Why the economic house of cards fell

In a more fair world, Franklin Raines and Jim Johnson would be doing a perp walk. After all, the CEOs of Fannie Mae and Freddie Mac committed the same white-collar crimes that brought down Enron and WorldCom, among others.

They cooked their books to overvalue assets and wildly overstated the profitability of their enterprises. Then they used the "profits" to justify enormous bonuses for themselves. They also made substantial donations to far-left outfits like ACORN and MoveOn.org, as well as to their enablers in Congress, including Barney Franks and Chris Dodd.

Those who prefer justice to be blind will find disappointment here. Congress is not about to open this can of worms, which would prove their own complicity in fraud.

But as slimy as Fannie and Freddie are, they weren't the root cause of the recent financial meltdown. Since the early 1990s, it has been explicit federal policy under the Community Reinvestment Act to increase homeownership by forcing banks to loosen traditional underwriting standards for home mortgages. As the Boston Federal Reserve instructed its banks in a 1992 memo, "special care should be taken to ensure that (underwriting) standards are appropriate to the economic culture of urban, lower-income and non-traditional customers."

Throughout the country, government interference in a stable, functioning market resulted in a complete transformation of lending practices. The proven practices of evaluating loan-to-value ratios and credit ratings were now frowned upon. Income verification was deemed unnecessary, so naturally "liar loans" became commonplace.

Banks not in compliance with the new rules were often featured in uncomplimentary newspaper articles. Attorney General Janet Reno wrote threatening memos to laggards. The results were pure Economics 101. Homeownership rose dramatically, to the delight of the community organizations and politicians. But home prices also shot up in response to the increased demand, while Fannie and Freddie backstopped the new, innovative loans.

Lenders like Countrywide, which plunged most enthusiastically into this new business opportunity, came in for special praise. The League of United Latin American Citizens gave Countrywide, later vilified as a predatory lender exploiting unqualified clients, an award for its "generosity" in "bringing the pride of homeownership to our communities." Fannie and Freddie also commended Countrywide for its prescience in following "the most flexible guidelines allowed," especially when no credit history was available.

Few original lenders held these mortgages, like they did in the supposed bad old days. When the time came to bundle and sell the paper, the economic nonsense flowed like a river. Bear Stearns (remember them?), underwriting mortgage-backed securities consisting of these CRA loans, coolly assured buyers that standards for LTV ratios, while considered important in the past, should be "adjusted" for these new "affordable" loans. Personal credit ratings were depicted as having "limited effectiveness with CRA loans," although no reason was offered as to why this might be so.

The whole scheme worked only so long as housing prices continued to rise. When the inevitable downturn came, defaults racked the system as owners, including speculators, walked away from properties in which they had little or no personal investment. Their now worthless loans spread like rot throughout the financial community. Banks floundered and failed while equity holders around the world lost trillions.

Americans to this day have a confused notion of what happened. Polls show that "Wall Street greed" and "lack of regulation" are perceived as the main culprits, reflecting the views of the mainstream media and even, unfortunately, candidate John McCain. Yet, the inevitable bad apples aside, the worst sin most lenders committed was to follow the lending guidelines demanded by government. Congress needs to regulate and discipline itself, not those dealing with the inevitable consequences of its policies.

The election of Barack Obama was hardly a step in the right direction. He was a member of the grass-roots organizations who successfully campaigned for "change" in lending practices. Fannie and Freddie execs are his close advisers, so there's little chance of repudiating them or recovering their ill-gotten gains. So far, there's not even any interest in reforming the overly flexible underwriting standards. Apparently that's too close to admitting fault.

We should learn from our mistakes. We've paid for them dearly.

East Valley resident Tom Patterson (pattersontomc@cox.net) is a retired emergency room physician and former state senator.