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The GOP, the financial crash, and the Washington Post editorial page

COMMENTARY | January 25, 2011

Republicans continue to hold to their radical ideology of free market infallibility, claiming now that the economic collapse was really the government’s fault. Henry Banta isn’t surprised that true believers would make such a claim -- but he is a little disappointed that the Washington Post seems to take it seriously.

By Henry Banta

The collapse of the financial markets in 2007-8 should have done irreparable harm to the radical free market ideology of the Republicans. But to hear them talk one would think the collapse never happened. Their doctrine of the infallible market has been rescued, at least for them, by a simple explanation: the government did it. Using a highly selective set of facts, they assert that the misguided efforts of the government to promote home ownership for people who couldn’t afford it pushed both borrowers and lenders into subprime mortgages and encouraged investors to buy such risky debts; that it was the collapse of this government-promoted market that produced the financial crisis; that one needn’t be concerned with massive explosion in the trading of insanely complex securities.

This explanation raises an extremely important question about the kind economic thinking that should guide our future policies. The current Republican leadership clings tenaciously to the Bush Administration’s simple policy of low taxes and deregulation. Despite much experience to the contrary, virtually every public policy problem, even health care, is approached with a rigid free market solution. Any deviation from this simplistic concept is attacked as “job killing.”

Essentially the Republican position is grounded on the concept that markets, if left alone, without government intervention, will always produce better results because they will always accurately reflect the real value of all assets from capital to labor, that even in the worst of circumstances there is nothing the government can do that will not make matters even worse. Therefore the crisis 2007-8 had to have been the government’s fault.

If the financial crisis represented a market failure, and not the failure of a government housing policy, the market fundamentalism comes apart. If the financial crisis was not caused by the unwise intrusion of the government into the mortgage market, but rather represented a failure of the financial markets themselves, then market fundamentalism must be rejected in favor of a more realistic, nuanced, and far less ideological approach. This approach would recognize that markets, especially capital markets, are inherently vulnerable to periods of instability, i.e. bubbles. Therefore government has a role in stabilizing markets and helping to avoid destructive collapses. When that fails, government must help clean up the mess at someone’s expense.

The acid test of for this question is what happened in the cataclysmic financial crisis of 2007-8. Did the collapse discredit the radical free market ideology, or was government intervention discredited?

The Republicans fully understand what is at stake. They miss no opportunity to advance their message: the government did it. Their most extensive narrative of the crisis is in the “Financial Crisis Primer,” issued by the Republican commissioners on the Financial Crisis Inquiry Commission. At the start it must be noted that this document gives up a lot of ground in its first sentence: “Bubbles happen.” In the pure world of the efficient market, bubbles do not happen; market prices always reflect real value. Nevertheless, the document strives to make the case for government failure, not market failure.

According to the primer, the government pushed investors towards investing in mortgage debt in three important ways:

"First, the regulatory capital requirements associated with mortgage debt were lower than for other investments. Second, the government encouraged the private market to extend credit to previously underserved borrowers through a combination of legislation, regulation, and moral suasion. Third, and most important, during the bubble’s expansion, the largest investor in the mortgage market, the government-sponsored enterprises (GSEs)–Fannie Mae and Freddie Mac–were instruments of U.S. government housing policy."

To meet the government’s housing goals, the GSEs were forced to “invest in mortgages of increasingly lower quality and higher risk to the taxpayer.”

The challenge to this narrative comes from those who do not claim it is untrue, but rather half true, incomplete as to the facts and misleading as to the timing of events. As the great Canadian humorist and economist, Stephen Leacock, once noted, a half-truth has the advantage over a half brick: you can throw it further.

Bethany McLean, coauthor of “All the Devils Are Here: The Hidden History of the Financial Crisis”,  an exhaustive investigation into the subprime mortgage debacle -- found the Republican primer “shockingly incomplete, which makes it, in the end, a ludicrous distortion of what happened." Ms. McLean, for example, noted in Slate magazine: "As for the implication that subprime lending began with Fannie and Freddie and resulted from the government’s affordable housing goals, that’s simply false. Subprime lending began in the 1990s with a group of other, nongovernment-affiliated companies more aggressive than Fannie and Freddie that sold the mortgages they made to Wall Street."

Paul Krugman put it more bluntly: “... [P]rivate players weren’t suckered into a government created bubble. It was the other way around. During the peak years of housing inflation, Fannie and Freddy were pushed to the sidelines; they only got into the dubious lending late in the game, as they tried to regain market share.”

But as a number of commentators have noted, there is a far more fundamental anomaly in the Republican narrative. The sheer scale of the financial crisis belies the Fannie-Freddie-did-it explanation. If the financial system was so fragile that it could be driven into crisis by a misguided housing policy, there had to have been something else wrong. The global nature of housing bubble alone raises a fundamental question. Beyond question, the housing bubble occurred simultaneously in countries around the world. Its effects ran from the Portuguese coast to the Rhine, from Scandinavia to the Costa del Sol, even reaching New Zealand. As these commentators have noted, all this gets hard to pin on poor Freddie and Fannie.

What is most significant about these challenges to the Republican narrative is that they do not involve matters of opinion or judgment; they do not depend on projections or forecasts, but rather involve issues of fact. It is here that the media must play a responsible role, and it is here that they have to date failed miserably. Neither side should be allowed to manipulate the facts for ideological purposes. As the late Senator Moynihan famously said, we are all entitled to our own opinion, but not our own facts.  To treat this simply as a matter of opinion is wrong.     

In December, the Washington Post ran an editorial captioned “The mortgage blame game.”  It started by noting the bitter dispute between Republicans and Democrats over how much blame could be put on Fannie Mae and Freddie Mac (sometimes referred to as GSEs – government-sponsored enterprise) for the 2008 economic collapse. The Post editorial fully recognized the ideological stakes in this debate: “If Republicans can win, score one for their broader free-market views. If Democrats win, it would vindicate government intervention.”

Unfortunately the Post attempted to finesse the issue by concluding that “both sides have a point.” As for blame, it concluded, “There is plenty to go around.” This a shameful way of slipping around the fundamental question. It is not whether Fannie and Freddy (or the government generally) share blame in the subprime mortgage debacle -- they obviously do -- but rather whether they can be used to absolve the banks and financial markets and thereby save the Republicans’ current ideology.

To trivialize this issue as a mere “blame game” is disgusting. To treat it as matter conflicting opinions, each of which have some merit, is a shameful copout. It is hard to avoid the suspicion that it is intended to avoid facing the obvious implications that would arise if the matter were resolved. (What might happen to carefully crafted “centerism” if the factual basis under one side of the argument collapsed?)

In situations where facts are extremely complex and subject to multiple interpretations, one opinion may turn out to be as good as any other. But looking at the debate as it has developed, that is not the case here. The facts and their implications are not beyond the reach of reasonably intelligent people – including reporters, editors or even TV news producers.

An issue of this magnitude demands serious investigation and resolution. If the Post really thinks the facts are in question, shouldn’t it get busy with resolving them? It is, after all, a newspaper with reporters and analysts who claim some expertise on such issues. The issue, as it has acknowledged, is very important. Indeed it is almost impossible to think of a more important domestic issue. If the factual basis of a political party’s ideology isn’t news, what is?

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