Reckless Endangerment

Gretchen Morgenson & Joshua Rosner “Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led To Economic Armageddon” Times Books 2011, 310 pgs

The authors, Gretchen Morgenson, a Pulitzer Prize-winning business reporter and columnist at The New York Times, and Joshua Rosner, an expert on housing finance, trace the beginnings of the 2008 financial collapse to the mid-1990s, when the Clinton administration called for a partnership between the private sector and Fannie and Freddie to encourage home buying. 

The authors focus on Fannie Mae, the government-sponsored enterprise that supported the home mortgage market by buying mortgages and packaging them into marketable securities which it then guaranteed and sold to investors.  The government’s implicit guarantee and favorable regulatory treatment protected Fannie (& Freddie) from competition and permitted them to rake in tremendous profits. Fannie’s CEO, James A. Johnson, personally took home roughly $100 million; his successor, Franklin D. Raines, did as well.  Of course, later losses were passed onto the taxpayer.

This book clearly shows that the problem is that Washington and the financial sector have become so tightly intertwined that public accountability has all but vanished.  The revolving door between financial institutions and Washington personnel as well as the dependency of politicians on campaign contributions has not stopped even today. 

For instance:  As Treasury secretary, Robert Rubin, formerly the head of Goldman Sachs, pushed for repeal of the ­Depression-era Glass-Steagall Act that had separated commercial from investment banking — a move that Sanford Weill, the chief executive of Travelers Group had long sought so that Travelers could merge with Citibank. After leaving the Treasury, Rubin became Citigroup’s vice chairman, and “over the following decade pocketed millions as the bank sank deeper and deeper.   

My Notes:

Pg. xiv:  Reckless Endangerment is an economic whodunit, on an international scale.  But instead of a dead body as evidence, we have trillions of dollars in investments lost around the world, millions of Americans jettisoned from their homes and fourteen million U.S. workers without jobs.  Such is the nature of this particular crime.

Pg. 26:  Traditionally, banks had required that borrowers put 20 percent of the property price down to secure a mortgage loan, but the 1992 Federal Housing Enterprises Financial Safety and Soundness Act encouraged Fannie and Freddie to buy mortgages where borrowers put down a nominal amount—5 percent or less—of the total loan amount. (Ironically the act was a prevention measure as no-one wanted a repeat of the shocking savings and Loan crisis where corrupt lenders enriched themselves at the taxpayers’ expense: $500 million to be exact).  The act required Fannie and Freddie to meet three separate housing goals through their mortgage purchases.  First were those related to low and moderate-income housing; then came so-called special affordable housing goals, and, finally, those associated with inner cities, rural areas, and other underserved areas.  And, incidentally, Fannie Mae was the key architect of the legislation.  This explains why the capital requirements for Fannie were set at 2.5 percent versus the 10 percent demanded of banks.

Pg. 83:  A CBO report reckoned the benefits accruing to Fannie and Freddie from their government ties amounted to $7 billion in 1995, which was by no means an unusual year.  Also, contrary to the claims made by Fannie and Freddie, the companies passed on to borrowers only about two thirds of the billions in benefits they received (for every $3 in savings they delivered $2 to homebuyers, while $1 stayed in the companies’ tills.)  The report concluded that Fannie and Freddie were an extremely costly way to help homeowners across America. 

Pg. 111:  As the S&L disaster faded into distant memory, Greenspan and others like him, put forward the concept that self-interested individuals operate in ways that benefit an entire group.  Therefore they can be counted on not to act destructively.

Regulators divide bank capital into tiers, with Tier 1 being the most conservative measure of a bank’s financial footing.  Tier 1 capital typically consists of cash held by the bank and proceeds from preferred and common stock it has issued.  Lower tiers consist of riskier and less liquid assets.  To be considered well capitalized, a bank must have a Tier 1 capital that is at least 6 percent of its risk—adjusted assets. The watering down of capital requirements began in the mid-1990s with actions taken by representatives of the ten major countries that make up the Basel Committee.  Its first recommendations are known as the Basel Accord.

Pg. 144:  Georgia’s bankruptcy system was the fastest in the country.  Lenders could call a borrower “in default,” foreclose, and take back the home all in as little as four weeks.  Georgia, like some twenty other states across the country, is a non-judicial foreclosure state, meaning that lenders can foreclose and repossess a home without having to present the facts to a judge. 

Pg. 153:  It was not until August 11, 2008, three weeks before Fannie was taken over by taxpayers, that S&P lowered Fannie’s risk rating: they moved the grade from A+ to A.  Now Fannie could join the long list of the S&P’s failure to appropriately judge risk, starting with Enron and WorldCom.

Pg. 157:  In the 1970s, Moody’s, S&P, and Fitch had changed their systems to require the issuer of the securities to pay for the ratings they received.  In previous times, investors had paid the freight for the agencies’ risk assessments. 

Pg. 224:  In 2005 alone, homeowners extracted three quarters of a trillion dollars from their homes, spending two thirds of it on personal consumption, home improvements, and credit-card debt.  Greenspan said “the surge in cash-out mortgage refinancing’s likely improved rather than worsened the financial condition of the average homeowner.”

Pg. 272:  2003 was the year to remember in mortgage originations.  A record 13.6 million mortgages worth $3.7 trillion were written that year; Wall Street’s issuance of mortgage-backed securities also peaked, reaching $463 billion in 2003.