Reckless Endangerment—-a book report
The recent book “Reckless Endangerment”, by Gretchen Morgenson and Joshua Rosner, documents how Jim Johnson, head of Fannie Mae, profited from the gap between what private mortgage lenders had to pay for funds, and what the government-backed Fannie Mae had to pay. Fannie Mae, and Johnson, kept back about 1/3 of this government subsidy, passing only 2/3 of the subsidy on to borrowers in the form of lower interest rates. The 1/3 cut was then spread around. Some stuck to Johnson and the rest of the management team. A lot of it was spent on advertising. A lot was spent on charity, most of that very strategic. A lot was spent, ultimately, on campaign contributions in favor of friends and against enemies. And a lot of it was spent on lobbying. Some of it was even spent to simply take out campaign ads against a candidate Fannie didn’t like. This, be reminded, was federal tax money.
The dishonor roll is long and heavy with big names.
Jim Johnson, Rep. Barney Frank, Rep. Henry B. Gonzalez, Alan Greenspan, Joseph Stiglitz, Robert Rubin, Peter Orszag, Larry Summers. Phil Gramm, Jim Leach, Thomas Bililey, Dianne Feinstein, Bob Zoellick, Jim Moran, Walt Fauntroy, Sen. Kit Bond, Sen. Robert Bennett, Henry Cisneros, Angelo Mozilo.
There’s an honor roll, too, of public servants and others who warned against easy credit to borrowers whose income would make it not only not easy, but well nigh impossible, to make the payments on the properties they would be buying.
Sen. Byron Dorgan, and Marvin Phaup and June O’Neill of the CBO, at the top of this much, sadly, shorter list.
How do Stiglitz and Orszag make this list? “The probability of a shock so severe as embodied in the risk-based capital standard is substantially less than one in 500,000—-and may be smaller than one in three million,” they wrote, in an academic paper. The reality, of course, was that the probability was much closer to 1. The shock happened. Now being wrong isn’t necessarily dishonorable, but being wrong so badly, when you know enough to know better, does raise suspicions.
How does Phaup make the honor roll? He led the charge at the CBO to point out that Fannie was the beneficiary of this huge subsidy. June O’Neill, then his superior, backed him. Johnson floated rumors that Phaup was insane. They didn’t work.
But in the end, Fannie was allowed to go on running huge risks, betting the farm. Fannie also served as a roll model. Countrywide Financial, Bear Stearns, Lehman, AIG—-they bet their farms too. And lost. When, inevitably, borrowers both rich and poor defaulted (for the practice of lending too much can be profitably pursued on a larger scale if the borrower borrows big, always assuming that chickens never will come home to roost), the whole house of cards collapsed. And here we are.
Phaup’s take, years later, on the upshot? In 2008, he wrote: “Now we have created a whole new generation of government sponsored entities with implied federal guarantees. The cancer isn’t gone—-now it has metastasized.”
We haven’t seen the last of this mess.