"The lenders" really needs to be split into the loan originators, Freddie/Fannie who set the standards and insured the prime conforming loans, the loan packagers (and especially the sub-prime loan packagers) who were mostly the investment banks, the packaged loan insurers (mostly AIG from what I've read, though I haven't seen any articles which even try to put numbers to this, so this could be way off), and the packaged loan buyers, which seem to include nearly every major financial industry player.
The question I've been trying to work out is, where were the regulators?
Fannie Mae and Freddie Mac at least were government entities, and had their own regulator. The Safety and Soundness Act of 1992, appears to have pulled the teeth from regulation and allowed Fannie and Freddie to start ignoring capital requirements. It wasn't until much later that the new regulatory agency, the Office of Federal Housing Enterprise Oversight began to develop some teeth.
And it was in 2003 with OFHEO finally breathing down the necks of Fannie and Freddie that the White House finally decided that Fannie and Freddie needed to be moved to a separate government agency under the direct control of the Treasury department.
To some Democrats, this looked like an effort to bury the problem. After all, with OFHEO finally doing a good job of investigating Fannie and Freddie, why not just give OFHEO teeth instead of hushing them up and moving the investigation to an entirely new agency, which might be more vulnerable to Fannie and Freddie's lobbying? This view was reinforced by the support of the plan by Fannie's CEO. To some, it looked like a continuation of the then ongoing Republican attacks on HUD, which was also to be included in the move. Some just didn't yet see the need to do anything. In any case, without a vote, the measure failed to make it out of the Republican-majority committee.
OFHEO continued to investigate, and their reports were damning. Fannie set huge payouts for its senior officers if they could meet earnings per share targets. The management which was to receive these payouts was allowed to set these targets, and they did everything they could to meet them. With capital reserve requirements still not in place, they could expand aggressively in order to try to meet them. When this was not enough, they shifted earnings between years in order to just barely meet the targets for each year. The accounting and auditing departments received these bonuses too, and became active participants in the deception. The head of the auditing department would cheer his underlings to meet the EPS goal.
By now every one of you must have 6.46 branded in your brains. You must be
able to say it in your sleep, you must be able to recite it forwards and backwards,
you must have a raging fire in your belly that burns away all doubts, you must
live, breath and dream 6.46, you must be obsessed on 6.46. . . After all, thanks to
Frank, we all have a lot of money riding on it. . . .We must do this with a fiery
determination, not on some days, not on most days but day in and day out, give it
your best, not 50%, not 75%, not 100%, but 150%. Remember, Frank has given
us an opportunity to earn not just our salaries, benefits, raises, ESPP, but
substantially over and above if we make 6.46. So it is our moral obligation to
give well above our 100% and if we do this, we would have made tangible
contributions to Frank’s goals.
The Fannie Mae chairman presented the extraordinarily stable earnings of his company to Wall Street as proof of the safety of his company, and used their stability to expand the company further.
There was now more will to do something about Fannie and Freddie, but still not enough. John McCain co-sponsored a bill which would place them along with HUD in an independent agency with a chairman who the President could remove "for cause". This again died in the Republican-majority Senate. A Republican-sponsored bill in the house called for a truly independent agency, and passed with bi-partisan support, but again died in Republican-majority committee in the Senate. The reform movement was stalled.
The Fannie Mae chairman went on to become one of Obama's horde of advisers.
Meanwhile John McCain's close friend future presidential-campaign co-chair Phill Gramm allowed Enron to draft much of a bill called the Commodity Futures Modernization Act of 2000, which was sponsored by 4 Republicans and 1 Democrat in the House and 4 Republicans and 2 Democrats in the Senate. McCain certainly favored deregulation of this type, and talked incessantly about the need for deregulation, but I haven't looked for specific comments on this bill, since I expected them to be difficult to find. It was introduced into appropriation bills without debate, like a typical pork earmark.
The effect of the bill was to nearly entirely exempt from all regulation energy market options and derivatives and default credit swaps. Two years after this, the use of energy options and derivatives to hide losses would result in the bankruptcies of Enron and MCI and more otherwise healthy companies. Recently, the unregulated issuance of default credit swaps by AIG has resulted in the FED taking it over, leaving it by far the most dangerous company to the world's financial stability.
Not to be outdone, the SEC voted to drastically reduce the amount of net capital they required for just 5 firms, the large Wall Street investment banks, all of which increased their leverage, and all of which are in deep trouble and have generated large financial jitters due to co-party risk.
The SEC let these respected firms cash in their reputations for money, by playing a heads-I-win, tails-you-lose, extreme leverage casino bet on low-quality mortgages.
Fortunately, we have seen relatively little in the way of bank closures. But, is that really fortunate, or are they just not looking for bank problems? Let's see what our chief bank regulator, John M. Reich, Director of the Office of Thrift Supervision, had to say about our recent financial troubles, as recently as July 21:
The third key to restoring confidence - avoiding interference - is important because, even if our industry sticks to stringent risk management principles, and all mortgage
originators are made to abide by the same rules, confidence in the industry can still be
derailed by interference. When I say interference, I mean interference with the regulatory
process by reporting and disseminating speculation about the condition of financial
institutions, thereby undermining public confidence in those institutions and causing
serious harm.
....
In a time when consumer confidence is already flagging and the general public is skittish
and understandably concerned about what their financial futures will hold, this behavior
goes beyond irresponsible. It’s reprehensible.
I am an ardent believer in free speech and the First Amendment, but I also know our
Supreme Court has ruled that free speech has its limits. You cannot scream “fire!” in a
crowded theater. Nor, in my view, should anyone feel free to scream “failure!” in a bank
lobby. This, in effect, is what happened across America just last week and it was
shameful.
...
In this age of instant telecommunications when information moves at the speed of light,
rumors are particularly potent. They can move markets and destroy institutions.
Particularly in a bear market, this is true. SEC Chairman Chris Cox seemed to recognize
the problem in a letter to the Basel Committee. After Bear Stearns was sold to
JPMorgan, he talked about rumors that had been spread about liquidity problems and said
that Bear’s undoing “was the result of a lack of confidence, not a lack of capital.”
Personally, I believe that the SEC should aggressively pursue rumors that fraudulently
manipulate markets.
In other words, don't worry. There's no problem at all. All we need to do is lock up anyone who says differently, and the problem will disappear.
Well, are you reassured?
