans and take enforcement action against them. (The Fed had unique authority once HOEPA was passed in 1994 to ban all liar’s loans, but Alan Greenspan and Ben Bernanke’s anti-regulatory dogmas ensured that the Fed refused to ban such loans even when it knew their fraud incidence was 90 percent. Their refusal had nothing to do with affordable housing goals and everything to do with the fact that they were co-celebrants of Wallison’s anti-regulatory dogmas.)
The WSJ op ed actually spends very little time discussing Wallison’s thoroughly and repeatedly discredited thesis that Fannie and Freddie, because of government housing goals, were the demons that caused the crisis. The WSJ op ed is really devoted to providing yet another apologia for the banksters – who are the victims of an overly aggressive DOJ.
Banks have been shaken down for billions in settlements for selling Fannie and Freddie subprime loans they demanded. They’ve been criminalized for paperwork shortcuts in the resulting foreclosure tsunami, though the result was no material injustice to borrowers.
I will take this very slow because to be hired to the WSJ editorial staff one must be certifiably Murdoch-delusional. First, bankers sell mortgage paper. Because of the two great epidemics of “accounting control fraud” in the loan origination process (“liar’s” loans and appraisal fraud) if those bankers were to sell their fraudulently originated mortgages to the secondary market they could only do so by making fraudulent “reps and warranties” to the purchasers such as Fannie and Freddie (but also many others). That was the third great epidemic of accounting control fraud. When you make fraudulent reps and warranties to a purchaser you have engaged in fraud. One remedy for fraud is to pay restitution. That is not a “shake down.”
Second, the primary “paperwork shortcut” was that the mortgage servicer prepared pervasively fraudulent affidavits and declarations (signed under penalty of perjury) that they had taken certain acts to ensure that foreclosure was appropriate. Those sworn statements were deliberate lies. That is also called fraud (and perjury) and in addition to being a felony, represents a host of regulatory violations. The extraordinary fact about all of these fraud epidemics is that none of the banksters have been prosecuted for the felonies I have described and one – out of tens of thousands – has been subjected to a meaningful civil recovery. The WSJ and Wallison ignore or dismiss as trivial the many other frauds committed by the banksters.
The WSJ op ed is so weak that it seems clear that despite their formulaic apologia for the banksters’ frauds they know that the jig is up.
The Barron’s Book Review Embracing Wallison is Far More Embarrassing
Peter H. Schuck, an emeritus professor of Law at Yale Law reviewed Wallison’s book in Barron’s. Schuck, unknowingly, demonstrates immediately how Wallison went off the rails.
In this important, eye-opening, although somewhat repetitious work, Wallison acknowledges the many factors involved, but insists the sine qua non, the propulsive force, was a colossal sin of commission: the relentless, irresponsible lowering of mortgage underwriting standards by administrations starting with George H.W. Bush and worsening under Bill Clinton and George W. Bush.
Wow, the most powerful force in American politics and our economy (finance) has no “agency” – it is a passive, powerless group acted upon by other actors who have wills (“agency”). So the “government” “lower[ed] mortgage underwriting standards” for twenty-six years – 1982-2008. Wallison and Schuck try to give their hero Ronald Reagan (Wallison authored a hagiographic ode to Reagan) a free pass. But under their “logic” he is the President who started “the relentless, irresponsible lowering of mortgage underwriting standards” with the passage of his Garn-St Germain Act of 1982, Dick Pratt’s lowering of underwriting standards in 1981-1983, and the passage of the Reagan administration’s bill that was enacted as the Competitive Equality in Banking Act of 1987 (CEBA).
Our reregulation of the industry and tightening of underwriting standards was done despite the opposition of Presidents Reagan and Bush and their lead staffer on financial deregulation – Wallison. Reagan, Bush, and Wallison’s opposition to our efforts to end the three “de’s” in the S&L industry had nothing to do with affordable housing. They were each fierce proponents of the three “de’s” in finance. Wallison’s role as Reagan’s staff leader on financial deregulation makes his amnesia in excluding the Reagan administration from the list of administrations that weakened underwriting standards all the more telling. Wallison’s bio shows:
From June 1981 to January 1985, he was general counsel of the United States Treasury Department, where he had a significant role in the development of the Reagan administration’s proposals for deregulation in the financial services industry, served as general counsel to the Depository Institutions Deregulation Committee, and participated in the Treasury Department’s efforts to deal with the debt held by less-developed countries. During 1986 and 1987, Mr. Wallison was White House counsel to President Ronald Reagan.
Savings and loans (S&Ls) were eager supporters of the passage of the Garn-St Germain Act, Pratt’s deregulation, and the “regulatory forbearance” provisions of CEBA that were crafted to make it far harder for us to take enforcement action against violations of our loan underwriting standards. I also recall that during the Reagan administration no significant legislation affecting S&Ls could be enacted without the active support of the S&L trade association. Further, none of these acts of deregulation were done for purposes of “affordable housing.” S&L CEOs had huge “agency.”
It was Reagan, Vice President George Bush, and Wallison that led the S&L deregulation that George Akerlof and Paul Romer’s research confirmed created the criminogenic environment that drove the S&L debacle.
The S&L crisis, however, was also caused by misunderstanding. Neither the public nor economists foresaw that [deregulations] of the 1980s were bound to produce looting. Nor, unaware of the concept, could they have known how serious it would be. Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better. If we learn from experience, history need not repeat itself (Akerlof & Romer 1993: 60).
But Wallison is an ideologue. He will never learn from experience when it comes to supporting the three “de’s.” He will instead create fake histories in which the villain is always government, regulation, and poorer people and the helpless “victims” are the banksters.
We drove “liar’s” loans (then called “low doc” loans) out of the S&L industry using our loan underwriting rule. I recall the industry in Orange County screaming to the heavens about how outrageous our actions were. Yes, they certainly used the excuse for their fraudulent lending that they were helping less wealthy Americans buy homes, but that was the point, the industry’s CEOs had (immense) “agency” and the Orange County subset was all for making what are known as “liar’s” loans. It had nothing to do with the Bush (I) administration imposing lousy underwriting on the unwilling CEOs running the industry, much less doing so to help affordable housing.
When the largest originator of liar’s loans, Long Beach Savings, gave up its federal charter as an S&L and federal deposit insurance to become the (renamed) Ameriquest it did so solely to escape our regulatory jurisdiction. It became an essentially unrelated mortgage bank – which is how the great bulk of liar’s loans were done for much of the decade of the 1990s. But that is a fatal problem for Wallison’s myth – why did the CEOs controlling the lending industry that specialized in making the fraudulent liar’s loans that would in a decade blow up the financial world move to the sector with virtually no federal regulation so that they could vastly expand its origination of liar’s loans?
Why in this era of the 1980s and 1990s when Fannie and Freddie still were quasi-governmental (as opposed to the wholly privatized entities they were by the Bush (II) administration) were they (1) very powerful politically and (2) the strongest force in the industry for raising underwriting standards? As they become fully privatized their controlling officers adopted the classically perverse financial incentives for executive compensation that have proven so criminogenic and Fannie and Freddie become serial accounting control frauds.
Wallison’s fable makes no sense. The financial industry’s leaders were immensely powerful. Had the government ever mandated they make fraudulent loans, and had they objected to making such loans, they would have raised holy hell. So, who remembers the American Bankers Association’s campaign to ban liar’s loans of 1991, 1995, 2000, 2004, 2006, or 2008? It is, of course, a trick question. The financial industry’s CEOs fought tooth and nail to try to prevent the Bush II administration regulators from issuing even unenforceable guidelines warning against liar’s loans. The financial industry’s CEOs continued to oppose the Fed banning liar’s loans even after the industry’s own anti-fraud group (MARI) reported that liar’s loans had a fraud incidence of 90 percent.
Who called for the adoption of rules banning liar’s loans? Overwhelmingly that call came from the pro-affordable housing groups, including the NAACP and ACORN.
Liar’s loans provide the “natural experiment” to test Wallison’s hypothesis. No regulator, even Bush (II’s) “wrecking crew” ever required or encouraged lenders to make liar’s loans – or Fannie and Freddie to purchase them. Because liar’s loans pervasively and substantially inflate the borrower’s income, they would be a nonsensical means of trying to meet Fannie and Freddie’s (unenforceable) guidance urging them to make more loans to those with less than median income. Even worse for Wallison’s thesis, Fannie and Freddie purchased NINA loans, which were ineligible for being counted towards those unenforceable affordable housing goals because a “No income; no assets” loan does not provide information on the borrower’s income.
Fannie and Freddie’s managers (eventually) purchased large amounts of liar’s loans for the same reason Lehman, Bear, and Merrill Lynch’s managers did. Liar’s loans optimized accounting control fraud. Lehman, Bear, and Merrill, of course, were not subject to any affordable housing goals.
But you will not learn these facts from reading Wallison and Schuck is not an expert in this field and shares Wallison’s dogmas so Schuck fails to subject Wallison’s thesis to any critical tests. Schuck’s review is littered with ideological embarrassments like this.
Government-sponsored agencies were pressed to purchase subprime and other nontraditional mortgages on a huge scale, with private investors following suit once they saw the profit opportunities that the government’s eased rules were creating. In the liberal version of events, the private sector led the way.
Well, no. Notice that Schuck has skipped over the entire origination of liar’s loans – actually he has skipped over liar’s loans entirely because they would refute his and Wallison’s mutual fable. Recall that by 2006 roughly half of all the loans called “subprime” were also liar’s loans – the two categories were frequently combined. First, the secondary market is helpful, but not essential to epidemics of accounting control fraud by lenders. The CEOs who caused mortgage banks like Ameriquest to make liar’s loans create the “sure thing” of reporting extreme profits. That means they can raise funds to originate more liar’s loans because lenders officers’ are eager to lend to firms reporting record profits.
Second, no one denies that lenders and their agents (loan brokers) created the “Gresham’s” dynamic that led to the epidemic of appraisal fraud in which appraised values were systematically inflated. No honest CEO of a lender would ever do that, but fraudulent CEOs find it optimal. No government entity ever encouraged lenders to ruin their underwriting by extorting appraisers to provide fraudulently inflated “market” values. This means that the leaders of lenders were, to aid their frauds, deliberately rendering their underwriting ineffective even though that was certain to cause severe losses to the bank (while making the CEO wealthy through the “sure thing” of accounting control fraud). The same fraud logic would cause the CEOs of lenders to deliberately gut other aspects of their underwriting standards, i.e., by making liar’s loans. But this would refute Wallison’s fable so he excluded any analysis of the implications of the epidemic of appraisal fraud and Schuck provides no indication that he is even aware of the epidemic of appraisal fraud.
Third, private investors did not “follow” Fannie and Freddie in purchasing liar’s loans in the secondary market. They dominated nonprime purchases for years, which caused Fannie and Freddie to lose considerable market share as the nonprime lending became common. So another name for the “liberal version of events” is “reality” supported by the data. Schuck endorsed this sentence that Wallison crafted to mislead the reader by eliminating this loss of market share from his fable.
Fannie and Freddie increasingly dominated nontraditional mortgages until the share held by federal agencies and their regulated entities had soared to 77% by June 2008, up from 40% in 1990-91.
Fannie and Freddie’s leadership switched heavily towards purchasing nonprime loans in 2005 when its regulator (OFHEO) banned their prior fraud schemes (involving rapid growth of MBS held in portfolio). The new managers switched to the more classic “fraud recipe” for a loan purchaser.
Even then, however, one must remember that Fannie and Freddie were very large organizations that had for decades pushed for high quality underwriting so hundreds of members of their underwriting staff resisted lowering quality. The result is that Fannie and Freddie, even at their leaders’ worst, reduced their underwriting standards far less than did their counterparts at firms such as Merrill Lynch, Bear, Lehman, Citi – and dramatically less than did their counterparts at firms like Washington Mutual (WaMu) and a host of mortgage banks. This is not a “liberal version of events.” The FCIC report, in loving detail, presents and explains the data that demonstrate that losses on liar’s loans and subprime non-liar’s loans purchased by Fannie and Freddie are far lower than the industry averages on such loans.
Contrary to the impression Wallison and Schuck try to leave with the reader, the FCIC fully considered Pinto’s data – which were fatal to Wallison’s claims. The key to Pinto’s work is not the data – but his labeling of the data. The issue in labeling is important, for there were no formal definitions of “prime,” “subprime” or “liar’s loans.” Pinto chose to use a very high bar for his definition of “prime” loans. He classified many loans that most people might consider prime as “subprime.” What matters, however, is not the label, but the actual default and loss upon default experience. Under Pinto’s classifications, which make a very large percentage of Fannie and Freddie loan purchases “nonprime” the starkly lower default and loss upon default figures for “nonprime” loans are even more remarkable. To state the obvious (except to Pinto, Wallison, and Schuck) – a loan that is very similar to a classic prime loan is not equivalent in risk to the subprime liar’s loans that Bear, Lehman, and Merrill Lynch were buying that had far higher credit risk. The difference (or lack of difference) in default rates between the two very different underwriting standards will show up in the default data. A profound difference showed up in the Fannie and Freddie data – their nonprime loans (under any consistent definition, but particularly under Pinto’s definition) had a substantially better default experience than their counterparts.
The data that FCIC did not fully consider – indeed, excluded – further invalidate Wallison and Pinto’s fables. The data FCIC excluded were from Citi’s most senior whistleblower, Richard Bowen. They showed how extreme the destruction of underwriting was at Citi on a portfolio of nonprime loans it purchased for resale profits – not for any affordable housing purpose.
Schuck’s uncritical acceptance of Wallison’s fables continues with his endorsement of this Wallison clunker: “there has been no significant and relevant deregulation of financial institutions in the past 30 years.” I explained above why this ignores desupervision and decriminalization. I also explained that it ignores the critical act of deregulation – of underwriting – not by legislation but by replacing a vital rule with a deliberately unenforceable guideline. Underwriting standards are the centerpiece of Wallison’s thesis, but we hear nothing about this key act of deregulation and its direct tie to the massive expansion of liar’s loans. The reason, of course, is that this evisceration of underwriting was not done for purposes of affordable housing, but for anti-regulatory ideological reasons that Wallison has spent his entire career proselytizing.
Note that fraud, despite all the findings and admissions, is excluded from Wallison and Schuck’s telling of their now joint fable. Schuck ends on an unintentionally hilarious note.
Hidden in Plain Sight has aroused furious opposition among liberal pundits like Joe Nocera, who, with scant analysis, denounced it in the New York Times as a “big lie.” Some others are no less intemperate in their invective and stigmatization-by-association. Instead, serious analysts and policy makers should grapple with this book’s challenging, plausible, evidence-based case.
Schuck must never have read the FCIC report’s annihilation of Wallison’s fable. Wallison’s claims are not “plausible.” They are based on torturing and ignoring the “evidence.”
Wallison is a lifetime proponent of the three “de’s” that blew up the financial world. There was no chance that he would have a Road to Damascus conversion and admit that he played a leading role in helping to blow up the world economy and that his hero Ronald Reagan led the charge to financial catastrophe.
“Serious analysts” tore Wallison’s fables apart four years ago – and Wallison has failed to come up with any “evidence-based” rebuttal to the evisceration of his purported history, analysis, and data. Schuck shows no awareness that any of this happened. FCIC devoted roughly 80 pages of its final report to refuting Wallison’s claims and the rebuttal was so effective that no Republican joined Wallison’s dissent. I have authored numerous detailed analyses of Wallison’s errors as have a number of scholars. Wallison’s fables rest on the consistent exclusion of facts, logic, and data that falsify his claims.
I’ll end on one thing in Schuck’s favor – of the dual book reviews in that issue of Barron’s his was the least insane. The other reviewer (utterly oblivious to the massive banking cartels that rigged bids) expressed his unconditional agreement with the author’s “valid argument that all antitrust laws should be abolished.” I will name neither the author nor the reviewer lest I provide them with any publicity for their efforts to promote elite crimes.
The Barron’s of industry openly yearn to return fully to the days of the Robber Barons when they could commit their crimes with absolute impunity. Adam Smith’s famous warning that “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices” represents the elite criminal classes’ desiderata. The criminal classes’ sycophants in the professorial ranks of economists and law and economics rise to the top of the septic tank through their willingness to say anything necessary, no matter how damaging to the Nation, to praise their patrons’ moral depravity.