Editor‚??s Note: This analysis is the third in a five-part series on Democrats‚?? mythical sound bites by Andrew Puzder, an economic adviser to Mitt Romney and CEO of CKE Restaurants, which employs about 21,000 workers.¬† The second installment was entitled ‚??Democratic Myth No. 2: Those Who Have Done Well Should Pay Their Fair Share.‚?Ě The first installment was ‚??Democratic Myth No. 1: GOP Is to Blame for Failure of Obama‚??s Job Policies.‚?Ě
President Obama has often asserted that ‚??there are some [people] who seem to be suffering from a kind of collective amnesia. After all that‚??s happened, after the worst economic crisis, the worst financial crisis since the Great Depression, they want to return to the same practices that got us into this mess.‚?Ě
In one form or another, the President and his surrogates often echo this myth with great enthusiasm, apparently believing that repetition and zeal can give a false statement both substance and veracity.¬† By any rational standard, they‚??re wrong.¬† Yet, as previously noted, in the wrong hands an oft-repeated myth can become more effective than the truth.
This ‚??return us to the same practices that got us into this mess‚?Ě mythical sound bite raises two questions.¬† First, what were the ‚??practices that got us into this mess‚?Ě?¬† Second, which of the candidates wants us to ‚??return‚?Ě to those practices?
A truthful answer reveals quite clearly that President Obama is the one suffering from amnesia on the cause of our continuing economic crisis and that he is either unaware of or consciously misrepresenting Gov. Romney‚??s policies.¬† Contrary to the myth, the ‚??practices‚?Ě that led to the 2008 economic crisis were, in large part, a byproduct of government-centered policies similar to those President Obama advocates and antithetical to Gov. Romney‚??s free enterprise-centered policies.
So, what caused the 2008 economic crisis?¬† As most people are at least somewhat aware, there was a real estate bubble and in 2008 the bubble burst, bringing our financial system to its knees.¬† Understanding how this real estate bubble came into being, why it burst and why our financial institutions were so vulnerable goes a long way towards explaining the cause of the 2008 economic crisis.
Sub-prime home loans
Beginning in the late 1990s, lenders making sub-prime home loans significantly increased the number of qualified borrowers to whom they would lend thereby increasing demand for homes and causing a surge in housing prices that peaked in about 2006.¬† In 2008, this housing price bubble burst as these sub-prime borrowers began to default on their mortgage loans.
Our financial institutions were heavily reliant on elevated real estate values and on borrowers generally continuing to make their mortgage payments.¬† When real estate values plummeted and large numbers of borrowers began defaulting, a number of financial institutions had to raise capital sufficient to offset the decline in the value of their real estate related assets.¬† Some (Lehman Brothers, Bear Stearns, Citigroup, etc.) were unable to do so and either went out of business or the government bailed them out with Troubled Asset Relief Program (‚??TARP‚?Ě) funds.
This was hardly a shocking result.¬† Sub-prime loans are by definition loans to people who are likely to have difficulty repaying them.¬† This is why they are called ‚??sub-prime.‚?Ě¬† Exacerbating the situation, many of these loans were adjustable rate mortgages that started with ‚??teaser‚?Ě or below-market interest rates that would go up over time.¬† Lenders designed these rates to entice sub-prime borrowers with an interest rate at which they could at least temporarily make mortgage payments they would otherwise have difficulty making.
With lenders easing credit standards below anything our economy had ever experienced, the demand for homes outpaced supply and prices soared.¬† Housing prices in the United States soon exceeded any rational relationship to actual value.¬† The teaser rates expired, massive numbers of homebuyers defaulted on their mortgages, lenders foreclosed and home values plummeted.¬† This resulted in outstanding mortgage balances exceeding the value of the underlying homes, even where the borrowers were making the payments, causing additional mortgage defaults, and the real estate bubble burst.
Why were subprime loans made?
One might well ask why rational profit motivated lenders would make loans to individuals who (i) lacked sufficient incomes to repay them (ii) at below market interest rates knowing that such individuals would be unable to make the payments when the teaser rates expired.
There are two answers to this question and both involve the federal government requiring or, at the very least, encouraging, subsidizing and facilitating such loans.¬† First, the Community Reinvestment Act requires lenders to invest in depressed and minority neighborhoods. ¬†Second, and more importantly, the primary lenders sold their sub-prime loans transferring to the purchasers the risk that borrowers might default.¬† The purchasers were often either Fannie Mae and Freddie Mac, two Government Sponsored Enterprises (‚??GSEs‚?Ě), or private sector investors (generally financial institutions) that purchased securities comprised of sub-prime loans bundled and sold as secured highly rated bonds.
As almost prophetically stated in a 1999 New York Times article entitled ‚??Fannie Mae Eases Credit to Aid Mortgage Lending:‚?Ě
‚??Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.
*¬†¬† *¬†¬† *
‚??In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980‚??s.‚?Ě
Five years later, the Times again expressed concern in an article aptly entitled ‚??Housing Bust: It Won‚??t be Pretty,‚?Ě stating that:
‚??[E]ven small declines in home prices could hurt the economy.¬† ‚??The precise degree of the vulnerability isn’t going to be clear until we see house prices slow,‚?? Mr. Wilson [a senior global economist at Goldman Sachs] said. ‚??You‚??ve never seen consumers this stretched, operating at levels of leverage we‚??ve never experienced before. House prices are starting at a level that is pretty high relative to what we think fair value is going to be, and the economy as a whole has gotten a lot more sensitive‚?? to housing-related spending.‚?Ě
As such, what appeared to be a very positive government-supported social goal (home ownership for the underprivileged) was putting our entire economy at risk.¬† Proponents of this policy soundly criticized anyone who attempted to point this out or who advocated regulatory oversight of Fannie and Freddie.¬† In 2004, Representatives Maxine Waters, Barney Frank, Gregory Meeks, and others attacked one regulator from the Office of Federal Housing Enterprise Oversight for merely pointing out the problem with the GSEs.
Creating trillions in bad investments
The government‚??s social goal of creating home ownership for low income individuals was again admirable but it simply ignored the consequences for our entire economy of making trillions of dollars in bad investments.¬† Following the crisis, the International Monetary Fund estimated the total write-downs from the sub-prime loan debacle at about $4 trillion, of which two-thirds fell on banks and the remainder on insurance companies, pension funds, hedge funds, and other intermediaries.
There is plenty of blame to go around in this situation.¬† Financial institutions, the government and individual borrowers were all somewhat at fault.¬† Wall Street saw a profit opportunity in bundling sub-prime loans and took advantage of it without fully considering the long-term consequences.¬† Borrowers incurred more debt than they could reasonably repay.¬† Federal regulators allowed the financial institutions they regulated (particularly banks) to put these sub-prime mortgage bundled securities on their books at full market value despite their inherent risks.¬† However, the core impetus for this conduct was a Federal government policy ‚??to expand mortgage loans among low and moderate income people.‚?Ě
Other aspects of the bubble
The housing bubble involved more than just sub-prime mortgages.¬† There were government subsidies with bipartisan support that further exacerbated the housing bubble driving all home prices up beyond their intrinsic value.¬† These subsidies include a) the tax deductibility of mortgage interest, b) the tax deductibility of property taxes, and c) the exclusion of a large portion of the profits from the sale of a primary residence from capital gains tax.¬† My intent here is not to question the wisdom of these policies but rather to point out that they exist and that they contributed to the housing bubble by making home purchase a very desirable and advantageous investment.
So, while the causes of the 2008 financial debacle are complex, the core ‚??practices that got us into this mess‚?Ě were well-intentioned, but fundamentally flawed, government housing policies initiated during the Clinton administration, supported by members of both parties, and laden with unintended consequences.
What Romney proposes
Gov. Romney is not the candidate advocating that we ‚??return‚?Ě to the government centered policies that are truly responsible for the 2008 crisis.¬† In fact, a government-centered approach to solving our financial problems is antithetical to his private sector based policy initiatives.¬† Gov. Romney‚??s economic policies essentially involve increasing economic liberty, structuring the tax code so it poses the least distortions in economic decision making, and reducing regulation.¬† Such policies have been shown to work throughout economic history, and are more reminiscent of the 1980s than the 2000s.¬† In particular, Governor Romney‚??s ‚??Plan for a Stronger Middle Class‚?Ě has five primary elements.
The first is ‚??Energy Independence‚?Ě and involves increasing access to domestic energy, streamlining permitting for exploration and development, eliminating regulations that are destroying the coal industry and approving the Keystone pipeline.
The Second is ‚??The Skills to Succeed.‚?Ě¬† Access to great schools and quality teachers.¬† Access to higher education and job training programs.¬† Retaining the best and brightest from around the world to help build our economy.
Third, Gov. Romney calls for ‚??Trade that Works for America.‚?Ě¬† Opening new markets for our goods, creating free enterprise zones, and curtailing unfair trade practices.
Fourth, Gov. Romney wants to ‚??Cut the Deficit.‚?Ě¬† Immediately reduce non-security discretionary spending by 5 percent, cap federal spending at 20 percent of the economy, transfer responsibility for programs to the states, consolidate agencies and align federal employee compensation with the compensation of their private sector counterparts.
Fifth and finally, Gov. Romney would ‚??Champion Small Business‚?Ě by reforming the tax code so as to reduce taxes on job creators, stop the increase in federal regulations that create red tape and slow job creation, protect businesses and workers from strong arm labor unions tactics, repeal Obamacare and replace it with healthcare reform that controls costs and improves care.
Despite President Obama‚??s claims to the contrary, it‚??s hard to see how Gov. Romney‚??s policies would ‚??return us to the practices that got us into this mess.‚?Ě¬† More appropriately, they are private sector based policies well designed to get us out of this mess. If energy independence, education opportunities, expanded trade, deficit reduction and advocating for small business take us in any direction its forward to an economic recovery and prosperity; something President Obama‚??s government centric policies have been unable to do.
In fact, its President Obama‚??s first term policies of expanded government, government dependence and government control of the economy (government, government and more government) that harkens back to the policies that ‚??got us into this mess.‚?Ě¬† It is difficult to know what decisions our President will need to make over the next four years.¬† What is important is that our current President would continue to view every decision from his big-government, government dependency perspective designed to transfer economic control to the government and limit individual liberty.¬† Gov. Romney, on the other hand, would view each decision from his private sector, individual and economic freedom perspective designed to liberate the American spirit and release the dynamic entrepreneurial energy of our free enterprise system.
Of course, it is somewhat difficult to compare Gov. Romney‚??s proposed policies for getting us out of ‚??this mess‚?Ě to President Obama‚??s proposals since the president has yet to tell us how a second Obama term would differ from the first.¬† If his first term is any measure, with the pending Tax Cliff, Fiscal Cliff (debt and deficit) and Obamacare Cliff, a second term for President Obama could well make the 2008 economic crisis look like a walk in the park.
The bottom line:¬† We simply can‚??t afford another four years like the last four years.
Andrew Puzder is CEO of CKE Restaurants, Inc., which employs about 21,000 people at Carl‚??s Jr. and Hardee‚??s restaurants. He is co-author of ‚??Job Creation: How it Really Works and Why the Government doesn‚??t Understand it.‚?Ě He is an Economic Adviser to presidential candidate Mitt Romney.¬†