The First Dominoes

If you're looking for the roots of the current financial crisis, take a look at this Bloomberg commentary by Kevin Hassett. As Director of Economic-Policy Studies at the American Enterprise Institute, Mr. Hasset is well-qualified to dissect the mess; he traces its origins to the 2005 accounting scandals at Fannie Mae and Freddie Mac.

Back in 2005, Fannie and Freddie were, after years of dominating Washington, on the ropes. They were enmeshed in accounting scandals that led to turnover at the top. At one telling moment in late 2004, captured in an article by my American Enterprise Institute colleague Peter Wallison, the Securities and Exchange Commission's chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's position on the relevant accounting issue was not even ``on the page'' of allowable interpretations.

Then legislative momentum emerged for an attempt to create a ``world-class regulator'' that would oversee the pair more like banks, imposing strict requirements on their ability to take excessive risks. Politicians who previously had associated themselves proudly with the two accounting miscreants were less eager to be associated with them. The time was ripe.

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What happened next was extraordinary. For the first time in history, a serious Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.

If that bill had become law, then the world today would be different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest and most venerable institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed.

But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.

In other words, the people now lining up behind the bailout are the same people who set the stage for this meltdown. To be fair, there is plenty of blame to go around; lots of Wall Street fat-cats thought they could re-write the laws of economics and leveraged their firms on the sub-prime market.

And, from a historical perspective, the "politicization" of Fannie and Freddie dates to the early days of the Clinton Administration, which put the Community Reinvestment Act of 1977 on steroids, and began forcing lenders to write mortgage loans in previously "red-lined" areas.

We should also note that Mr. Hassett is an advisor to John McCain, so yes, he has a dog in the fight. But no matter how the Democrats spin it, one fact is clear. Mr. McCain was a vocal sponsor of Senate Bill 190, which could have prevented this mess--if the Democrats hadn't killed it.