South Park explains the federal decision making process used by both the Bush and Obama Administrations for dealing with the current economic downturn.

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Hat tip to Andrew Sullivan.

Barack Obama recently told the press that he thought about it for some time before deciding to go ahead and unleash attacks on AIG employees receiving contractually-specified compensation for job performance or as retention incentives. Doubtless, the president talked over whether it would be a good idea to use the White House as a platform to whip up public emotion into outraged anger directed at ordinary private citizens with his Chief of Staff Rahm Emanuel.

Rahm Emanuel, as the Chicago Tribune reports, had at the time already long since collected his own bonus for passive collaboration on the board of the Federal Home Loan Mortgage Corporation “Freddie Mac” in the policies directly responsible for the mortgage default crisis, unlike Jake DeSantis, for example, who would soon be nationally targeted despite having no actual real connection.

Before its portfolio of bad loans helped trigger the current housing crisis, mortgage giant Freddie Mac was the focus of a major accounting scandal that led to a management shake-up, huge fines and scalding condemnation of passive directors by a top federal regulator.

One of those allegedly asleep-at-the-switch board members was Chicago’s Rahm Emanuel—now chief of staff to President Barack Obama—who made at least $320,000 for a 14-month stint at Freddie Mac that required little effort. ...

The Freddie Mac money was a small piece of the $16 million he made in a three-year interlude as an investment banker…

He was named to the Freddie Mac board in February 2000 by Clinton, whom Emanuel had served as White House political director…

The board met no more than six times a year. Unlike most fellow directors, Emanuel was not assigned to any of the board’s working committees, according to company proxy statements. Immediately upon joining the board, Emanuel and other new directors qualified for $380,000 in stock and options plus a $20,000 annual fee, records indicate.

ACORN probably won’t be busing any demonstrators over to Representative Rosa DeLauro’s house (where Emanual lives in the basement) to threaten him though, will they?

The New York Times published yesterday’s resignation letter from Jake DeSantis, executive vice president of the American International Group’s financial products unit, to Edward M. Liddy, the chief executive of A.I.G.

Dear Mr. Liddy,

It is with deep regret that I submit my notice of resignation from A.I.G. Financial Products. I hope you take the time to read this entire letter. Before describing the details of my decision, I want to offer some context:

I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage.

After 12 months of hard work dismantling the company — during which A.I.G. reassured us many times we would be rewarded in March 2009 — we in the financial products unit have been betrayed by A.I.G. and are being unfairly persecuted by elected officials. In response to this, I will now leave the company and donate my entire post-tax retention payment to those suffering from the global economic downturn. My intent is to keep none of the money myself.

I take this action after 11 years of dedicated, honorable service to A.I.G. I can no longer effectively perform my duties in this dysfunctional environment, nor am I being paid to do so. Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid. Having now been let down by both, I can no longer justify spending 10, 12, 14 hours a day away from my family for the benefit of those who have let me down. ...

The profitability of the businesses with which I was associated clearly supported my compensation. I never received any pay resulting from the credit default swaps that are now losing so much money. I did, however, like many others here, lose a significant portion of my life savings in the form of deferred compensation invested in the capital of A.I.G.-F.P. because of those losses. In this way I have personally suffered from this controversial activity — directly as well as indirectly with the rest of the taxpayers. ...

But you also are aware that most of the employees of your financial products unit had nothing to do with the large losses. And I am disappointed and frustrated over your lack of support for us. I and many others in the unit feel betrayed that you failed to stand up for us in the face of untrue and unfair accusations from certain members of Congress last Wednesday and from the press over our retention payments, and that you didn’t defend us against the baseless and reckless comments made by the attorneys general of New York and Connecticut. ...

I have decided to donate 100 percent of the effective after-tax proceeds of my retention payment directly to organizations that are helping people who are suffering from the global downturn. This is not a tax-deduction gimmick; I simply believe that I at least deserve to dictate how my earnings are spent, and do not want to see them disappear back into the obscurity of A.I.G.’s or the federal government’s budget. Our earnings have caused such a distraction for so many from the more pressing issues our country faces, and I would like to see my share of it benefit those truly in need.

On March 16 I received a payment from A.I.G. amounting to $742,006.40, after taxes. In light of the uncertainty over the ultimate taxation and legal status of this payment, the actual amount I donate may be less — in fact, it may end up being far less if the recent House bill raising the tax on the retention payments to 90 percent stands. Once all the money is donated, you will immediately receive a list of all recipients. ...

This choice is right for me. I wish others at A.I.G.-F.P. luck finding peace with their difficult decision, and only hope their judgment is not clouded by fear. ...

Sincerely,

Jake DeSantis

Matt Drudge:

OBAMA SEEKS EXPANDED POWER TO SEIZE FIRMS

The Washington Post puts it slightly differently, but Drudge is more accurate.

Carol Baum, at Bloomberg, reads today’s news and finds herself living in a Rand novel.

Somewhere John Galt is smiling.

The hero of Ayn Rand’s “Atlas Shrugged” is smiling because he’s seen it all before: the government’s intervention in the private sector; the constraints placed on business in the name of the people; the desperation on the part of government bureaucrats when they realize their leverage is limited; and—this part is still fiction—the decision on the part of business leaders to walk away from the enterprises they built.

That’s all I could think about when I read that American International Group Inc., recipient of $173 billion in taxpayer funds, was paying out $165 million in bonuses to employees of its financial-products group, the poster boy for risk and greed.

The Obama administration, Congress and the public are outraged taxpayer dollars are going to enrich the folks who got us into this mess. So am I.

Members of Congress want to blame Edward Liddy, the former chief executive officer of Allstate Corp., who was recruited by former Treasury Secretary Hank Paulson in September to steer AIG away from the shoals.

Liddy is paid $1 a year for his efforts. “My only stake is my reputation,” Liddy said in a March 16 open letter to Treasury Secretary Timothy Geithner.

His only crime, as far as I can tell, is inheriting compensation contracts providing for retention bonuses for certain AIG derivative traders, some of whom have left the company, and listening to lawyers on his options. ...

I’m not alone in noting the parallels in the government’s evolving response to the financial crisis. For a year I’ve been waiting for Paulson or Geithner to announce “the John Galt Plan to save the economy,” which is right out of Rand’s novel.

It wasn’t until the AIG bonus brouhaha broke last weekend and I watched government officials flailing to contain the fallout that I realized the government is losing its leverage. Or maybe it never had any leverage to begin with.

Let me explain. The government has been propping up teetering financial institutions, including AIG, Citigroup and Bank of America, creating the illusion that the banks need the government.

The government doesn’t care about these institutions. It cares about the stability of the financial system: the totality, not the parts.

Congress can refuse to allocate more money to institutions in which it already owns a share (80 percent in the case of AIG). It can levy a tax on the AIG bonus payments or withhold them from the next $30 billion cash infusion, although who would notice? And it can install new management.

Why hasn’t the government put in its own people already? Maybe no one wants the job.

The government needs Liddy and Citigroup’s Vikram Pandit and Bank of America’s Ken Lewis to continue working to restore their firms to prosperity in the same way the looters in Rand’s novel need Hank Reardon and Francisco d’Anconia and Dagny Taggart, respectively, to run their steel mills, copper mines and railroad.

From their perches as chairmen of the House Financial Services Committee and Senate Banking Committee, respectively, Democrats Barney Frank and Chris Dodd fulminate about the lack of regulation and about inflated CEO compensation. For Dodd, it’s a good opportunity to deflect attention from his sweetheart mortgages from former Countrywide CEO Angelo Mozilo and his questionable real estate deal in Ireland.

All that’s left for life to imitate art completely is for these CEOs to quit. Let Barney Frank and Chris Dodd run AIG. Let’s see how they fare.

The government needs these companies to survive—and buy back the government’s ownership stake—more than they need the government. Most of these CEOs are already wealthy. They don’t need a job working for the government, which is what running a bank amounts to today.

What’s in it for them? One dollar of compensation? Their reputations? The house on the lake looks more appealing by the day.

Is anyone surprised sales of “Atlas Shrugged” have spiked in recent months as reality comes to resemble Rand’s fiction?

Charles Krauthammer puts into perspective the scale of the AIG bonuses which have occasioned such histrionics in Washington. Targeting executives as overpaid is a handy way of diverting the public’s attention from the really significant looting going on at the hands of Congress itself.

A $14 trillion economy hangs by a thread composed of a comically cynical, pitchfork-wielding Congress, a hopelessly understaffed, stumbling Obama administration, and $165 million.

That’s $165 million in bonus money handed out to AIG debt manipulators who may be the only ones who know how to defuse the bomb they themselves built. Now, in the scheme of things, $165 million is a rounding error. It amounts to less than 1/18,500 of the $3.1 trillion federal budget. It’s less than one-tenth of 1 percent of the bailout money given to AIG alone. ...

[A] contract is a contract. The AIG bonuses were agreed to before the government takeover and are perfectly legal. Is the rule now that when public anger is kindled, Congress summarily cancels contracts?

Even worse are the clever schemes now being cooked up in Congress to retrieve the money by means of some retroactive confiscatory tax. The common law is pretty clear about the impermissibility of ex post facto legislation and bills of attainder. They also happen to be specifically prohibited by the Constitution. We’re going to overturn that for $165 million?

Nor has the president behaved much better. He too has been out there trying to lead the mob. ...

It is time for the president to state the obvious: This recession is not caused by excessive executive compensation in government-controlled companies. The economy has been sinking because of a lack of credit, stemming from a general lack of confidence, stemming from the lack of a plan to detoxify the major lending institutions, mainly the banks, which, to paraphrase Willie Sutton, is where the money used to be.

Michael Graham, at the Boston Herald, observes that the 4th District of Massachusetts’ representative in the House has a lot more to do with the current financial mess than AIG does.

The only thing more painful than watching 180 billion tax dollars swirl down the AIG drainpipe is listening to Barney Frank bloviate about it.

I don’t know The World’s Most Expensive Legislator personally, but I hear he’s quite a cut-up at cocktail parties. However, as legislator and politician, he is an unmitigated disaster. Frank combines the economic success of AIG, the business ethics of Enron and the personal accountability of Ruth Madoff.

Frank began his career opposing Reaganomics, an opposition that stubbornly resisted 25 years of nearly constant economic growth. In the 1990s, Frank sat on the Banking Committee regulating Fannie Mae, even as his then-partner, Herb Moses, worked as a Fannie exec.

Is it a coincidence that Frank has been a die-hard advocate for expanding Freddie/Fannie at any cost?

Since at least 2002, Frank fought an ever-growing drumbeat of calls to slow down the Fannie Mae/Freddie Mac train wreck.

In 2003, he famously said that Freddie and Fannie were “not in a crisis,” that they were “fundamentally sound financially.” He repeated that expert testimony in 2005, all the while rejecting the argument that the taxpayers were responsible for Freddie and Fannie’s bills.

And in 2007, he actually proposed raising the caps on Fannie/Freddie’s portfolios – exposing taxpayers to even more risk – and then dumping the new money into (drum roll, please) even more subprime mortgages.

Less than a year later, the Fannie/subprime/derivatives catastrophe was upon us. And the cheerleader for all three? Our Barney.

Which is why it so astonishes that anyone takes him seriously as the self-declared watchdog of Wall Street. Please, Barney, just shut up.

Phillip Broughton lays the blame right at the doorstep of some buildings on the Charles.

If Robespierre were to ascend from hell and seek out today’s guillotine fodder, he might start with a list of those with three incriminating initials beside their names: MBA. The Masters of Business Administration, that swollen class of jargon-spewing, value-destroying financiers and consultants have done more than any other group of people to create the economic misery we find ourselves in.

From Royal Bank of Scotland to Merrill Lynch, from HBOS to Leh-man Brothers, the Masters of Disaster have their fingerprints on every recent financial fiasco.

I write as the holder of an MBA from Harvard Business School – once regarded as a golden ticket to riches, but these days more like scarlet letters of shame. We MBAs are haunted by the thought that the tag really stands for Mediocre But Arrogant, Mighty Big Attitude, Me Before Anyone and Management By Accident. For today’s purposes, perhaps it should be Masters of the Business Apocalypse.

Harvard Business School alumni include Stan O’Neal and John Thain, the last two heads of Merrill Lynch, plus Andy Hornby, former chief executive of HBOS, who graduated top of his class. And then of course, there’s George W Bush, Hank Paul-son, the former US Treasury secretary, and Christopher Cox, the former chairman of the Securities and Exchange Commission (SEC), a remarkable trinity who more than fulfilled the mission of their alma mater: “To educate leaders who make a difference in the world.”

It just wasn’t the difference the school had hoped for.

Sent to my class list this morning in response to the contention that “government had to step in” because capitalism failed, because businessmen “made such a mess.”

Government created a credit crisis by arm-twisting lenders to make uncreditworthy loans while supplying securitization of the same. Government (at more than one level) additionally laid the groundwork for a housing bubble by forcing prices upward by making 30 year financing of home loans universal and easy to obtain and by creating regulatory environments that made building extremely expensive and nearly impossible in some of the housing markets featuring the greatest demand. Government lent people money to fuel bidding wars, while doing everything it could to keep new housing in short supply.

George W. Bush’s administration pursued simple-minded conventional policies attempting to placate the economy with characteristic timidity and inconsistency. Obama has taken the housing-bust induced recession as an excuse to throw funding at every democrat party special interest and constituency and to justify a power grab socializing large segments of the economy. Bush did not succeed in calming economic turmoil largely because he could not persuade the markets that he had not already lost the next election to a democrat party radical. Obama has, in a very short time in office, demonstrated that he isn’t simply a bloviating and benign big city machine crook, but is rather an extreme radical leftwing ideologue philosophically committed to every form of economic destruction. The economy is cratering as a result.

As we Baby Boomers start canceling our vacations at Gstaad and lining up to apply for jobs at supermarket checkout counters, Colby Cosh (the insolent little twit) consoles himself for the damage to his own portfolio with a little gloating at our expense.

For the children of the Baby Boomers, there is a special delight in watching the world economy shake itself to pieces like a two-dollar pram at this particular moment. Our elders, who bought prosperity and nice pensions at our expense and pulled the ripcords on their “Freedom 55” parachutes without leaving any behind in the passenger cabin, are getting it in the neck just when they thought a secure old age, with money for travel and expensive pastimes, was a safe bet. I’m willing to watch my meagre savings suffer from market turmoil in exchange for contemplating the dilemma of those who are now between 55 and 65.

These are people who started their working lives at a time when labour unions were strong, taxpayers outnumbered retirees nearly 10 to one, housing was as cheap as borscht and the basic personal exemption covered most of a living wage. They congratulated themselves on building an elaborate “social safety net” at the expense of their children. Their great numbers have allowed their preferences and superstitions to dominate culture and media. They’re the ones who burned through tonnes of pot and then launched a War on Drugs when they grew bored with it; they drove mighty-bowelled Mustangs and Thunderbirds in their youth, and only started worrying about the environment when they no longer needed a capacious backseat to fornicate in; they espoused and took full advantage of sexual liberation, but were safely hors de combat by the time AIDS reared its head. The first time I see one shopping for dog food, I doubt I’ll be able to suppress a laugh.

As for the younger crowd, it is a quite distinct pleasure to watch their panic and uncertainty. The actually existing danger is not too great, but no one born after about 1980 has much practical experience of severe recession. ...

Hat tip to Karen L. Myers.

Obama’s primary campaign left Hillary feeling like Poland, and Obama’s presidential campaign left John McCain feeling like France. The political blitzkreig combining media support, misdirection, and image continued on, right over the Congressional Republican minority, with the passage of the unread Stimulus bill.

Paul Schlichta, at American Thinker, suggests Republicans need to go back to staff college and start studying the Campaign of 2008 in order to figure out how to defeat his next offensive.

The audacity and speed with which Obama railroaded the stimulus bill through Congress took Republicans by surprise. It shouldn’t have; it was a logical extension of his campaign tactics.

Like the spear-carrying soldiers of Ethiopia, overwhelmed by Mussolini’s tanks and poison gas in 1936, the Republicans simply don’t know what hit them in last year’s election. Some felt that they had conducted an old-fashioned 20th century campaign while Obama mounted the first truly information-age 21st century political blitzkrieg. Others blame the blatant media bias, the race issue, or the unprecedented scale of fund raising and spending.

The first month of Obama’s regime has provoked a similar bewilderment. A dazed Congress hastily authorized a huge document, filled with hidden booby traps like RAT, that none of them had actually read, let alone comprehended. Republicans are now cowering in corners, wondering what atrocity will come next

Anyone hoping to launch a successful counterattack must first analyze Obama’s campaign and assess the factors that contributed to its success.

Mr. Schlichta fails to remark that General Recession has played a major role in panicking the civilian population into supporting “liberation” by Mr. Obama. Unreasoning fear caused voters to plump for an alternative, any alternative to Republicans who were inevitably tarred with responsibility for alarming economic developments during the final months of the lame duck Bush regime.

Personally, I think General Recession is already mightily indignant over the socialist measures recently adopted, and I believe that he and Marshall Inflation will before long turn on Mr. Obama, waging scorched earth war on his economy. The suffering public will inevitably assign responsibility where it belongs: to democrats, and the Emperor Obama’s Army of supporters will begin getting a whole lot smaller.

President Obama comes down hard on people who purchased large houses they couldn’t really afford.

It’s a plan that won’t help speculators or that neighbor down the street who bought a house he could never hope to afford but it will help millions of Americans who are struggling with declining home values.”

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Former Senator Phil Gramm dispels with clarity and precision the liberal malarkey about deregulation being responsible for the credit crisis, and puts the blame where it belongs.

I believe that a strong case can be made that the financial crisis stemmed from a confluence of two factors. The first was the unintended consequences of a monetary policy, developed to combat inventory cycle recessions in the last half of the 20th century, that was not well suited to the speculative bubble recession of 2001. The second was the politicization of mortgage lending. ...

In the inventory-cycle recessions experienced in the last half of the 20th century, involuntary build up of inventories produced retrenchment in the production chain. Workers were laid off and investment and consumption, including the housing sector, slumped.

In the 2001 recession, however, consumption and home building remained strong as investment collapsed. The Fed’s sharp, prolonged reduction in interest rates stimulated a housing market that was already booming—triggering six years of double-digit increases in housing prices during a period when the general inflation rate was low.

Buyers bought houses they couldn’t afford, believing they could refinance in the future and benefit from the ongoing appreciation. Lenders assumed that even if everything else went wrong, properties could still be sold for more than they cost and the loan could be repaid. This mentality permeated the market from the originator to the holder of securitized mortgages, from the rating agency to the financial regulator.

Meanwhile, mortgage lending was becoming increasingly politicized. Community Reinvestment Act (CRA) requirements led regulators to foster looser underwriting and encouraged the making of more and more marginal loans. Looser underwriting standards spread beyond subprime to the whole housing market. ...

The 1992 Housing Bill set quotas or “targets” that Fannie and Freddie were to achieve in meeting the housing needs of low- and moderate-income Americans. In 1995 HUD raised the primary quota for low- and moderate-income housing loans from the 30% set by Congress in 1992 to 40% in 1996 and to 42% in 1997.

By the time the housing market collapsed, Fannie and Freddie faced three quotas. The first was for mortgages to individuals with below-average income, set at 56% of their overall mortgage holdings. The second targeted families with incomes at or below 60% of area median income, set at 27% of their holdings. The third targeted geographic areas deemed to be underserved, set at 35%.

The results? In 1994, 4.5% of the mortgage market was subprime and 31% of those subprime loans were securitized. By 2006, 20.1% of the entire mortgage market was subprime and 81% of those loans were securitized. The Congressional Budget Office now estimates that GSE losses will cost $240 billion in fiscal year 2009. If this crisis proves nothing else, it proves you cannot help people by lending them more money than they can pay back.

Blinded by the experience of the postwar period, where aggregate housing prices had never declined on an annual basis, and using the last 20 years as a measure of the norm, rating agencies and regulators viewed securitized mortgages, even subprime and undocumented Alt-A mortgages, as embodying little risk. It was not that regulators were not empowered; it was that they were not alarmed.

With near universal approval of regulators world-wide, these securities were injected into the arteries of the world’s financial system. When the bubble burst, the financial system lost the indispensable ingredients of confidence and trust. We all know the rest of the story.

The principal alternative to the politicization of mortgage lending and bad monetary policy as causes of the financial crisis is deregulation. How deregulation caused the crisis has never been specifically explained. Nevertheless, two laws are most often blamed: the Gramm-Leach-Bliley (GLB) Act of 1999 and the Commodity Futures Modernization Act of 2000.

GLB repealed part of the Great Depression era Glass-Steagall Act, and allowed banks, securities companies and insurance companies to affiliate under a Financial Services Holding Company. It seems clear that if GLB was the problem, the crisis would have been expected to have originated in Europe where they never had Glass-Steagall requirements to begin with. Also, the financial firms that failed in this crisis, like Lehman, were the least diversified and the ones that survived, like J.P. Morgan, were the most diversified.

Moreover, GLB didn’t deregulate anything. It established the Federal Reserve as a superregulator, overseeing all Financial Services Holding Companies. All activities of financial institutions continued to be regulated on a functional basis by the regulators that had regulated those activities prior to GLB.

When no evidence was ever presented to link GLB to the financial crisis—and when former President Bill Clinton gave a spirited defense of this law, which he signed—proponents of the deregulation thesis turned to the Commodity Futures Modernization Act (CFMA), and specifically to credit default swaps.

Yet it is amazing how well the market for credit default swaps has functioned during the financial crisis. That market has never lost liquidity and the default rate has been low, given the general state of the underlying assets. In any case, the CFMA did not deregulate credit default swaps. All swaps were given legal certainty by clarifying that swaps were not futures, but remained subject to regulation just as before based on who issued the swap and the nature of the underlying contracts.

In reality the financial “deregulation” of the last two decades has been greatly exaggerated. As the housing crisis mounted, financial regulators had more power, larger budgets and more personnel than ever. And yet, with the notable exception of Mr. Greenspan’s warning about the risk posed by the massive mortgage holdings of Fannie and Freddie, regulators seemed unalarmed as the crisis grew. There is absolutely no evidence that if financial regulators had had more resources or more authority that anything would have been different.

A must read analysis.

Scott S. Powell, writing in Barron’s, exonerates George W. Bush for the mortgage crisis and blames instead a long-term trend featuring the intrusion of politics into the US economy.

Well, electing Obama will certainly fix that, won’t it?

The Bush administration made many mistakes, but deregulation was not one of them.

Not only was there no major deregulation passed during the past eight years, but the Bush administration and a Republican Congress approved the most sweeping financial-market regulation in decades.

The bipartisan Sarbanes-Oxley Act was enacted in 2002 to prevent corporate fraud and restore investor confidence after the collapse of Enron and WorldCom. It failed to prevent the accounting fraud and influence-peddling scandals at Fannie Mae and Freddie Mac. And even after those scandals were widely understood, regulators sent Fannie and Freddie back into the market to continue buying subprime loans, lending and borrowing with implied taxpayer backing.

Across the government, the Bush administration supported new regulations that added almost 1,000 pages a year to the Federal Register, nearly a record. If this is insufficient regulation, it’s hard to imagine a scope that would be effective.

We are in this mess largely because critical thought and moral judgment have been subordinated to the politicization of our economy, resulting in regulatory gaps and excessive controls of the wrong kind.

Government regulations should be limited to those that increase and protect transparency and competition, protect public and private property, promote individual responsibility and enforce equal opportunity under the law. Even if the right laws and regulations could be found, they would prove insufficient to protect freedom and prosperity.

In his farewell address, George Washington said that religion and morality are essential to sustain democracy in America. He might well have added that virtue is just as indispensable to its economy. When the captains of banking and finance and their congressional overseers fail in moral judgment, the results are disastrous for everyone. As we are now witnessing in the real-estate, stock- and bond-market dislocations, once trust is lost, markets freeze and long-standing relationships break down, resulting in illiquidity, irrational pricing and severe losses.

Today’s problems have their roots in programs and financial instruments that shifted the locus of moral responsibility away from private individuals and institutions to wider circles that were understood to end with a government guarantee. Heads of the top banks and financial institutions could approve substandard home-mortgage underwriting—prone to increased default—because those loans could be securitized by Wall Street and sold off to investors or to government-sponsored enterprises (GSEs), with no likely recourse to the financial institution of origin.

Our present crisis began in the 1970s, during the Carter administration, with passage of the Community Reinvestment Act to stem bank redlining and liberalize lending in order to extend home ownership in lower-income communities. Then in the 1990s, the Department of Housing and Urban Development took a fateful step by getting the GSEs to accept subprime mortgages. With Fannie and Freddie easing credit requirements on loans they would purchase from lenders, banks could greatly increase lending to borrowers unqualified for conventional loans. In the name of extending affordable housing, this broadened the acceptability of risky loans throughout the financial system.

The risk lurking in the GSE portfolios was acknowledged in the Bush administration’s first fiscal-year budget, released in April 2001. It stated that Fannie and Freddie were “a potential problem” because “financial trouble of a large GSE could cause strong repercussions in the financial markets, affecting federally insured entities and economic activity.” Fed Chairman Alan Greenspan issued repeated warnings that the GSEs “placed the total financial system of the future at substantial risk.” Such warnings went unheeded even after accounting scandals rocked Fannie and Freddie.

The collapse and government seizure of Fannie and Freddie in September 2008 ended the experiment in partial socialization of the U.S. housing sector. Before we try complete concentration of federal financial power, we should understand that power and political corruption abrogated moral judgment on every level.

The poor and middle class were encouraged to live beyond their means and buy houses they couldn’t afford; speculators were lured into excessive risk-taking; banks were rewarded for lowering their loan standards; and Wall Street found new windfall profits from securitizing and reselling bad loans in bulk. With the support of regulators, credit-rating agencies provided cover for the whole charade.

There is plenty of blame to go around on both sides of the political aisle. But the lesson should be clear that socializing failed businesses—whether in housing, health care or in Detroit—is not a long-term solution. Expanding government’s intrusion into the private sector doesn’t come without great risk. The renewing and self-correcting nature of the private sector is largely lost in the public sector, where accountability is impaired by obfuscation of responsibility, and where special interests benefit even when the public good is ill-served.

Hold on for the ride.

From Greg Mankiw via Bird Dog.