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How an odd bipartisan alliance in '90s led to loan debacle

The bad-home-loans mess that has slowed the U.S. economy can be traced to a strange 1990s alliance of Democratic social engineers and Republican finance-industry allies.

Originally published July 6, 2008

The bad-home-loans mess that has slowed the U.S. economy can be traced to a strange 1990s alliance of Democratic social engineers and Republican finance-industry allies.

They agreed on one point: All who wanted a home should be able to buy one. Even if they couldn't quite afford it.

Many of these people, and their acolytes, have gone on to advise John McCain or Barack Obama. So it matters what they think went wrong when Wall Street financed so many risky mortgage loans to people who couldn't pay.

"Throughout the Clinton administration and ever since, immense pressure has existed on commercial banks to make low-interest, high-risk loans with negligible down payment," former Sen. Phil Gramm (R., Texas), now a top McCain adviser, told me from his office at UBS Securities in Washington.

Gramm says he wanted more loans, too - but while Democrats wanted to force banks to serve low-wage-earners, Gramm felt lenders would make more loans - to the poor, speculators, and other worthy borrowers - if they were freed from onerous federal reporting requirements.

Gramm led the fight for the 1999 law that allowed consumer and investment banks to link up. That law was written so Citigroup could finance subprime mortgage loans through its finance-company branch network, and sell the loans to investors through its investment bank.

Under President Bush, these loan-backed securities became Wall Street's growth business. The people who made the loans grew more and more remote from the people who owned the loans, until rising defaults last year wrecked the market.

Gramm said there was "no evidence" his law caused the bubble or burst it. But there is one thing he'd do differently.

"Most of the bad loans," he said, "were made by mortgage brokers that were not federally regulated. If we had known then how important they were going to be as lenders, I think we might have been able to reach a bipartisan agreement concerning loan standards that mortgage brokers would have to meet."

Former Fed chief Alan Greenspan won't go that far. In a Financial Times column, he blamed "the misjudgments of the investment community" and "investors of all stripes" who gobbled mortgage-backed bonds without caring that the loans were risky.

"It is not credible that regulators would have been able to prevent the subprime debacle," he added. Regulators, in Greenspan's view, can't be smarter than the private sector.

Democrats blame Greenspan and Gramm. While the Clinton White House backed Gramm's bank-deregulation law, the administration sought more supervision, says a key member of the Clinton cabinet.

"We put forth quite an ambitious agenda of calling for more transparency and more regulation with respect to predatory-lending practices," Lawrence Summers told me. He was Clinton's treasury secretary before becoming president of Harvard University, and he is now an Obama adviser.

"Unfortunately, the idea of any legislative changes was blocked by the Republican Congress, and there was much less appetite than we would have liked at the Fed," Summers added. Clinton's other treasury secretary, Citigroup executive Robert Rubin, said he wouldn't comment for the record.

"Alan Greenspan and Phil Gramm, they had these ideological blinders on. That was the real problem," said Michael Barr, a former Summers aide, who is now a law professor at the University of Michigan.

But the Clinton administration caved too easily, said Dan Hoffman,

a Philadelphia housing-program developer, who joined New York and Chicago activists in White House meetings to demand that banks publish data on whom they lent to and how much they charged, as a condition for Gramm's bill.

Clinton aides said that was politically impossible. "The Clinton administration had no intention of fighting for this issue," Hoffman said. "They had greater interest in giving lenders vast new powers."

There's blame to go around, said Jeremy Nowak, chief executive officer of the Reinvestment Fund, a Philadelphia-based nonprofit lender.

Free-market Republicans, including President Bush, and poverty-fighting Democrats, including President Clinton, said the nation would be a stronger place when more people owned their homes. Their administrations allowed - at times urged - more permissive underwriting by Fannie Mae and other government-affiliated agencies to boost sales.

"There is a bipartisan myth that more home ownership is better," Nowak said. "The ideology had been so widely accepted, it led all of us to say: 'How can we lower the barriers of home ownership?' And, 'Don't prices always go up?'

"The problem is that, sometimes, home values don't go up. And then, for poor people, and in some places like California, even for middle-class people, you can't afford to keep up the home. It loses value, and it locks you into the neighborhood."

Top minds in both parties failed to read the signs that led to the credit crisis. They still have influence at the highest levels, so let's hope they've learned something. Too bad no one forecloses on bad ideas.