Wallison Reinvents History – and His Own Positions on the Causes of the Crisis

By Barry Ritholtz

The big news in U.S. regulation last week was the release of the Financial Crisis Inquiry Commission reports. (There’s a major article in the New York Times about Kabul Bank that supports warnings made in my earlier column on that scandal.) The Commission report and the two dissents discuss some of the most important topics in financial regulation, so I will devote a series of columns to the reports, beginning with the dissent of the nation’s leading anti-regulator – Peter Wallison. Wallison’s passion, for forty years, has been financial deregulation and desupervision. The Republican Congressional leadership appointed him to the Commission to serve as apologist-in-chief for the deregulation and desupervison that made the crisis possible.

We’ll explore Wallison’s dissent in greater detail in future columns, but this overview column addresses his three primary arguments: Fannie and Freddie are the Great Satans, they caused the crisis because of demands politicians put on it to purchase the subprime loans that caused the crisis, and all of this was compounded by the Fed’s easy money policies.

This column discusses Wallison’s views on the first two subjects while the crisis was developing. Wallison is well-known for his long-standing criticisms of Fannie and Freddie, but most people do not know the nature of those criticisms. Wallison praised subprime mortgage loan and complained that Fannie and Freddie purchased too few subprime loans. Wallison (correctly) explained that Fannie and Freddie’s CEOs acted to maximize their wealth – not to fulfill any public purpose involving affordable housing. He also explained that they used accounting abuses to make themselves wealthy. He predicted that low capital costs would increase economic growth. Wallison’s prior views contradict his current claims. Aspects of Wallison’s prior views were correct. They support the conclusion that Fannie and Freddie were accounting control frauds.

Wallison’s Ode to Low Interest Rates

http://www.aei.org/speech/16590

Testimony before the Subcommittee on Securities of the Senate Committee on Banking, Housing and Urban Affairs
By Peter J. Wallison | Senate Committee on Banking, Housing, and Urban Affairs
(July 19, 2000)

If capital costs are low, more capital will be available for companies that need it, capital will be allocated more efficiently, we will have faster and broader-based economic growth, and the welfare of all Americans will be enhanced.

(Parenthetically, Wallison’s July 19, 2000 Senate testimony disputed the claim that there was a high tech bubble – even as the bubble was collapsing.)

Wallison’s Ode to Subprime Lending

Wallison and his AEI colleague Charles Calomiris co-chaired AEI’s project on financial market deregulation . They were also members of the Shadow Financial Regulatory Committee (a self-selected group of deregulatory scholars and practitioners associated with AEI).

Statement of the Shadow Financial Regulatory Committee on Predatory Lending
December 3, 2001. Statement No. 173

The Federal Reserve is in the process of drafting detailed regulations dealing with alleged problems of so-called “predatory lending” in the subprime mortgage market, and the Congress is considering actions to curb various alleged abuses in this type of lending.
Because much of what is classified as predatory lending involves loans to low-income, minority, and higher-risk borrowers, a central principle that should guide legislation and regulation in this area is the desirability of preserving access to subprime mortgage credit for such borrowers, who are most at risk of losing access to this market in the wake of misguided and punitive regulations. The democratization of consumer finance that has occurred over the past decade has created new opportunities for low-income consumers. This is now threatened by chilling effects that inappropriate regulations and laws might have on the supply of subprime credit to these consumers.
Subprime credit to low-income consumers necessarily entails higher interest rates.
As recent evidence of increasing loan defaults demonstrates, this line of business is risky, and institutions will only be willing to provide such credit if interest rates are sufficiently high relative to risks and other costs of servicing consumers. One of the risks that must be borne by intermediaries is regulatory risk. Laws or regulations that place lenders at greater risk of legal liability for having entered into a loan agreement (for example, state and municipal statutes that penalize refinancings that could be deemed contrary to the interests of the borrower) generally will reduce the supply of beneficial lending as well as predatory lending. Illegal lending, however, would not be reduced; indeed, it would be encouraged. .. [..]

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