While Karl Rove is a pretty bright guy, politically savvy and a great political analyst, his recent comments in defense of President Bush are somewhat weak. Or at least proportionally inconsistent with the facts.

Writing in the editorial pages of the Wall Street Journal, Rove claims that … 

“President Bush Tried to Rein In Fan and Fred: Democrats and the media have the housing story wrong.”

“Mythmaking is in full swing as the Bush administration prepares to leave town. Among the more prominent is the assertion that the housing meltdown resulted from unbridled capitalism under a president opposed to all regulation.”

Market forces …

President Bush’s complicity in the housing meltdown pales in comparison to the natural consequences of the downturn in real estate values as the speculative housing bubble burst and overleveraged speculators lead the downward spiral of housing prices. It is a fact that President George Bush had little or nothing to do with outrageous valuations of “ $50,000 crapbox” properties which were now commanding prices of $400,000.

His culpability also pales in comparison to the egregious actions of the Wall Street Wizards which, once again, allowed illiquid and ill-understood derivatives to drive a frenzy of commission sales with little or no opposition to regulatory agencies which may have been precluded from seeing the “larger risk picture” due to inappropriate, but legal, accounting rules which  allowed much of the growing risk and contingent losses to be masked in “off balance sheet accounts.”

If President Bush were to be guilty of anything, it would probably be the charge of cronyism and the appointment of people who were clearly not up to the leadership tasks required of their respective agencies.

People like now-Senator Mel Martinez at HUD who attempted to create mortgage reform in a blackout zone of secrecy with even Congress wondering what the final RESPA (Real Estate Settlement Procedures Act) would look like. An egregious action which brought forth over 40,000 comment letters and side-tracked the effort at “predatory lending” reform. Next up at HUD was Alphonso Jackson who attempted to carry on RESPA reform, but was side-tracked by several investigations into his allegedly hyper-partisan handling of contracts, work assignments and other issues based on political considerations. Jackson, with his wall-mounted photo gallery of his portraits prominently placed, was followed by Steve Preston who finally released a working final rule; some of whose provisions are being hotly debated in the industry as we speak. Preston, compared with his predecessors, appears to be a competent administrator and the clean-up man chosen to allow soon-to-be ex-President Bush to claim some regulatory victory on the housing front.

Another appointment that comes to mind is Alberto Gonzales at the Department of Justice who might have been so preoccupied with political matters than he failed to prosecute those who were wreaking havoc on our mortgage marketplace; such as those who were allegedly manipulating the books of Fannie Mae and Freddie Mac for personal gain – and who were engaging in outlandish lobbying activities. Not to mention those financial institutions on Wall Street who were engaged in paper scams.

Of course, no recitation of dud appointments would be complete without the mention of Securities and Exchange Commission’s Christopher Cox, who for reasons that I am sure are yet to be examined, failed to notice or regulate the growing systemic risk that was being hidden in “off balance sheet” accounts and therefore was inadequately disclosed to the public, investors, counterparties and the regulators.

The SODDI defense  …

“Like most myths, this is entertaining but fictional. In reality, Fannie Mae and Freddie Mac were among the principal culprits of the housing crisis, and Mr. Bush wanted to rein them in before things got out of hand.”

In criminal law, the SODDI defense (Some Other Dude Did It) can be heard echoing in courtrooms. In the present instance, the charges that the democrats and their overt and covert protection of the GSEs (Government Sponsored Enterprises) Fannie Mae and Freddie Mac played a major role in the current mortgage meltdown, are somewhat overstated. 

There is no doubt that the actions of Fannie Mae and Freddie Mac were conditioned primarily on their desire to maintain or gain market-share in a market becoming  increasingly dominated by private origination and securitization efforts such as those by Countrywide and Merrill Lynch.

In the case of the GSEs, the systemic risk was a result of the extreme leverage allowed by the regulators and was well known by all. Truth-be-told, all banks exhibit an extreme amount of leverage as they can hardly redeem all of their short-term deposits  when the capital is unavailable in long term loans.

Why the regulators and the Department of Justice did not take stronger action against the GSE's executives for allegedly managing earnings to earn tens of millions of dollars in bonuses while concealing material facts from Wall Street is unknown.

Clearly, in my opinion, 80% of the blame for the mortgage meltdown lies with the Wall Street Wizards and the inappropriate use of derivatives and the hedging schemes which convinced complicit “pay-for-play” ratings agencies to provide "investment grade" ratings to impaired and illiquid securities; based on a data model which did not account for the modified lending standards prevalent under a "risk deferral" model.

However, the real culprit behind the debacle is the extraordinary amount of leverage used by financial institutions to "juice" their yields and the fact that FASB accounting rules allowed them to hide the growing risk (and losses) "off balance sheet" in Enron-type "special purpose vehicles." There is enough blame to go around -- and George Bush and his politics are the very least of those culpable for this current disaster.

A disaster, I might add, which has been exploited by the unregulated hedge funds which put further downward pressure on financial institutions and which are now scooping up assets at pennies on the dollar -- with the apparent instigation of government agencies such as the FDIC.

“Rather than a failure of capitalism, the housing meltdown shows what's likely to happen when government grants special privileges to favored private entities that facilitate bad actors and lousy practices.”

Here I think Karl is not stating the case as well as he could or should. It is not so much the government granting special privileges to favored entities, be they hybrid quasi-governmental institutions like Fannie Mae and Freddie Mac which have an inherent conflict of interest: promoting government policy and trying to serve the interests of their private investors, or any other company.

It is the government engaging in social engineering to bring about a politically desired and expedient result that has no constitutional basis for government intervention. There is no place in the Constitution of the United States that mandates that the federal government involve itself in the housing matters of private citizens. In essence, to allow the modification of sound lending practices to include those who could not ordinarily qualify for a loan under prudent underwriting standards. To allow government agencies to prosecute those who refused or were reluctant to lend in depressed areas, often to people who could not afford traditional loans or who were charged higher rates for a measurably higher risk of default. And to take such actions as to encourage companies to purchase these “impaired” loans to prevent “regulatory action.”

“Fannie and Freddie are ‘government-sponsored enterprises’ (GSEs), chartered by Congress. As such, they had an implicit promise of taxpayer backing and could borrow money at rates well below competitors.

It is a problem when government interferes in any private business, but it is especially egregious when the government creates and implicitly controls a quasi-public entity.

Fannie Mae was created by the democrats to move the growing housing debt off the federal books so as to disguise the mounting federal debt. Freddie Mac was created later, ostensibly to provide competition to the burgeoning Fannie Mae. These institutions were mostly controlled by democrats and, in some cases, served as a “piggy bank” to assist democrats in their quest to attain or maintain political office. Using their foundations and a system of “reverse earmarks,” Fannie Mae or Freddie Mac could assist a politician by allocating more funding to housing projects in the affected district thus increasing the prestige and power of the politician championing the project.

Much of this activity pre-dated the Bush Administration and, in spite of the efforts of the President and others, continues to this present day. These organizations continue to be protected by high-ranking members of Congress and remain mostly immune to Presidential powers.

Rove leaves the argument wanting …

“ Because of this, the Bush administration warned in the budget it issued in April 2001 that Fannie and Freddie were too large and overleveraged. Their failure ‘could cause strong repercussions in financial markets, affecting federally insured entities and economic activity’ well beyond housing.”

“Mr. Bush wanted to limit systemic risk by raising the GSEs' capital requirements, compelling preapproval of new activities, and limiting the size of their portfolios. Why should government regulate banks, credit unions and savings and loans, but not GSEs? Mr. Bush wanted the GSEs to be treated just like their private-sector competitors.”

Yes, it is widely acknowledged that the GSEs posed a great systemic risk. But risk of what? If the GSEs collapsed they merely made the implicit guarantee of federal funding support explicit. Nothing much would affect our economy other than the public relations fallout from additional monies being used to shore up their day-to-day operations.

“But the GSEs fought back. They didn't want to see the Bush reforms enacted, because that would level the playing field for their competitors. Congress finally did pass the Bush reforms, but in 2008, after Fannie and Freddie collapsed.”

This I regard as a red herring; simply because the magnitude of the private sector problem, with its reliance on inappropriate hedging, was a far greater risk to the system than were the GSEs.

“The largely unreported story is that to fend off regulation, the GSEs engaged in a lobbying frenzy. They hired high-profile Democrats and Republicans and spent $170 million on lobbying over the past decade. They also constructed an elaborate network of state and local lobbyists to pressure members of Congress.”

While it is true that the mainstream media did not concentrate on the often inappropriate lobbying efforts of Fannie Mae and Freddie Mac, they also failed to mention that House Financial Chairman Barney Frank’s gay lover was a Fannie Mae executive allegedly charged with increasing Fannie Mae’s affordable housing business and staving off expansion challenges to its charter, purchasing power limits and reform attempts.

Again, this is a red herring. One need only look at the leverage ratios of financial institutions which insured that the institution’s equity would be wiped out in a market downturn of almost inconsequential three to five percent. Or the use of insurance-like credit default swaps which were not actuarially sound and were issued by corporations whose balance sheets could not possibly handle the appropriate  contingent liabilities – that is if they were reported correctly and/or not kept in offshore or “off balance sheet accounts.” To put this matter into financial perspective, the contingent liabilities of the GSEs were said to be about $5 trillion – whereas the contingent liabilities of these credit default swaps was said to be an estimated to be between $43 trillion and $57 trillion – “more than half the size of the entire asset base of the global banking system” according to Bill Gross, the widely-respected investment guru at PIMCO. And as measured against the total issuance of an estimated $500 trillion in total derivatives.

By any measure, the use of inappropriate leverage and the contingent liabilities associated with derivatives and credit default swaps makes President Bush’s involvement in the current economic crisis a non-issue: good for talking points, but far from the reality of the situation. But then again, that is what Rove is attempting to demonstrate. 

So what did cause the systemic failure …

For the most part, the catastrophe was caused by the Wizards of Wall Street and their ill-understood and illiquid derivative operation and the greed that allowed bonuses in the range of tens- or hundreds of millions of dollars to be earned with no more effort than selling dodgy securities to those who believe that everybody, especially the ratings agencies, had all of the significant risks hedged; leaving only the profitable upside.

Also, in part, it was the regulatory agencies who couldn’t or wouldn’t take prompt and appropriate action against those who were creating and marking toxic derivatives. Or prosecute those who were engaging in predatory lending activities which were not only detrimental to the borrower, but extremely toxic to the overall mortgage system.

But few had forecast a significant downturn in the housing markets when the speculative bubble burst and those who were manipulating the mortgage system by continually re-financing troubled borrowers into higher and higher loans would be caught short when the property appraisals would not support increasing loan amounts without resorting to fraudulent over-value appraisals.

Assigning blame to President Bush …

If George Bush is to be blamed for anything, let it simply be based on the Navy’s “chain of responsibility” model. It happened on his watch – so he assumes the responsibility. No more, no less.

As a footnote, we should all thank the President for keeping us relatively safe from domestic attack and for attempting to always do the right thing. If one wants to fault the President of something, let it be his lack of communication with the American people and his refusal to engage the democrats on their failed and failing policies.

-- steve

Quote of the Day: “While it is natural to assign blame, the real shame is in not profiting from the situation.” -- steve

A reminder from OneCitizenSpeaking.com: a large improvement can result from a small change…

The object in life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane. -- Marcus Aurelius

Reference Links:

Karl Rove: President Bush Tried to Rein In Fan and Fred - WSJ.com