A recent Wall Street Journal article highlighted the astounding value of $110 Billion that various federal and state governments have received from their prosecution of banks for their alleged part in “creating” the conditions for the mortgage-induced financial market crash that led to the Great Recession. First, let me get this racket straight: The Federal Reserve spends years promoting over-investment into property through use of loose monetary policy. That same loose monetary policy leads to a predictable chase for yield in risky asset classes, including subprime mortgages. For its part, federal and state government agencies provide a complementary punch to central bank policies by actively promoting and manipulating investments in properties through distortionary tax policies such as the mortgage interest rate deduction and subsidized loans through agencies such as Fannie Mae and Freddie Mac. Furthermore, various government bodies craft legislation designed to push lenders into lending to higher risk individuals lest they get prosecuted for discrimination in an effort to promote home ownership as the ultimate American dream. Then when the whole house of cards come crashing down, ignore your own creation of the mess as the puppet-master and instead scapegoat and go after the puppets.
In essence, the mortgage-induced financial crisis was a result of government involvement, not a lack thereof, as this Forbes article written in the immediate aftermath indicates. I quote the key section below:
It is popular to take low lending standards as proof that the free market has failed, that the system that is supposed to reward productive behavior and punish unproductive behavior has failed to do so. Yet this claim ignores that for years irrational lending standards have been forced on lenders by the federal Community Reinvestment Act (CRA) and rewarded (at taxpayers’ expense) by multiple government bodies.
The CRA forces banks to make loans in poor communities, loans that banks may otherwise reject as financially unsound. Under the CRA, banks must convince a set of bureaucracies that they are not engaging in discrimination, a charge that the act encourages any CRA-recognized community group to bring forward. Otherwise, any merger or expansion the banks attempt will likely be denied. But what counts as discrimination?
According to one enforcement agency, “discrimination exists when a lender’s underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants.” Note that these “arbitrary or outdated criteria” include most of the essentials of responsible lending: income level, income verification, credit history and savings history–the very factors lenders are now being criticized for ignoring.
The government has promoted bad loans not just through the stick of the CRA but through the carrot of Fannie Mae and Freddie Mac, which purchase, securitize and guarantee loans made by lenders and whose debt is itself implicitly guaranteed by the federal government. This setup created an easy, artificial profit opportunity for lenders to wrap up bundles of subprime loans and sell them to a government-backed buyer whose primary mandate was to “promote homeownership,” not to apply sound lending standards.
Now fast forward a few years, and the Government is assuming the mantle of champion of the jilted poor, tirelessly and heroically prosecuting the banks whose malfeasance created the mess. Except as laid out above, the government is the entity that created the conditions for the mess. Turning to the research provided by the Wall Street Journal, when the money can be accounted for, it is going to pay for things such as barns and stables for the state fair in New York. The vast majority of the funds are staying within the organizations that prosecuted the banks, who predictably want no part of the people paying attention to the fake wizard that is really a corrupt man behind the curtain. As far as money being retained by organizations such as the Justice Department – talk about a tremendous conflict of interest. The Wall Street Journal reports that, “…some of the biggest chunks of money stayed with the entity that levied the fines in the first place. Of $109.96 billion of federal fines related to the housing crisis since 2010, roughly $50 billion ended up with the U.S. government with little disclosure of what happened next, according to a Wall Street Journal analysis”.
The richest and most tragicomic part of the analysis is that the Treasury Department itself received almost half of the $110 Billion that government has captured in these prosecutions. Much of this money was funneled to Treasury by Fannie and Freddie Mac. This is analogous to a chief arsonist, who gathered all of the needed accelerants and who lit the first match and set a building ablaze and then directed others to loot the property before the fire gets too hot, is now busy prosecuting the looters and taking the loot that they happened to gain before the fire consumed it all. While banks may hold little esteem in the minds of many, and while there was no doubt some wrongdoing on the part of banks that drives the partially deserved reputation, I don’t believe justice is served with one set of corrupt and incompetent entities scapegoating and profiting from another set of corrupt and incompetent entities simply because the former has the title of government. To paraphrase a Milton Friedman quip on governments somehow being morally superior to the private markets, “you think the U.S. and State government bureaucrat doesn’t have greed and reward virtue? Where are you going to find these angels to run mortgage markets for us”
The antidote to such malfeasance is not more government regulation and centralization of markets, it is less government involvement and decision making in the markets in the first place.