Politics & Policy

Standing Athwart Bailout

A conservative resistance.

Only Richard Nixon could go to China.

Only Bill Clinton could sign welfare reform.

Perhaps only George W. Bush can bring about a $700 billion government takeover of a segment of the American economy — by far the largest in United States history.

#ad#“Unfortunately, President Bush has presided over the biggest expansion of government in our history,” said Sen. Jim DeMint (R., S.C.), referring to the 2003 Medicare Part D prescription-drug benefit and the budget increases of recent years. “This is kind of the crowning achievement. . . . They’re in a panic, and they don’t want the economy to collapse under their watch. They’re willing to throw any amount of money at the problem to buy some time.”

Fear over the value (or lack thereof) of mortgage-backed securities has already led to the government bailout of Bear Stearns, the government takeover of Fannie Mae and Freddie Mac, and the government’s virtual purchase of the American International Group (AIG), whose complicated investments were tied to the secondary mortgage market.

The Bush administration’s plan to spend $700 billion clearing shaky mortgage-backed securities from private markets is far from a fait accompli. Democrats are objecting, calling for even more government control over the economy. On Tuesday, some key Republicans finally began coming forward to object as well. But the irony is that probably no Democratic president could have assembled broad, bipartisan support behind such a concept at all. Most Republicans, who could normally be relied on to oppose such a plan immediately and vigorously, have been cautious and late in their criticism.

Only a few conservatives — including DeMint and Reps. Jeb Hensarling (R., Tex.), John Shadegg (R., Ariz.), and a few others, spoke out early against the idea as the administration began to hurry its proposal through Congress.

Root Causes

Democratic presidential nominee Barack Obama has tried to tie the current crisis to an unrelated banking deregulation law from 1999. But the real cause was a bipartisan policy arrived at in that same year, whose effects were predicted by experts very early on.

In 1999, Fannie Mae instituted a pilot program to increase low-income homeownership — granting mortgages to people who were bad credit risks — by selling securities backed by those risky loans. At the time, the New York Times noted that Fannie Mae had “been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people, and felt pressure from stock holders to maintain its phenomenal growth in profits.”

The commentary from that same New York Times article was startlingly prescient, predicting that such a policy could result in a massive government bailout in the event of an economic downturn.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.

“From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. “If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

“You could see it coming,” Wallison told me this week. “This is the problem with institutions that are seen as being guaranteed by the government. People don’t pay sufficient attention to the risks they’re taking.”

President Bush continued Clinton’s policy of increasing low-income homeownership by using Fannie and Freddie, allowing the companies’ sales of securities backed by risky mortgages to expand. This helped drive up real-estate prices, because lenders were able to make more money available to more people than ever before, confident that they had in Fannie and Freddie willing, government-sponsored buyers of the risk. Nor were Fannie and Freddie short of institutions willing to buy the securities into which they packaged these mortgages.


“These [mortgage-backed] securities were an especially profitable thing for institutions to hold in their portfolio, because the interest rates on riskier loans are much higher,” Wallison explained. The problems arose along with doubts over the ability of many non-creditworthy borrowers to pay their mortgages.

DeMint argued that, even now, there are measures available to improve the economy short of a $700-billion bailout. He promotes the idea of indexing capital gains to inflation, in order to lower the tax burden on many long-term investment transactions to encourage more economic activity. Rep. Jeb Hensarling and members of his House Republican Study Committee have suggested a two-year suspension of that tax. Both have floated the idea of cutting corporate tax rates quickly — an idea that enjoys some bipartisan support, although Obama has said he sees “no evidence” this would help the economy.

#ad#DeMint told me on Monday night that conservatives cannot afford to let Obama’s and the media’s current narrative of the crisis — as a failure of the market requiring increased regulation — go unchallenged.

“They’re all going to say this is a problem with deregulation,” he said. “But that is false. If we’re going to go forward with this bailout and allow that narrative to stand, we’ll never be able to get the government out of this.”

What’s worse, as Senate Banking Committee ranking member Richard Shelby (R., Ala.) observed yesterday, “We could very well spend $700 billion and not resolve the crisis.”

David Freddoso is an NRO staff reporter.

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