I Am John Galt (26 page)

“I think it's a worthy undertaking—to provide a decent apartment for a man who earns fifteen dollars a week. But not at the expense of other men. Not if it raises the taxes, raises all the other rents, and makes the man who earns forty live in a rat hole. That's what's happening in New York. Nobody can afford a modern apartment—except the very rich and the paupers.”

Ultimately Roark's housing project fails despite his brilliant engineering. When bureaucratic interference destroys his design and thwarts its economies, Roark dynamites the building site. A spectacular blowup to be sure, but it was only one building. The blowup triggered by Frank's bureaucratic interference occurred on a nationwide scale, and the panic it induced spread throughout the global economy. It will take many years for the world to recover from it.

When the end came for Frank's housing bubble, the crowning irony was that the final lethal blow to the system came not from corrupt politicians exploiting the rich, but from corrupt businessmen who became rich beyond the dreams of avarice by figuring out how to exploit corrupt politicians. Just as in
Atlas Shrugged
the corrupt railroad executive James Taggart forged an unholy alliance with bureaucrats like Mouch, corrupt financiers such as Countrywide's Angelo Mozilo (whom we met in Chapter 4, “The Parasite”) rode on the easy-money mortgage gravy train made possible by politicians like Barney Frank—and leveraged it up until they drove it straight off the cliff.

Rand once wrote,

To a . . . primitive socialist mentality—a mentality that clamors for the “redistribution of wealth” without any concern for the origin of wealth—the enemy is all those who are rich, regardless of the source of their riches. Such mentalities, those aging, graying “liberals,” who had been the “idealists” of the 30's, are . . . frantically evading the spectacle of
what kind of rich
are being destroyed and what kind are flourishing under the system they, the “liberals,” have established. The grim joke is on them: . . . The collector of their efforts is not the helplessly, brainlessly virtuous “little man” of their flat-footed imagination and shopworn fiction, but the worst type of predatory rich, the rich-by-force, the rich-by-political-privilege, the type who has no chance under capitalism, but who is always there to cash in on every collectivist “noble experiment.”
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If Frank was the last link in a long, corrupt chain, let's go back to the first link.

Franklin D. Roosevelt created the Federal Housing Administration (FHA) in 1934 as part of his New Deal initiative. During the Great Depression, banks were all but frozen. Mortgage loans, if they were made at all, required 50 percent equity with repayment terms of just three to five years. During this time, less than half of all households owned their homes.

The FHA was born to provide insurance in the form of a government guarantee to give banks confidence in lending on more liberal terms, including significantly lower down payments and 30-year amortization schedules with fixed rates of interest. If a homeowner with an FHA-backed loan defaulted, the federal government would reach into its deep pockets as the ultimate backstop and make the lender whole.

Over time, private mortgage insurance companies came to largely fill this role. Yet despite having outlived its initial usefulness in successfully bridging the scale gap long enough for private enterprise to take hold, the FHA continues to exist in a larger mutated form. As always, once government gets a toehold in the commercial markets, it grows like a fungus. In 1938, the FHA created the Federal National Mortgage Association—now famous by its nickname, Fannie Mae—to sell government-backed bonds and use the proceeds to purchase FHA-guaranteed loans, further institutionalizing the role of government in the private housing market.

From 1968 through 1970, Congress treated the already morphing mass of federal housing programs to a legislative injection of growth hormone. Fannie Mae spawned Ginnie Mae and Freddie Mac, creating an alphabet soup of parallel agencies. Fannie was then spun off as a strange hybrid—a shareholder-owned company trading on the New York Stock Exchange, yet chartered with a “public purpose” and incestuously guided by the department of Housing and Urban Development. To ensure its survival in the savage world of competitive free markets, the enfant terrible also retained special government-sponsored privileges, including tax breaks and an implicit government guarantee of its obligations.

These new so-called government-sponsored enterprises (GSEs) were also given free rein to buy up nongovernment bank mortgages, assuming they met certain standards, including loan limits and credit quality, making them what would henceforth be known as “conforming.” Suddenly, commercial banks had a way to offload their mortgages from their books, clearing the way to add new ones and earn new fees. Over a period of years, banks transitioned from lenders who directly retained risks and reaped rewards from their portfolio of investment assets to mere originators of standardized loans passed through to the GSEs for a cut of each transaction. The GSEs, in turn, were permitted to pool conforming loans and package them for further resale to private investors, spawning the first mortgage-backed securities (MBSs), and, in the process, create even more lending capacity.

In its pure form, the MBS is a valuable market innovation. It diversifies away the risk of mortgage default by any individual homeowner, which is inherently difficult to predict. Collect a hundred or so similar loans into a portfolio, and the law of large numbers ensures that whereas any one individual borrower may fall on hard times, the odds that everyone will simultaneously default are small. Investors could buy a share of a mortgage pool and earn a portion of the total profits while spreading the risk of individual default among the entire investor syndicate. To further reduce investor risk, the sponsoring GSE would backstop any losses with a guarantee, making mortgage-backed securities a safe and liquid investment for individuals, institutions, and pension funds alike. Suddenly the housing industry, previously constrained by local lending capacity, was now limited only by the appetite of a gargantuan base of global investors.

And sure enough, during the 1970s as MBSs took hold, home ownership rates rose steadily from 63 percent to 66 percent in 1979. Total national mortgage debt rose modestly as well, from $1.2 trillion in 1970 to $1.9 trillion by the end of the decade. Yet home prices were remarkably stable. The capital markets provided a natural limit to the amount of funding available based on the risk profile of the borrower. As potential homeowners saved responsibly and generated stable income, they could qualify for a mortgage. Others simply rented.

The 1980s ushered in the Reagan era of deregulation, which Frank and his bureaucratic ilk decry as the root of our current mess. The reality is quite different.

In the deregulated world of MBSs, lenders had a larger tool kit of financing options and were able to serve a broader segment of the market with more flexible and customized products while retaining the ability to obtain compensation commensurate to the risks they took. Far from causing a stampede of high-risk loans and a wave of abusive lending practices, the effects were modest at best. Home ownership remained stable during the 1980s, with subprime funding accounting for a tiny fraction of loan volume. So much for the big, bad bugaboo of deregulation. It was the eventual governmental intrusions into that deregulated market under misguided notions of social subsidy—policies originated, pushed, and approved relentlessly by Barney Frank throughout his career—that led us to disaster. (See
Figure 6.1
.)

Figure 6.1
Home Prices versus Mortgage Credit. (
Left axis
) Case-Shiller Real Home Price Index; (
right axis
) Fannie Mae Mortgage Credit Book of Business ($ Billions). Under Barney Frank's meddling oversight, government agencies spawned the housing bubble . . . and eventual global economic collapse.

Source: Case-Shiller Real Home Price Index, Fannie Mae 10-Ks
, Congressional Record

It began when new laws in 1986 created a tax asymmetry that caused a wave of debt transfer from consumer loans to mortgages.
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Mortgage loan volume nearly doubled from a flat-line average of about $1.9 trillion earlier in the decade to $3.5 trillion in 1990. And yet homeowners seemed to have no more trouble than usual making good on their payments. The market ticked along accordingly with modest home price appreciation in line with previous decades. Fannie Mae remained a minor adjunct to the mortgage market during this time, buying primarily bread-and-butter single-family 30-year fixed-rate mortgages and never holding more than 3.5 percent of the nation's total debt outstanding.

Yes, this seemingly subtle change in tax status of debt started a wave. But at first it was only a wave. Frank was about to make it a tsunami.

Government-Sponsored Booby Prize

Enter the Clinton era and Barney Frank's big chance to spread the nation's productive wealth among the least capable custodians under the banner of social fairness. The Housing and Community Development Act of 1992, co-sponsored by Frank, placed the GSEs, including Fannie Mae, under direct control of the Department of Housing and Urban Development (HUD) and disbanded their advisory board of independent experts in housing finance, actuarial science, and economics. It also authorized the HUD secretary to establish affordable housing goals for the GSEs—putting the fox in charge of the henhouse.

At the time, Herb Moses (Frank's live-in lover and self-proclaimed “only member of the congressional gay spouses caucus”) was working at Fannie. Thanks to his relationship with Frank, Moses would rise to become assistant director for product initiatives at the very organization that Frank's committee was charged with overseeing. According to
National Mortgage
News
, from his senior-level perch obtained through perks and pull, Moses “helped develop many of Fannie Mae's affordable housing and home improvement lending programs.”
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There are two ways to make housing affordable. The first is to create fundamental conditions of economic prosperity that encourage productive work and investment. As overall prosperity increases due to core economic growth, more citizens will join the ranks of homeowners with an equity investment in their abodes under rational market economics.

The second is to artificially lower the cost of housing by subsidizing those who can't afford to buy a home priced at a fair market level. Regardless of the terminology used to couch such tactics (government guarantees, lowered down payments, or outright credits), the end result is a redistribution of dollars from people who have earned to people who haven't—and the creation of unsustainable economic distortions that inevitably end in ruin. What Barney Frank and his utopian, quick-fix policies completely miss is that giving someone a house and expecting that person to become economically prosperous is like giving a kid a roomful of books and expecting the child to become literate. Just as literacy breeds book sales, prosperity breeds home ownership—not the other way around.

By 1995, the new law was fully in effect and HUD began jacking up the affordable housing quotas for Fannie from 30 percent to 40 percent, to 50 percent, and eventually to a peak of 56 percent just before the crash. Fannie began buying up mortgages at a furious pace. With so much home-purchasing capacity now open, lenders and mortgage originators couldn't give money away fast enough. Fannie's mortgage credit book ballooned from $254 billion in 1995 to $610 billion in 2000—fully 11 percent of all mortgages in the country—and it hadn't even gotten started.

Frank wanted even more. Barney boldly proclaimed in Congress, “We have an economy that is booming and has helped many people. But it does not help everybody equally, and some people are not helped at all. . . . I think we have an obligation morally, and it makes sense economically, to help with the production of housing.
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But there was a problem. It seemed the safe mortgages were already on Fannie's and Freddie's books, so they had to get creative to meet their ever-increasing government lending goals. So in 2000, under Barney Frank's committee's oversight, Fannie and Freddie expanded their mortgage purchases to include Alt-A, A-minus, and subprime mortgages in addition to private-label securities (these are all technical terms for mortgages of less than stellar credit quality, sometimes very much less than stellar).

Alt-A mortgages have little or no borrower income or asset documentation backing them. A-minus and subprime mortgages are made to borrowers with low credit scores and a history of trouble repaying lenders. With a new government-sponsored buyer willing to gobble up these risky loans, the subprime market exploded like Barney Frank's waistline at an all-you-can-eat buffet. What was a minor fringe product in the 1990s accounting for a mere $35 billion in debt outstanding—less than 1 percent of all mortgages—quickly reached critical mass under the GSEs' radioactive funding injection, spawning a mushroom cloud of $1 trillion in new subprime originations during 2006—fully 50 percent of all mortgages issued.
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