Regulators under fire for ignoring red flags

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The administration’s and Fed’s obsession with curbing the empire of Fannie and Freddie likely accelerated the crisis, analysts say, as the mortgage agencies had been in effect the main “regulators” in the market throughout the housing boom, imposing minimum lending standards on independent mortgage brokers seeking to sell them loans.

Fannie’s and Freddie’s seemingly old-fashioned insistence on making loans to people with good credit, documented income and a stake in their property caused them to lose market share to private issuers who abandoned traditional standards.

Fannie and Freddie made limited forays into the nontraditional loan market, but their higher standards enabled them to survive the mortgage market rout last summer that wiped out the subprime industry and many firms specializing in exotic and jumbo loans. Since that time, the agencies have played a larger role than ever, providing three-quarters of the funding for new mortgages today.

The laissez-faire policies that led Mr. Greenspan and the administration to encourage privatization of the mortgage market and hold off regulating lenders reflected both their deep-held convictions as well as Republican orthodoxy about how to best manage the economy.

But they also catered to the interests of the administration’s financiers. During the critical 2004 political campaign when subprime and exotic lending was taking off, Mr. Bush was by far the top recipient of funding from all the affected industries — including Wall Street investment firms, commercial banks, savings and loans, credit companies, and mortgage and real estate brokers.

The $23.8 million Mr. Bush raked in from financial and real estate businesses that year was more than two times the $10.6 million received by Sen. John Kerry of Massachusetts, the Democratic presidential candidate and the second top beneficiary of financial contributions, according to OpenSecrets.org.

Some key lawmakers also were among the top recipients of finance company cash. Sen. Charles E. Schumer, New York Democrat who became Joint Economic Committee chairman when Democrats gained control of Congress in 2007, pulled in $2.65 million from financial firms. Sen. Christopher J. Dodd, Connecticut Democrat who became the Senate banking chairman, attracted $2 million.

Both of those Democrats, even while out of power in 2004, received more contributions from the financial sector than Sen. Richard C. Shelby, Alabama Republican, who was then chairman of the Senate Committee on Banking, Housing and Urban Affairs.

Other Democrats who enjoyed the largesse of financial firms were Sen. Barack Obama, freshman Illinois Democrat, with $1.8 million in contributions; and Sen. Hillary Rodham Clinton, freshman New York Democrat, with $1 million.

The campaign contributions shed light on why Congress was sluggish in responding to the developing crisis. Mr. Dodd, while berating the Fed for not cracking down on abusive lending, spent much of last year campaigning for the Democratic presidential nomination and failed to push legislation through his committee addressing the housing crisis even as Mr. Frank shepherded a comprehensive bill through the House.

Mrs. Clinton has pushed for vigorous action to address the mortgage crisis, calling for a nationwide moratorium on foreclosures last fall, while Mr. Obama crafted his response to the housing crisis only this spring and took a less heavy-handed approach toward the industry.

While the politicians were blinded by the contributions to the risks created by the unbridled housing and lending bubbles, they were able to tell the public about the benefits of the housing boom and the easy loans that fed it.

Mr. Bush touted the “ownership” society as one with less crime and social ills and more jobs and opportunities, while Democratic lawmakers trumpeted that loans with low initial payments and easy terms enabled many disadvantaged Americans to stretch their incomes and become homeowners for the first time. Subprime loans, in particular, went disproportionately to black and Hispanic borrowers.

In addition, a community reinvestment law passed by Congress in the 1990s required banks to go to great lengths to make loans available to minorities. Many mortgage brokers who made loans to people who couldn’t afford them rationalized that they were just doing what Congress and the federal authorities wanted.

“The political pressure to create a housing ‘happy meal’ was enormous,” said George Cormeny, a former loan officer and vice president at Allfirst Bank who also worked as a legislative aide. The circular reasoning rationalizing the subprime lending boom became “unreal” to any longtime observer in the lending world, he said.

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