`International Journal of Political Economy Vol. 38, No. 2 (Summer 2009), in press
Too Big To Bail:
The “Paulson Put,” Presidential Politics, and the Global Financial Meltdown
Part II: Fatal Reversal– Single Payer and Back
1Thomas Ferguson and Robert Johnson
This paper continues our study of how a world financial crisis developed out of
subprime mortgage markets. Part I, “From Shadow Banking System to Shadow Bailout,”
appeared in the preceding issue of this journal (Ferguson and Johnson, 2009). It traced
the bipartisan deregulatory bacchanal that allowed Wall Street to build an entire line of
new, risky, and almost completely unsupervised financial products out of raw materials
that mortgage markets supplied. The analysis also chronicled how, amid growing world
economic imbalances, a tidal wave of political money encouraged regulatory failures that
allowed banks and investment houses to take on extreme amounts of leverage. The
combination of high leverage and regulatory indulgence guaranteed that when a crisis hit,
it would be severe.
In the summer of 2007, the paper argued, the gravity of the crisis finally dawned
on policymakers. In response, the U.S. Federal Reserve and Treasury evolved the strategy
of the “Paulson Put” (analogous to the more famous “Greenspan Put,” that promised Wall
Street relief via lower interest rates at times of market stress). The idea behind the
1 Thomas Ferguson is Professor of Political Science at the University of Massachusetts, Boston. Robert
Johnson was formerly Managing Director at Soros Funds Management and Chief Economist of the United
States Senate Banking Committee.
Paulson Put was simple: push off high profile public financial bailouts and regulatory debates until after the election, when they were less likely to trigger a political firestorm
1 and open up a Pandora‟s Box of reform demands.
The Put, we suggested, had two tracks. The first was widely publicized and centered on the Fed: It consisted of aggressive cuts of both Fed Funds and the discount rate, along with a widening of acceptable collateral requirements for borrowing from the Fed. By contrast, the second track was virtually unheralded. This “Shadow Bailout”
aimed to prop up the financial system as unobtrusively as possible. The previous paper outlined the first two devices the scheme embraced: Assistance on a gigantic scale to banks and thrifts from the obscure Federal Home Loan Bank System and concerted efforts to play down eventual taxpayer liabilities for Federal Deposit Insurance Corporation (FDIC) payouts. As the presidential campaign kicked into high gear in January 2008, the Put appeared to be virtually the only administration initiative that was working: Only rarely did banking issues make the front pages of American newspapers and they figured hardly at all in the presidential campaign.
The “Shadow Bailout,” however, had two additional components: One was dicey
indeed: Large scale purchases by the Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac, of home mortgages and mortgage bonds to stem declines in those markets and alleviate pressures on the balance sheets of private firms. The second involved unconventional expansions of the Federal Reserve‟s balance sheet. Along with the crucial fact that existing law blocked Fed assistance to investment banks except in emergencies, the first would fatally undermine the Put, and eventually topple the entire world financial system in the midst of the presidential campaign.
We resume our discussion where we left off in the earlier paper.
The Shadow Bailout: Freddie and Fannie
In January 2008, the Republican White House and the Democrat controlled
Congress both agreed that modest fiscal stimulus through tax rebates would be good
public policy in an election year. Some Democrats, mostly in the House, appear to have
favored a larger stimulus. Most Democratic leaders, however, were at best lukewarm to
this, while Republican Congressional leaders were actively hostile. Proposals for
mortgage relief provoked additional discord. Representative Barney Frank, Chair of the
House Financial Services Committee, talked up a plan to let bankruptcy judges modify
mortgage terms – normal American legal practice for everything but mortgages. Other
Democratic leaders in both houses shied away from forcing the issue in the face of
intense opposition from banks and the mortgage industry. In the end, the Democrats
settled on a plan for mortgage relief originally promoted by Credit Suisse, Bank of
America, and other financial institutions. While decidedly more aggressive than the
administration‟s, it did not include the bankruptcy language. The Democrats also
embraced a proposal supported by the Mortgage Bankers Association that expanded the
size of mortgages the two GSEs, Fannie Mae and Freddie Mac, could purchase. Both
choices limited mortgage relief, since few banks saw any reason to make concessions and
2the jumbo provision aided primarily affluent neighborhoods.
Because the GSEs were, along with the Home Loan Banks, the instruments most
perfectly adapted for use in a bailout intended to stay below the radar scan, they were
swept up in the Shadow Bailout. Bending them to this purpose, however, was fraught
with political peril and economic risk. Because of the clouds of sometimes partisan
misinformation that now swirl around the GSEs, some clarification is necessary about
exactly what they were and how they figured in the debacle that unfolded.
Fannie Mae had been founded during the High New Deal as the Federal National
Mortgage Association. For decades, it was the only game in town when it came to
secondary mortgage markets; because of defaults and prepayments, making markets in
3 In 1968, President Lyndon secondary mortgages was just too risky for private lenders.
Johnson was looking to get as much debt as possible off the government‟s books. So
Fannie Mae was privatized. In 1971, Congress chartered a similarly structured competitor,
the Federal Home Loan Mortgage Corporation (“Freddie Mac” – both corporations
eventually became known by their nicknames). Various administrations kept repeating
the mantra that the GSEs were private corporations without full government backing.
Markets, however, mostly disbelieved this. Possibly, in the end, widespread confidence
that the GSEs would be bailed out stemmed as much from their sheer size as from any
putative moral obligation. In any case, once foreign central banks began buying large
amounts of their bonds, perhaps on assurances of government guarantees offered by
individuals who may not have had authority to make such commitments, Fannie and
Freddie evolved into American originals: semi-public institutions too big and
4complicated to fail without international ramifications.
The spectacular growth of mortgage lending in the 1980s fundamentally altered
the GSEs‟ environment. They were allowed to buy only medium sized (“conforming”)
mortgages from high grade credit risks. Unlike the much smaller Government National
Mortgage Association (“Ginny Mae”), whose obligations were carried on the books of
the Treasury and were therefore backed by the “full faith and credit” of the U.S. government, Fannie and Freddie remained privately run and owned. But the presumption that they could count on a government bailout allowed them to raise money more cheaply than private firms. The latter thus had little prospect of competing in market segments the GSEs dominated (Muolo and Padilla, 2008).
As mortgage companies proliferated and secondary mortgage markets boomed in the 1980s, increasing numbers of banks and other potential competitors began to lobby Congress and successive administrations to prune back or even eliminate Freddie and Fannie. Wells Fargo Bank, General Electric Finance, Household Finance and other large firms all became players in one or another of these efforts. GE even tried to persuade a group of Wall Street firms to form a direct competitor to the GSEs (Muolo and Padilla, 2008). Prominent business supported thinks tanks on the political right took up the cause of abolishing the GSEs; the notion became a staple of media commentators who wanted to appear sophisticated and curry favor.
The GSEs defended themselves by spending more and more money on political contributions and lobbying. A very conservative analysis limited to GSE contributions flowing only to sitting members of Congress in 2008 from 1989 onward reported total
5 Another 2008 study that included lobbying donations of just under $5 million dollars.
totals as well as contributions suggested that “over the past decade” the two GSEs had
spent almost $200 billion “to buy influence” (Lerer, 2008). Through foundations they controlled, Freddie and Fannie also distributed millions of dollars more in grants, which, reporters have suggested, were sometimes awarded as favors to influential political
6 figures (Journal, 2008b).
The subtlety of the GSE‟s maneuvering has been insufficiently appreciated by their myriad critics, in part because of the serpentine ways political money flows in the
American political system. The New Deal legacy ensured that the two GSEs had a natural
elective affinity with Democrats. Their political contributions reflect this: by one
reckoning, between 1989 and 2008, they channeled 57% of their political funds to
Democrats, with the three biggest recipients being Senate Banking Committee Chair
Chris Dodd ($165, 400) and Senators Barack Obama ($126,349) and John Kerry
7 But they also maintained strong ties with a succession of “moderate” ($111,000).
Republicans and lobbyists linked to the highest levels of the GOP, including Kenneth
Duberstein, Frederick V. Malek, and Robert Zoellick (Shaffer, 2008).
In the meantime, Fannie and Freddie mirrored with special force the Democratic
Party‟s broad “Right Turn” after 1980 (Ferguson and Rogers, 1986). Many “New
Democrats” gravitated naturally to the GSEs, which were, after all, exactly what “New Democrats” professed to admire: big, highly profitable businesses. Gradually, the GSEs
began to function as a kind of political machine for this wing of the party. As Bill Clinton
left office, for example, he appointed several top staffers to the boards of the GSEs,
8including Rahm Emmanuel and Harold Ickes. In the nineties, long time Democratic
operative Jim Johnson ran Fannie Mae, before moving on to the compensation committee
of Goldman, Sachs, where he helped set the remuneration of Hank Paulson, then head of
the firm. (In 2008, Democratic Presidential nominee Barack Obama picked Johnson to
vet possible running mates; he was forced to step aside when it came out that he, along
with many other political figures, including Senate Banking Chair Chris Dodd, received a
9sweetheart loan from Countrywide Credit, long a staunch GSE ally).
The GSE‟s political evolution affected their business strategies as the housing
boom took off in the new millennium. By then they ranked among the largest enterprises
in the United States. Like the rest of corporate America, remuneration of their top officers
and advisors had spiraled upward, despite all the talk about their public service mission.
An indulgent Congress also permitted the concerns to behave like most private
companies and conceal or camouflage much of that compensation (Bebchuck and Fried,
2005). Individual members of Congress who inquired about these arrangements were
10 sometimes bluntly threatened.
Developments in mortgage markets after 2001, however, made traditional GSE
rhetoric about their unique role in promoting homeownership ring hollow. Nothing
Freddie or Fannie had to offer could top privately offered “Ninja” mortgages that – as
long as they lasted – funneled home loans to people with no income, no jobs, and no
assets. In the meantime Franklin Raines, who left the job of Budget Director in the
Clinton White House to takeover as Johnson‟s successor at Fannie, and other GSE
executives continued steering the two giants in what was sometimes described as more
Or, in other words, on a trajectory embracing many of the shenanigans other
financial houses engaged in to inflate reported profits. Not because of any “dual
mandate” Fannie had to serve the public interest and also make profits, but because the
top management would then become fabulously rich and share the wealth with friendly
11Congressmen and women and allied community groups. Soon after he took the helm of
12Fannie in 1998, Raines explicitly set a target of doubling earnings per share. William
Black has shown that that suborning the audit department‟s internal controls through high
13 pressure and a munificent new bonus scheme appear to have been critical to his success.
The boom in collateralized debt obligations, described in our earlier paper, gave
the GSEs a new, crucial, and hugely remunerative role: They provided guarantees that
helped secure AAA ratings for the top tranches of the CDOs rolling off the assembly
lines of Wall Street (Muolo and Padilla, 2008). Eventually, however, the GSE‟s
emulation of Wall Street‟s business models caught up with them. To increase earnings,
the firms took on more leverage. Along with the additional risk, they also tried smoothing
earnings, just as many American businesses did during the stock market boom. They
were caught and eventually forced to restate earnings (OFHEO, 2006) (Smith, 2006)
Raines, an African-American who was by then Co-chair of the Business
Roundtable, lashed back at his critics in a stormy Congressional hearing. The hearing
transcript reveals that he was vigorously assisted by several members of the
Congressional Black Caucus who had supported Raines and the GSEs for years. They
sought to deflect critics by drawing attention to the campaign business interests had been
mounting against the GSEs. One, Representative William Clay of Missouri, compared the
attacks to a “witch hunt” and a “lynching.” Eventually, however, mounting evidence of
accounting irregularities and disclosures of bonus and pension benefits of almost
Medician proportions to Raines and other executives soured the mood. Congressman
Barney Frank labeled Raines‟s compensation and pension benefits “inappropriate” and
14Congressmen and women started demanding the money be returned.
While there was talk of indictments, no one was charged, though the Securities
and Exchange Commission sued Raines and two others. The case was settled after Raines
departed Fannie in December 2004, amid a chorus of promises of sweeping reforms by
politicians in both parties.
At the time, the GSEs‟ prospects looked dire. But in fact their position was not as
bleak as it seemed. With the housing boom cresting, homeownership as a political goal
was irresistibly attractive, even to Republicans who might normally be sympathetic to the
idea of cutting the GSEs down to size (Becker et al., 2008). In addition, the
administration, just like the Fed, warmly approved of subprime or any other kind of
lending “free markets” threw up. In a speech in Arizona in 2004, for example, President
George W. Bush proclaimed that “we want more people owning their own homes.” Yet,
the President lamented, “not enough minorities own their own homes. And it seems like
to me it makes sense to encourage all to own homes. And so we‟ve done some interesting
things. Again, I want to thank Congress. But we passed down payment assistance
programs that will help low-income folks buy their own home…I proposed that mortgages that have F.H.A.-backed insurance pay no down payment.” Just in case that was not enough, however, the Housing Boom Cheerleader in Chief also averred that
“I‟ve called on private sector mortgage banks and banks to be more aggressive about
lending money to first-time home buyers. And the response has been really good….” (Norris, 2008).
At just about that moment, the CEO of the most aggressive mortgage bank in the
United States, who – not coincidentally -- happened to be a prominent financial supporter of the President‟s reelection bid, was cranking up a broad national campaign in
favor of exactly what the President professed to want: “homeownership for all.” But
Angelo Mozilo, Countrywide Credit‟s visionary founder, was also a long time supporter
of Freddie and Fannie. He and his now gigantic concern were also anything but
doctrinaire: While he supported Bush for reelection, along with many other Republicans,
Mozilo and his firm had also maintained close relations with many Democrats in
Congress and the GSEs, from Fannie‟s Jim Johnson on down (Muolo and Padilla, 2008).
The mortgage giant quickly reached across the aisle to Democrats for help with its
homeownership campaign – and to shield Freddie and Fannie in their moment of
15 maximum vulnerability.
The campaign to save the GSEs enjoyed a singular advantage: It could tap a broad,
preexisting network of allies for help. For many years, a network of community
organizations (including parts of ACORN) and small, local businesses had functioned as
a loose, decentralized, and pluralistic support network for the GSEs. The original
inspiration for many participants appears to have been the cause of low income housing.
But as the Neoliberal Democratic tilt in the GSEs increased, the network‟s uses for
broader campaigns that profited the GSEs and allied mortgage bankers became apparent.
The result was a political movement and ideological syncretism that has not received the
attention it deserves. The mostly Neoliberal business executives and their friends in
Congress reached out to community activists who were hungry for funds and meaningful
roles in a social system that increasingly exalted business as the speculum mentis, the
highest activity of the human mind. As they became comfortable with casual references
to “working class housing,” mortgage bankers often joined the GSEs in picking up the
tab for community “housing campaigns.” Countrywide‟s drive on behalf of “home