In Plain English: How Did The Biggest Financial Scandal in History Happen? – UPDATED!

This article is a bit long for a blog post, but if you wish to truly understand, this article is a great place to start. – Editor

First a little perspective…..

Enron generated huge press when it failed, lots of money went “POOF”, and the elite media and the Democrats had a great time “blaming Bush” for it until the investigations started and they realized that it was Democrats that worked in the Clinton administration that had set up their “accounting system” when those people worked in the private sector. It proved to be a bi-partisan scandal so it vanished from the front pages just like that.

Global Crossing was another huge one, it got even less press because just before they went belly up they gave $18 million to Democratic National Committee Chair Terre McAuliffe.

Halliburton just had a few accounting errors and the occasional overcharge, which is to be expected in an operation the size of a country in a war zone. The reported accounting and billing errors were all caught by the inspectors and it was settled easily. The press pounded it and pounded it because Vice-President Cheney used to be the CEO of Halliburton. Of course when it was learned that Bill Clinton gave Halliburton no bid contracts and Al Gore had given Halliburton an award that press went away too.

The next big one was the UN Oil for Food Program. It was supposed to administer Iraq’s oil revenues so they could be used for food, medical supplies, and infrastructure instead of weapons programs. The UN handlers managed to bilk (read rob) up to $26 billion from the program. Until Fannie Mae and Freddie Mac went belly up, this was the biggest financial scandal in world history.

The media and politicians have had a cow over $30 billion in profits from oil companies. Of course they don’t tell you that they often pay more in taxes than they make in profit, but why would politicians who demagogued the issue and a leftist press want to tell you that?

Now we have the current scams, which is approaching a $1Trillion and will go into the trillions of dollars more if these countless home mortgages do not get covered or sold in the future. This is the biggest financial scandal in the history of the world and is so big that it likely is bigger than most previous scandals combined.

Congress yanked the oil company CEO’s in front of a committee to grill them so why not Fannie Mae? Answer: Franklin Raines, James Johnson, Jamie Gorelick etc… they are all Clinton political appointees.

So now that you have some perspective, let’s start to look at how this all happened.

Before the stock market crash of 1929 and before the great depression, commercial banks and investment banks either worked closely together or in many cases were one. A single bank could do both roles. An investment bank did investments and securities and all those things associated with it and commercial banks would do home loans, savings accounts, checking, CDs etc.

One of the elements that led to the stock market crash and the depression is that the investment banks were counting the saving accounts (& deposits), mortgages (good and bad) and all they had as assets that they could use for trading in the market. When the market gets out of control and people cook the books to ensure that on paper it looks like you have a growing quarterly profits so people could get paid more things get shaky. They ended up having a lot of “bad paper” mortgages and investments and eventually it all came crashing down.

Laws were passed such as the Glass-Steagal Act. Among other things Glass-Steagal divided commercial banks and investment banks so that people’s savings would not be put at such investment risk. This law weakened the banks but disproportionately weakened the Morgan Bank which pleased the Rockefeller Bank (Yup influence peddling back then too).

Over the years other countries unified banks had an advantage over American banks so Congress moved to even things up and re-unify the banks and set up a regulation and monitoring system to make sure that what happened to help lead up to the Crash of 1929 did not happen again. The first vote in the Senate went along party lines but after compromises with Democrats and the Clinton Administration it passed the Senate 90 votes to 8. The law is called the Gramm-Leach-Bliley Act.

Clinton Signs Legislation Overhauling Banking Laws
New York Times Published: November 13, 1999

President Clinton signed into law today a sweeping overhaul of Depression-era banking laws. The measure lifts barriers in the industry and allows banks, securities firms and insurance companies to merge and to sell each other’s products.

”This legislation is truly historic,” President Clinton told a packed audience of lawmakers and top financial regulators. ”We have done right by the American people.”

The bill repeals parts of the 1933 Glass-Steagall Act and the 1956 Bank Holding Company Act to level the domestic playing field for United States financial companies and allow them to compete better in the evolving global financial marketplace.

Analysts and industry leaders say the measure will probably fuel a wave of mergers as companies compete to build financial supermarkets offering all the services customers need under one roof.

Financial stocks were winners on Wall Street today, with J. P. Morgan & Company, Citigroup, American Express and Merrill Lynch all posting big gains. That helped the Dow Jones industrial average end up 174.02 points, at 10,769.32.

The Senate approved the final bill by 90 to 8 on Nov. 4 and the House followed suit by a vote of 362 to 57. Congress had previously made almost a dozen unsuccessful attempts over the last 25 years to revise the statutes, which had increasingly come to be viewed as anachronisms.

The Obama campaign and far left web sites are blaming this law for the current economic problems. They are pointing to the first vote which was mostly along party lines but ignore the second vote which was almost unanimous. If you examine the wikipedia entry on the Gramm-Leach-Bliley Act it tells how one of the compromises that Democrats insisted upon was a strengthening of the Community Reinvestment Act (CRA).

The CRA was the first step to this crisis because even with unified banks, if sound and ethical financial practices were used all would have been fine. The Obama campaign says that re-unifying the banks and “deregulating” is what caused this and capitalism is what caused the economic problems of today, yet other countries have unified banks and don’t get these problems so what is the real problem?

The Community Reinvestment Act likely started out with good intentions. It made it illegal to engage in what is known as “redlining” or singling out loan applicants by race. The problem is that there are enough minorities in poverty stricken inner city areas that banks who simply use standard good credit practices would leave out most anyone in those regardless of race. This created a loophole for groups such as ACORN to file a long series of harassment lawsuits charging redlining. ACORN also engaged in physical harassment of bank employees and other tactics to get them to lower credit standards.

Under the Clinton administration, federal regulators began using the act to combat “red-lining,” a practice by which banks loaned money to some communities but not to others, based on economic status. “No loan is exempt, no bank is immune,” warned then-Attorney General Janet Reno. “For those who thumb their nose at us, I promise vigorous enforcement.”

In the name of fighting “racism”  and “redlining” ACORN and the government forced banks to make riskier loans in areas less economically feasable and to customers who had a low and/or unstable income, e.g. those who are a high credit risk. Banks said it was risk management, Democrats said it was racism.

Abuse of the CRA was the first step in what became the mortgage crisis. For a more detailed article on ACORN and the abuse of the CRA, and Barack Obama’s role in ACORN please visit this link HERE.

April 3, 1998. After announcing billions in fines via CRA Andrew Cuomo is bold in pride that CRA would be abused to force banks to give bad loans.

CUOMO: To take a greater risk on these mortgages, yes. To give families mortgages that they would not have given otherwise, yes.

Q: [unintellible] … that they would not have given the loans at all?

CUOMO: They would not have qualified but for this affirmative action on the part of the bank, yes.

Q: Are minorities represented in that low and moderate income group?

CUOMO: It is by income, and is it also by minorities? Yes.

CUOMO: With the 2.1 billion, lending that amount in mortgages — which will be a higher risk, and I’m sure there will be a higher default rate on those mortgages than on the rest of the portfolio …

This risk banks were subjected to was amplified because loan customers wanted fixed rates and depositors wanted a variable rate. The banks had to keep enough liquid assets to cover loans. This limited the number of loans that a bank could issue. Banks were being pushed into more lending by the political and regulatory environment. The government tracked every loan and the banks were issued a “CRA rating” by the government. So how did they get around these problems and buffer the risk?

Government Sponsored Enterprises (GSE) Fannie Mae and Freddie Mac were created as a partially private corporation backed by the US Government to buy loan bonds or buy the mortgages outright from banks. Congress created a regulation and monitoring agency called the OFHEO that reported to the Banking Committee’s in the Congress and exempted them from reporting to the Securities Exchange Commission (SEC).

OFHEO has two missions.

An affordable housing mission that reports to HUD, but has no real enforcement power and a mortgage finance mission that has almost no enforcement power and reports to the finance committee’s in Congress.

OFHEO is paid for by Fannie Mae and Freddie Mac and is not paid for by the tax payer.

Sounds odd you say? It is. Separation of powers would be true for a real constitutional agency, but Fannie Mae, Freddie Mac and OFHEO are a part of the GSE system and are not real constitutional agencies as authorized by Congress under Article I Section VIII.

Most of the mortgage industry debt is managed by GSE’s which are unique animals in government being part government and part private. That is why GSE’s do not follow the standard separation of powers as they were set up. It is no surprise that their monitoring and enforcement are not typical as well.

OFHEO has begged Congress year after year to have itself replaced by REAL banking regulators with REAL enforcement power either under the Federal Reserve or the Treasury Department. Here is an example from their 2007 Report:

Legislation
OFHEO has continued to strongly support enactment of legislative reform to strengthen GSE oversight. During the past year, the agency worked with the Bush Administration, Congress and interested parties on legislation that will provide bank regulator-like powers to a newGSE regulator overseeing Fannie Mae, Freddie Mac and the Federal Home Loan Banks.The House of Representatives passed, on a bipartisan basis, GSE regulatory reform legislation (H.R. 1427) in May 2007 [Barney Frank and Finance Committee Democrat members in both houses of Congress opposed it year after year till 2007 – Editor]. It is a balanced bill that will strengthen the nation’s housing finance system by enhancing oversight of Fannie Mae, Freddie Mac and the Federal Home Loan Banks. It is my hope that the Senate will complete its work on this important legislation soon.
http://www.ofheo.gov/media/pdf/OFHEOPARNovember2007508.pdf

Democrats blocked that legislation year after year and below we posted the youtube VIDEO of members of the Finance Committee’s in Congress showing Democrats like Chris Dodd and Barney Frank and Maxine Waters all saying that Fannie Mae and Freddie Mac and the mortgage industry was in just dandy financial shape.

This was step two that led to this crisis. The abuse of CRA as we described above forced banks to make more loans available that carried more risk, so banks were eager to sell these higher risk loans to Fannie Mae and Freddie Mac. With the housing boom the inflated value of the houses it had as collateral for the loans on paper made it look like Fannie and Freddie had more collateral assets than reality could bear. With the housing market inflating due to easy loans and low interest rates making it TOO EASY to get a loan for a new home, demand for loans went up. Fannie and Freddie started buying loans at a furious rate. The more loans they bought, the more income on paper they could claim, but more and more people were defaulting on the bad loans….

Political appointees (not financial guru’s) were placed in charge of Fannie Mae and Freddie Mac; people like Franklin Raines, Jeff Johnson and former Clinton Deputy Attorney General Jamie Gorelick. It was the policy of the Clinton Administration and Congressional Democrats to lean on banks, and Freddie and Fannie to get loans to low income people so that “everyone could have a home” (besides all that loan money out there propped up and somewhat inflated the economy so it helped make the numbers look good).

So let’s add up the cards we have now, the government and Fannie and Freddie, are encouraging banks to give bad loans and Freddie and Fannie would buy them up to help absolve the banks from the risk by buying the high risk loans up. Political appointees with political motivations, rather than sound financial motivations were in charge, and the people the regulators and Fannie and Freddie reported to, was not the SEC, which demands sound accounting practices, but the congressional committees that as policy wanted more loans given out as well, mostly Democrats. Here is step three.

Corruption and influence peddling begin to infect the entire system. While the law made it clear that sound financial principles were to be practiced, political pressure caused people to look the other way. The political cronies running Fannie and Freddie realized that they could make themselves rich with tens of millions of dollars in bonuses by buying more loans to make it seem on paper that they had all this money coming in from people’s house payments as if the loans they owned were good, but they weren’t. Too many of the loans were high risk, they had bought “bad paper”. The bonuses were spread around, but they wanted to keep the cash train flowing and help their fellow political friends so Fannie and Freddie gave $200 million away in political donations, to candidates and partisan organizations, a majority of those being Democrats. Barack Obama and Banking Committee Chairman Chris Dodd were the two biggest recipients of this money in the Senate. Fannie and Freddie had become the money train for the corrupt. The regulators who reported to Congress warned what was going on but members of the banking committee who were getting paid didn’t want to hear it.

And that was step four folks.

President Bush tried to put an end to this in 2003 along with a group of Republican Senators (Dole, Sununu, Chafee, McCain). Congressional Banking leaders Chris Dodd and Barney Frank said that everything was just fine and no reforms were needed.

Before you accuse us of just trying to be partisan and making it all up here is some of the evidence. These attempts to fix the system were blocked by Democrats.

New York Times Excerpt:

September 11, 2003
New Agency Proposed to Oversee Freddie Mac and Fannie Mae
By STEPHEN LABATON

The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry.

The new agency would have the authority, which now rests with Congress, to set one of the two capital-reserve requirements for the companies. It would exercise authority over any new lines of business. And it would determine whether the two are adequately managing the risks of their ballooning portfolios.

”The current regulator does not have the tools, or the mandate, to adequately regulate these enterprises,” Mr. Oxley said at the hearing. ”We have seen in recent months that mismanagement and questionable accounting practices went largely unnoticed by the Office of Federal Housing Enterprise Oversight,” the independent agency that now regulates the companies.

”These irregularities, which have been going on for several years, should have been detected earlier by the regulator,” he added.

“These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,” said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ”The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.”

Representative Melvin L. Watt, Democrat of North Carolina, agreed.

”I don’t see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing,” Mr. Watt said.

Here is an OFHEO report form 2006 that warned of what was coming. McCain mentions this report (in a pre-release version) in his remarks. Here is a summary from the OFHEO saying:

The report details an arrogant and unethical corporate culture where Fannie Mae employees manipulated accounting and earnings to trigger bonuses for senior executives from 1998 to 2004.

A large number of Fannie Mae’s accounting policies and practices did not comply with Generally Accepted Accounting Principles (GAAP). The Enterprise also had serious problems of internal control, financial reporting, and corporate governance. Those errors resulted in Fannie Mae overstating reported income and capital by a currently estimated $10.6 billion.

Here is McCain’s Bill and Statements:

S. 190 [109th]: Federal Housing Enterprise Regulatory Reform Act of 2005
A bill to address the regulation of secondary mortgage market enterprises, and for other purposes. Here is the text of the bill. HERE is the link to McCain’s remarks on the floor of the Senate. The bottom line, Bush and McCain, who Obama accuses of knowing nothing about the economy and putting us in this mess, predicted it and tried to fix it, while Obama and Dodd and others were taking the largest sums of money from these people. They should have gone public and made a big stink in the press, but Republicans since Nixon have been awful at communications strategy.

The House version of S.190 was H.R. 1461

In fact Senators Sununnu, Hagel, and Dole introduced this legislation repeatedly (link HERE).

While I do not like quoting party sources THIS LINK (now taken down) from GOP.com has some good information, fully sourced, that is pretty spot on. It leaves out that some Republicans were a part of this influence peddling scandal though.

You can also read quotes of what Senators and Representatives said about Fannie Mae and Freddie Mac HERE.

Here is a video of McCain lecturing on the issue:

Step 5 … After the Enron scandal the Congress passed a new regulatory law called Sarbanes-Oxley. This law had a major flaw. It changed the accounting rules laws so that a non-indexed mark to market rule was used.

What it does, according to federal accounting rules, is artificially lower the value of an asset or security that has lost value and artificially inflates an asset’s or security’s value when the market is going up. So when these mortgage securities crashed companies had to say they were worth nothing (because no one wanted to buy them) in spite of the fact that there is a house there that has some value. This problem was a real factor in why things crashed so quickly because it lowered the liquidity rating and solvency rating of those assets artificially.

When the housing market was going up the companies holding them had their rating inflated by them, making it all look dandy on paper and when they crashed they had their rating set artificially low and the company fell below solvency standards.

Former House Speaker Newt Gingrich and many business leaders and economists asked to have this rule fixed; no one in government listened.

Fast forward to today.

Three events in the economy greatly accelerated the rate of default on the loans. Energy prices skyrocketed because of increased global demand and OPEC learned that it could gouge us and we had no immediate way of stopping them. This caused food, transportation, etc. prices to skyrocket and slowed the economy. Many states were raising property taxes and as time went on housing had become so inflated that the market values had to make an adjustment. If the value of homes just went up and up eventually people could not afford to buy a home so the market had to adjust.

Step 6: The number of home loan defaults skyrockets and it all crashes down to the mess we have now.

As you can see, the banking unification of Gramm-Leach-Bliley Act would have been fine if the system was not filled with corruption, cronies, politics, and regulated by Congress. A system could have been set up where high risk loans were made cautiously and generally accepted accounting and finance practices were used. If that was done, we would not be in the spot we are in. This is not and was never a problem with bank unification, it was a problem with influence peddling and political cronyism. What we need are ethics laws that have jail time teeth and regulatory laws that help to protect the regulators from political pressures. For more details on the influence peddling part of this scandal and the political consequences click HERE.

The left and the Obama campaign are saying essentially, “Oh so you Republicans are the big regulators now…what happened to low regulation and free markets” This article is a common example http://www.salon.com/tech/htww/2008/09/19/mccain_the_regulator/index.html.

Those who make such arguments are counting on people’s ignorance. While conservatives believe in less government they do not believe in NO government. It is a proper constitutional role of government to protect people from fraud and theft. A proper policing structure to help ensure safety and stability to prevent fraud and promote ethics is a proper role of government that no conservative would object to. This kind of criticism is just designed to deflect attention away from the real issue here; corruption and influence peddling in Congress.

UPDATE: Famed author and legal scholar Mark Levin gives a highly charged yet factually accurate lecture on how this all came about. Levin is a partisan guy, but the facts he gives are verifiable and the analysis is sound. Levin is furiousabout this scandal so there is some adult language. People should be carted off for influence peddling and bank fraud. Barney Frank and Chris Dodd should be removed from the Banking Committee’s in Congress immediately. Hat Tip Hotair.com for the link, we love you guys.

UPDATE II:Bloomberg Financial News gives a similar analysis to ours today (Monday Sept.22) http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_hassett&sid=aSKSoiNbnQY0

UPDATE III: Hotair.com comments

UPDATE IV: FBI investigates fraud at Fannie Mae and Freddie Mac… thanks W it’s about freakin’ time.

UPDATE V: Brit Hume covered this story on Sept 23 and came to many of the same facts we did here at IUSB Vision

The Republicans, in a bill co-sponsored by John McCain (see HERE), tried to change the Fannie Mae and Freddie Mac oversight regulations to those that are used by bank regulators (now they answer to the banking committee’s in Congress that set up a small agency to report to the committee’s so Congress KNEW this was coming and have for years). The bill to change the oversight rules was killed in a party line vote with Democrats against it. Alan Greenspan testified in favor of the bill (transcript HERE and HERE) and warned:

If we fail to strengthen GSE regulation, we increase the possibility of insolvency and crisis. … As I concluded last year, the GSEs need a regulator with authority on a par with banking regulators, with a free hand to set appropriate capital standards, and with a clear and credible process sanctioned by the Congress for placing a GSE in receivership, where the conditions under which debt holders take losses are made clear.

Hotair.com has the following commentary:

By special request of Ace. Nothing here you haven’t read and/or heard before, but Fox deserves a little publicity for being willing to challenge the narrative. Especially now that we’re about to be told it’s McCain’s campaign manager and his lobbyist pals, not the Democrats they lobbied who actually cast the votes, who are the real culprits in all this. The FBI: Doing the (after-the-fact) oversight job Congress wouldn’t.

UPDATE VI: Bloomberg News covered the story and gives similar information.

UPDATE VII:Fox updated the story and has a devastating new report. The Report mirrors the investigation IUSB Vision Published HERE, HERE, HERE and HERE. Hotair.com comments on this new report from Fox HERE.

UPDATE VIII: Bill Clinton sets the record straight on the Gramm Leach Bliley Act. It was not the deregulation Obama said it was, and it had little to do with the mess we see ourselves in now.

A running cliché of the political left and the press corps these days is that our current financial problems all flow from Congress’s 1999 decision to repeal the Glass-Steagall Act of 1933 that separated commercial and investment banking. Barack Obama has been selling this line every day. Bill Clinton signed that “deregulation” bill into law, and he knows better.

In BusinessWeek.com, Maria Bartiromo reports that she asked the former President last week whether he regretted signing that legislation. Mr. Clinton’s reply: “No, because it wasn’t a complete deregulation at all. We still have heavy regulations and insurance on bank deposits, requirements on banks for capital and for disclosure. I thought at the time that it might lead to more stable investments and a reduced pressure on Wall Street to produce quarterly profits that were always bigger than the previous quarter.

“But I have really thought about this a lot. I don’t see that signing that bill had anything to do with the current crisis. Indeed, one of the things that has helped stabilize the current situation as much as it has is the purchase of Merrill Lynch by Bank of America, which was much smoother than it would have been if I hadn’t signed that bill.”

One of the writers of that legislation was then-Senator Phil Gramm, who is now advising John McCain, and who Mr. Obama described last week as “the architect in the United States Senate of the deregulatory steps that helped cause this mess.” Ms. Bartiromo asked Mr. Clinton if he felt Mr. Gramm had sold him “a bill of goods”?

Mr. Clinton: “Not on this bill I don’t think he did. You know, Phil Gramm and I disagreed on a lot of things, but he can’t possibly be wrong about everything. On the Glass-Steagall thing, like I said, if you could demonstrate to me that it was a mistake, I’d be glad to look at the evidence.

“But I can’t blame [the Republicans]. This wasn’t something they forced me into. I really believed that given the level of oversight of banks and their ability to have more patient capital, if you made it possible for [commercial banks] to go into the investment banking business as Continental European investment banks could always do, that it might give us a more stable source of long-term investment.”

We agree that Mr. Clinton isn’t wrong about everything. The Gramm-Leach-Bliley Act passed the Senate on a 90-8 vote, including 38 Democrats and such notable Obama supporters as Chuck Schumer, John Kerry, Chris Dodd, John Edwards, Dick Durbin, Tom Daschle — oh, and Joe Biden. Mr. Schumer was especially fulsome in his endorsement.

http://online.wsj.com/article/SB122282635048992995.html?mod=todays_us_opinion

Hotair.com commented on this issue HERE

UPDATE IX: Investors Business Daily and Human Events Magazine came out with a similar analysis (albeit they are a bit more strident in their partisanship) on September 30th, nine days after the IUSB Vision. Once again we beat the big guys. These two articles, especially the one from Human Events, has much evidence we demonstrated or linked too.

UPDATE X: Dennis Prager Explains how this happened on his radio show and famed author and economist Dr. Thomas Sowell’s explanation mirrors our analysis HERE

UPDATE XI – There are two other factors that aided to magnify the crisis. The main thing that is missing in my series of articles is a piece that explains the role of the Federal Reserve. In keeping interest rates artificially below market levels for political reasons, they encouraged bad lending and the housing market bubble. Dr. Hayek wrote a paper on this subject that helped him get the Nobel Prize for Economics.

Another factor that I left out because it gets too much into the weeds of financial technospeak is the “credit default swaps” or CDS. A credit default swap (CDS) is like an insurance policy on an investment. You by the CDS and if your investment tanks the CDS pays you a portion of what you lost. As the housing market became more inflated, and along with it the issued mortgage securities, more people bought this type of insurance. When it all crashed the CDS insurance had to be paid to those who lost and as a result in helped bring down Lehman Brothers, AIG etc.

Every facet of the mortgage crisis story, who benefited and who is lying can be found HERE, HERE, HERE, HERE, HERE, HERE, HERE, HERE and HERE. – Editor

Chuck Norton