Crony Capitalism: This Example Shows How it Works For the Cronies and Against Taxpayers

First, one must understand that the Federal Government was the architect of the U.S. Housing Bubble of the 2000s.  The government has always had programs to encourage and facilitate home ownership.  Tax deductible mortgage interest, tax exemptions on gains realized from the sale of principal residences, FHA loan guarantees, direct government loans at low interest rates through the Federal Home Loan Bank and public/private entities Freddie Mac and Fannie Mae, to name the most well known.   In the 2000s the government became more active than ever before, and in a new way.  In addition to the 160 already existing housing programs the Federal Reserve adopted a low-interest rate monetary policy the made money virtually free to borrowers when the Federal Funds rate fell below the rate of inflation.

At first, only those with clout and collateral could get this money.  These were big banks and Wall Street Investments houses to begin with, but they soon started making this money available to other borrowers.  Consumers then gained access to this money for housing loans.  New business models developed selling things no one had ever heard of before, such as “credit default swaps.”

Next the government, through the Department of Housing and Urban Development, began requiring Freddie and Fannie to invest at least 50% of their assets in low-end loans, known as sub-prime loans.  The government, through bank regulation with the involvement of then attorney general Janet Reno, began telling the banks they regulated, that “discrimination may be observed when a lender’s underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants.” The government’s definition of “outdated criteria” involved criteria no lender acting without government pressure would have considered outdated. Normal lending criteria such as past credit history and income level were now deemed outdated by government mandate. Suddenly lots of people whose financial situation could not be taken into account qualified for loans they could never repay.

Now the government did what it always does when a government program turns out to be a total failure. It instituted a new program to double down on the failure. This time the new program was called the Home Saver Loan Program. Unbelievably, at least to anyone with a lick of common sense, this Fannie Mae program made loans available to defaulting home owners to pay arrears on their mortgage. Predictably, Freddie and Fannie were soon underwater and in need of a Federal bailout.

By March 2012, the government had dumped $183 billion into bailing out Freddie and Fannie. Meanwhile, Obama Administration was also pressing for more forgiveness of loans. Here is where crony capitalism took over.

Mortgage loan forgiveness of course helped those borrowers who should never have been given loans in the first place. It helped the big banks even more. How can that be? you might say. Weren’t the big banks going to have to write off a lot of first mortgages? No, because the first mortgages were guaranteed by Freddie and Fannie, both of which had been bailed out. In many instances the big banks had sold those loans to Fannie and Freddie. In the meantime they had acquired and now held a ton of second mortgages. With the first mortgages in default, these second mortgages were currently worthless, but became valuable when the first mortgages were written off by the government’s Home Saver program.

All of this cost the government a lot of money. More accurately, it cost American taxpayers a lot of money. To help the big banks. Crony capitalism, ain’t it grand? I mean, if you’re a crony.