A fistful of your tax dollars

The National Bureau of Economic Research published a paper March 21st by Deniz Igan, Prachi Mishra, and Thierry Tressel titled, “A Fistful of Dollars: Lobbying and the Financial Crisis.” They conclude:

lobbying was associated with more risk-taking during 2000-07 and with worse outcomes in 2008. In particular, lenders lobbying more intensively on issues related to mortgage lending and securitization (i) originated mortgages with higher loan-to-income ratios, (ii) securitized a faster growing proportion of their loans, and (iii) had faster growing originations of mortgages. Moreover, delinquency rates in 2008 were higher in areas where lobbying lenders’ mortgage lending grew faster. These lenders also experienced negative abnormal stock returns during the rescue of Bear Stearns and the collapse of Lehman Brothers, but positive abnormal returns when the bailout was announced. Finally, we find a higher bailout probability for lobbying lenders. These findings suggest that lending by politically active lenders played a role in accumulation of risks and thus contributed to the financial crisis.

These findings fit perfectly with the conservative narrative of the financial crisis which holds that federal government policy encouraged risky investments financed ultimately by you, the taxpayer. But the authors focus a lot on “lax regulation” writing:

Why are some lender more likely to benefit from lax regulation? These lenders, for example, may be specialized in catering to riskier borrowers. … An extreme view could be that certain lenders engaged in specialized rent-seeking and lobbied to increase their chances of preferential treatment, e.g. a lower probability of scrutiny by bank supervisors or even a higher probability of being bailed out in the event of a financial crisis.

But the problem with government policy wasn’t regulated to just lax regulation and private firm bailout. The government sponsored entities (GSEs) Fannie Mae and Freddie Mac used their implicit taxpayer guarantee and political connections to transform the mortgage security landscape. Consider Fannie Mae’s partnership with Countrywide Financial.

Founded in 1969, for many years Countrywide was a marginal player in the mortgage security industry. But then between 1985 and 2003 Countrywide delivered a 23,000% return on investment.  What happened? How did Countrywide go from nothing to a huge industry player? This 2000 report by the Fannie Mae Foundation provides a clue:

Countrywide tends to follow the most flexible underwriting criteria permitted under GSE and FHA guidelines. Because Fannie Mae and Freddie Mac tend to give their best lenders access to the most flexible underwriting criteria, Countrywide benefits from its status as one of the largest originators of mortgage loans and one of the largest participants in the GSE programs. …

When necessary—in cases where applicants have no established credit history, for example—Countrywide uses nontraditional credit, a practice now accepted by the GSEs.

In other words, Countrywide figured out how to work with Fannie Mae to best leverage taxpayer dollars into profit. Not only did Fannie become the biggest buyer of Countrywide loans, but when he was CEO of Fannie Mae, President Obama campaign adviser Jim Johnson worked personally with Countrywide CEO Angelo Mozilo to streamline the two companies’ business relationship. Mozilo told Dow Jones he was “working very closely … with Jim Johnson of Fannie Mae to come up with a rational method of making the process more efficient by the use of credit scoring.

This partnership was a great success. In 2006, Countrywide financed 20% of all mortgages in the United States — 45% of which were subprime. Amazingly, despite these facts, Countrywide is mentioned only once in the NBER paper and Fannie Mae is not mentioned at all.

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