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Clinton’s Legacy, Part 1: The Financial and Housing Meltdown

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Bill Clinton leads a charmed life. The former president is treated like a respected elder statesman whose tenure in office was so good that even some Republicans look back fondly on the years 1993–2001.

On the surface the record indeed looks good. The 1990s were a period of economic growth, and the central government actually shrank as a percentage of the total economy. But it would be rash to give Clinton the credit. During his time in office the information revolution shifted into high gear, boosting
productivity and business formation as the new World Wide Web emerged as a major commercial arena. (At the end of Clinton’s tenure, of course, the dot-com bubble, inflated by Federal Reserve easy money, burst.) When his Democratic Party lost control of the House and Senate in the 1994 midterm elections, Clinton had to accept spending restraints, which meant somewhat less obstruction to economic growth. (A few years later he declared — rather prematurely — that “the era of big government is over.”)

Supporters of Barack Obama’s bid to raise taxes on upper-income people point to Clinton’s tax increase as proof that raising the tax burden does not have to slow economic growth. That is a fallacy. The sound economic warning against tax increases must always acknowledge that other factors, such as a boost in productivity from technological advances, could to some extent offset the negative effects of a new tax burden. One may reasonably conclude, then, that the rate of economic growth would have been even greater without the tax increase, since more money would have been left in the productive private sector.

Another reason Clinton gets favorable reviews for his eight years in the White House is that the damage of particular policies pursued by his administration did not surface until he was out of office. It is barely understood that Clinton’s policies contributed to two catastrophes that have few parallels in American history: The housing and financial debacle that began in late 2007 (the Great Recession), and the attacks by hijacked airplanes on the World Trade Center and Pentagon on September 11, 2001, which took more than 3,000 lives.

Anyone who gets his information solely from the mainstream news media will most likely be astounded by those claims. What could Bill Clinton possibly have to do with the Great Recession or 9/11? He had much to do with them.

Deregulation

The financial and housing meltdown is typically attributed exclusively to the two administrations of George W. Bush, who succeeded Clinton in 2001. But that is shortsighted and only slightly more plausible than blaming the October 1929 stock market crash and the initial 1930s recession on Herbert Hoover, who took office in March 1929. (However, Bush does bear some responsibility.) Clinton himself has helped to propagate that myth. In a commercial for the Obama reelection campaign, he accused Mitt Romney of wanting to “go back to deregulation. That’s what got us in trouble in the first place.”

The irony is that Bush signed no financial deregulation during his two terms in office. At most he’s blamed for not having used existing regulations to better police Wall Street — a misleading claim.

So if Bush wasn’t a deregulator, who was?

Bill Clinton.

In 1994 Clinton signed the Riegle-Neal Interstate Banking and Branching Efficiency Act, which legalized interstate branch banking. Until then banks were forbidden to have branches in more than one state, limiting diversification and service to customers. (Through most of American history, many states forbade intrastate branch banking, making undiversified banks vulnerable to local crop and business failures.)

Five years after Riegle-Neal, Clinton signed the Gramm-Leach-Bliley Act, which repealed a key portion of the New Deal-era Glass-Steagall Act, namely, the part that forbade a single financial institution from offering commercial (depository) banking and investment banking services.

So Bill Clinton was the financial deregulator. Is that why he is partly culpable for the financial and housing meltdown? No. Neither of Clinton’s actions contributed to the crisis. Contrary to widespread belief about the repeal of Glass-Steagall’s separation of commercial and investment banking, the American Enterprise Institute’s Peter Wallison writes, “None of the investment banks that have gotten into trouble — Bear, Lehman, Merrill, Goldman or Morgan Stanley — were affiliated with commercial banks.”

Then why is Clinton culpable? Because his secretary of Housing and Urban Development (HUD), Andrew Cuomo, currently the governor of New York and a likely 2016 presidential aspirant, accelerated easy-housing polices, helping to inflate the housing bubble and setting the stage for its collapse.

The housing boom

We must back up a step. The meltdown was the consequence of a combination of easy money and low interest rates engineered by the Federal Reserve and easy housing engineered by a variety of U.S. government agencies and policies, including HUD; the Federal Housing Authority; and two nominally private “government-sponsored enterprises” (GSEs), Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). The agencies, along with enactments such as the Community Reinvestment Act (passed in the 1970s then fortified in the Clinton years), which required banks to make loans to people with poor and nonexistent credit histories, made widespread home ownership a national goal. All that, fueled by Fed-induced cheap credit, led to a home-buying frenzy and an explosion of subprime and other nonprime mortgages, which banks and the GSEs bundled into securities and peddled to investors worldwide. (The GSEs bought and guaranteed a huge number of those mortgages originated by banks and mortgage companies, some of which it sold as mortgage-backed securities and some of which it held on its own balance sheet.)

The housing boom could last for a while. If lenders and borrowers believe that housing prices (fueled by government-stimulated demand) will rise for the foreseeable future and interest rates will stay low, they will be attracted to adjustable-rate mortgages with low teaser rates. Both sides will also be willing to borrow and lend for more-expensive houses than otherwise. After all, if after six months, a buyer can’t make his payments when the mortgage’s interest rate jumps, he can refinance or sell the house at the newly inflated price.

Eventually, however, interest rates will rise (as the Fed fears too much inflation) and the perpetual-motion machine will come to a halt. Suddenly many formerly attractive mortgages held by banks, GSEs, and buyers of mortgage-backed securities will look like bad investments, as home “owners” who are “underwater” (owing more than their houses are worth) simply walk away, preferring default to continued payment, especially those who made little or no down payment and therefore have no equity, as government programs permitted and encouraged.

The housing and financial crisis could not have occurred in the absence of government housing and monetary policies. Hovering in the background throughout the bubble was the knowledge that the federal government would bail out troubled “too big to fail” financial corporations, including Fannie and Freddie, which went into government receivership.

Clinton’s contribution to the crisis lay in his appointment of Cuomo to the Department of Housing and Urban Development. Cuomo became HUD secretary in 1997 after holding the position of assistant secretary under Henry Cisneros beginning in 1993. In a heavily researched 2008 article in the Village Voice, Wayne Barrett wrote,

Andrew Cuomo, the youngest Housing and Urban Development secretary in history, made a series of decisions between 1997 and 2001 that gave birth to the country’s current crisis. He took actions that — in combination with many other factors — helped plunge Fannie and Freddie into the subprime markets without putting in place the means to monitor their increasingly risky investments. He turned the Federal Housing Administration mortgage program into a sweetheart lender with sky-high loan ceilings and no money down, and he legalized what a federal judge has branded “kickbacks” to brokers that have fueled the sale of overpriced and unsupportable loans. Three to four million families are now facing foreclosure, and Cuomo is one of the reasons why.

“Perhaps the only domestic issue George Bush and Bill Clinton were in complete agreement about,” Barrett continued,

was maximizing home ownership, each trying to lay claim to a record percentage of homeowners, and both describing their efforts as a boon to blacks and Hispanics. HUD, Fannie, and Freddie were their instruments, and, as is now apparent, the more unsavory the means, the greater the growth….  [Cuomo] did more to set these forces of unregulated expansion in motion than any other secretary and then boasted about it, presenting his initiatives as crusades for racial and social justice [emphasis added].

To add insult to injury, when Cuomo became New York’s attorney general he pursued mortgage lenders who were said to have taken advantage of the boom conditions he helped to create.

When the crash came in late 2007, and the government jumped in to bail out financial institutions, some of those chickens that came home to roost belonged to Bill Clinton. More people should know about it.

This article was originally published in the December 2012 edition of Future of Freedom.

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    Sheldon Richman is vice president of The Future of Freedom Foundation and editor of FFF's monthly journal, Future of Freedom. For 15 years he was editor of The Freeman, published by the Foundation for Economic Education in Irvington, New York. He is the author of FFF's award-winning book Separating School & State: How to Liberate America's Families; Your Money or Your Life: Why We Must Abolish the Income Tax; and Tethered Citizens: Time to Repeal the Welfare State. Calling for the abolition, not the reform, of public schooling. Separating School & State has become a landmark book in both libertarian and educational circles. In his column in the Financial Times, Michael Prowse wrote: "I recommend a subversive tract, Separating School & State by Sheldon Richman of the Cato Institute, a Washington think tank... . I also think that Mr. Richman is right to fear that state education undermines personal responsibility..." Sheldon's articles on economic policy, education, civil liberties, American history, foreign policy, and the Middle East have appeared in the Washington Post, Wall Street Journal, American Scholar, Chicago Tribune, USA Today, Washington Times, The American Conservative, Insight, Cato Policy Report, Journal of Economic Development, The Freeman, The World & I, Reason, Washington Report on Middle East Affairs, Middle East Policy, Liberty magazine, and other publications. He is a contributor to the The Concise Encyclopedia of Economics. A former newspaper reporter and senior editor at the Cato Institute and the Institute for Humane Studies, Sheldon is a graduate of Temple University in Philadelphia. He blogs at Free Association. Send him e-mail.