Republicans Strike Back?

By Robert Romano



Senate Majority Leader Harry Reid has scheduled another procedural vote for today on the Dodd financial takeover bill. This follows two failed votes on proceeding to the bill this week that are solely designed to bully one or two Republicans into supporting the measure without making any significant concessions.



Senate Republicans must not take the bait. As Americans for Limited Government President Bill Wilson said yesterday, "Republicans can wield the upper hand in this debate by holding the majority to account for covering up for the real villain of the crisis: government." And so far, that is exactly what the Senate minority is doing.



Yesterday, Republican after Republican came to the floor to criticize not only what is in the bill — which, as ALG News has previously reported, is horrendous — but what is not.



Senator Pat Roberts (R-KS) said of the Dodd bill, "it sends a signal that the government will bail out institutions just as it did with Fannie Mae and Freddie Mac, the two troubled mortgage giants that have received $125.9 billion in direct government funding and now have an unlimited U.S. credit line. Yet there's no mention of Fannie or Freddie in this bill."



Senator Roberts is exactly right. A text search of the Dodd bill will find that they are not at all included, despite the fact that Fannie Mae and Freddie Mac weakened mortgage underwriting standards and mislabeled high-risk mortgage-backed securities, defrauding investors. All told, the GSE's brought some $1.835 trillion of these risky assets onto their books, out of the $4.7 trillion in mortgage-backed securities. That's about 39 percent.



"Failure to deal with Fannie and Freddie keeps taxpayers on the hook for more bailouts of these entities," Roberts continued. Again, he's right. "Too big to fail" cannot end while the government maintains the bailed-out firms like Fannie and Freddie with no end in sight and an unlimited credit line.



A Senate Republican alternative plan obtained by ALG News to the Dodd bill would begin to bring an end to government ownership of the companies. It would require the GSE's to "reduce their portfolio holdings by 10 percent of the prior year's holdings" and the President to submit a plan to reform the GSE's within six months of the bill's passage.



Although this particular provision holds some promise, it is meager in comparison to an outright requirement that the firms be sold off by the government. That must be included so that there is no mistake that, at the end of the day, the government will not be in the mortgage market.



Further, there needs to be protection such that the $4.7 mortgage-backed securities are not simply purchased by the Federal Reserve or the Treasury.



Why? Because under the Republican alternative, "Fed lending that leads to the Fed holding assets on its balance sheet for a maximum period of time shall be moved on-budget and counted as new budget authority, receipts, or deficits or surpluses for purposes of the budget of the U.S. government." The Federal Reserve has already bought $1.25 trillion of Fannie and Freddie securities. And under this provision, after a period of time, they would be transferred to taxpayers explicitly, being added directly to the national debt.



That would leave the government in charge of the mortgage industry.



Overall, moving Fed assets onto budget is actually a very good provision in comparison to current law, because it would restore honesty to accounting to the Federal Reserve and the U.S. budget. Under current law, the Fed has purchased the $1.25 trillion of securities with printed money in its program that replaced the Troubled Asset Relief Program. But, this did not appear on the government's balance sheet as it should.



New law should require those specific securities to be sold on the private market, and the Fed should be restricted from making any further intrusions into the mortgage market. The goal must be to get government out of housing finance altogether, and very explicit restrictions will need to be placed to prevent the GSE's from surviving in some other form under some other agency's regulatory umbrella.



Other parts of the Republican plan do not directly address the Federal Housing Administration's weakened down payments policies, nor do they repeal the Department of Housing and Urban Development Community Reinvestment Act regulations that forced banks to make risky loans to low-income Americans in the first place.



A final version of the GOP plan may include such provisions (such as in their title addressing underwriting standards), and they should, because they were an integral part of how so many bad mortgages were given out. Excluding that exempts another root cause of the crisis from reform.



Another critical aspect missing is reining in the Federal Reserve's easy money policies. Specifically, its lower-than-justified interest rates allowed the credit bubble to inflate to appalling proportions in the first place. It is solely up to Congress to protect the American people from another government-inflated bubble by reining in the excesses that fueled it.



According to research by Stanford economics professor John Taylor, "the Fed's target for the federal-funds interest rate was well below what the Taylor rule would call for in 2002-2005. By this measure the interest rate was too low for too long, reducing borrowing costs and accelerating the housing boom." By not placing restrictions on the Federal Reserve to wield interest rates policy as a mechanism for inflating asset bubbles, there will be nothing in place to prevent it from happening again.



There are other parts of the GOP alternative plan which accept many of the premises of the Dodd bill, like putting the FDIC as receiver of failing financial companies. Why not use bankruptcy courts? These are not depository institutions. They are investment firms, hedge funds, insurance companies and other non-banks. And the government should be in no position to seize them.



There is good reason for this. According to the Washington Times, "the government's non-bank rescues have become the biggest drain on taxpayers, including the burgeoning bailouts of mortgage giants Fannie Mae and Freddie Mac, insurance giant American International Group, and Detroit's General Motors and Chrysler." This can only be remedied by ending the bailouts, and allowing companies to enter bankruptcy that belong there.



At the end of the day, there are some good ideas in the Senate Republican alternative, but it does not go far enough to addressing the root causes of the crisis. The American people are really expecting a comprehensive alternative plan that will end "too big to fail," reinstate risk to the markets, strengthen credit standards, and restore the faith of the American people that the government does not have aspirations upon the private sector.



Robert Romano is the ALG Senior News Editor.