First, a few basic facts: It is universally understood that the present financial meltdown began with the problems of two enormous government‐sponsored enterprises (GSEs) — Fannie Mae and Freddie Mac. These two enterprises purchased mortgages from banks to allow banks to issue larger and riskier mortgages with the explicit goal of increasing homeownership.
Fannie and Freddie were allowed to have a lower percentage of capital reserves, needed in case of losses, than other purely private banks were required to keep. Fannie and Freddie both engaged in accounting practices that the courts have ruled to be improper and fraudulent. Fannie and Freddie have contributed millions of dollars to political candidates, including most members of Congress.
During the Carter administration, the Democratic Congress passed the Community Reinvestment Act (CRA), which gave federal regulators the power to pressure banks into issuing loans to high‐risk households and small businesses. During the Clinton administration, the CRA was given more power to force banks to issue even riskier loans to poor households. Officials of the Bush administration and members of Congress, who tried to rein in the CRA because they saw a train wreck coming, were accused of racism by some congressional Democrats and left‐wing activist groups.
The Federal Reserve engaged in a policy of excessively easy money, cutting the federal funds rate to only 1 percent in June 2003, a rate lower than inflation. Thus, banks were encouraged to provide many very low‐rate adjustable mortgages that they, in turn, could offload on the GSEs. Everyone knew interest rates would eventually rise and many borrowers would then be unable to pay the mortgages. But each party in the chain thought it could pass off the bad paper to the next sucker. The result, the taxpayer becomes the ultimate sucker.
Financial regulators are supposed to protect the integrity of the system, the investors and consumers. It was the anti‐capitalist left that insisted the regulators make banks originate bad loans and made sure that the GSEs would not have to abide by the rules that everyone else did. If you have any doubt about this, take at look at this video,which shows members of Congress attacking the regulator and defending the improper practices of Fannie Mae and Freddie Mac, which touched off the financial crisis.
There is a danger that the bailout bill and other related measures will be used to further undermine free‐market capitalism, and again permanently expand the scope of the federal government, rather than put in measures to correct the real problem of laws and regulations that undermine the proper functioning of the market. Ronald Utt, former association director of the Office of Management and Budget and now a senior fellow at the Heritage Foundation, recently wrote this following bit of history that all too many have forgotten: