Daily Archives: December 29, 2011

Fannie and Freddie Fantasies

By William K. Black

(Cross-posted from Benzinga)

An important but fundamentally flawed debate about Fannie and Freddie’s role in the ongoing crisis has raged since the SEC sued the former senior managers of both entities for securities fraud.  The Wall Street Journal and Peter Wallison (in the WSJ) have claimed that the suit vindicates their positions and discredits the Federal Crisis Inquiry Commission (FCIC).  Joe Nocera, in his New York Times column, has thundered at the SEC and then Wallison,accusing him of “The Big Lie.”  Nocera’s column is also interesting because it (implicitly) argues that the thesis of Reckless Endangerment is incorrect.  His colleague Gretchen Morgenson and Joshua Rosner co-authored that book.  I write to provide yet another view, distinct from each of the sources.

There are two primary issues about Fannie and Freddie and the crisis discussed in the debate. First, why did Fannie and Freddie, relatively suddenly, change their business practices radically and begin purchasing large amounts of nonprime mortgages?  Second, what role did declining mortgage credit quality that did not descend to the level of loans that the industry described as “subprime” play in the Fannie and Freddie crisis?  The first issue is vastly more important and this article focuses on it. (The short answer to the second question is:  “The first issue, for everyone except theSEC, comes down to this question: did Fannie and Freddie’s controlling officers(eventually) cause them to buy large amounts of nonprime loans for the same reason their counterparts running Lehman, Bear Stearns and Merrill Lynch did(the higher nominal short-term yield maximized their current compensation) or because “the government” made them buy the loans?)  (Lehman, Bear Stearns, and Merrill Lynch were not subject to any governmental requirements to purchase any category of nonprime loans.)

I show that Fannie and Freddie’s controlling officers (eventually) caused them to buy huge amounts of nonprime loans for the higher short-term nominal yield (though they knew that the actual yield would be negative as soon as the housing bubble stalled).  I exploit a “natural experiment” provided by liar’s loans – loans made without prudent underwriting of the borrower’s capacity to repay the loan.  No governmental entity ever required any lender, or any purchaser of loans (and that includes Fannie and Freddie), to make liar’s loans. The mortgage industry’s anti-fraud experts, the FBI, and the banking regulators all warned about liar’s loans producing an epidemic of fraud.  If Fannie and Freddie purchased large amounts of liar’s loans, then their controlling managers did so because liar’s loans’higher short-term nominal yield maximized their near-term compensation – not because “the government” made them do so.

OFHEO, which was Fannie and Freddie’s regulator during the relevant period, had ample regulatory authority to prevent Fannie and Freddie from purchasing liar’s loans and its head, James B. Lockhart, was a George Bush appointee and one of his oldest friends (from prep school).  Lockhart had President Bush’s full support and he was in no way intimidated by Barney Frank or Chris Dodd.  Lockhart shared Bush’s anti-regulatory mindset, his inability to envision elite business leaders as felons, and his strong support for even the most perverse executive compensation systems.  Lockhart was not “captured” by Fannie and Freddie.  He was not a supporter of either entity.  He and his senior regulators that I met simply did not believe it was legitimate for the government to regulate compensation or, absent proof that the business practice had already produced large losses, Fannie and Freddie’s business strategy.

The, SEC complaint, takes the unique, naïve, and untenable position that Fannie and Freddie bought very large amounts of nonprime loans in order to increase market share.  This position is exceptionally important because it reveals the SEC’s unwillingness to take on even the most perverse executive compensation systems that are driving our recurrent, intensifying financial crises.  Suffice it to say that the documentary record at Fannie and Freddie is replete with evidence that the controlling officers drove the decision to adopt a new business plan of purchasing vast amounts of nonprime loans and that the reason for the plan was to increase short-term nominal yields. Their risk people repeatedly warned them that the new plan could be disastrous.  High short-term yield produced extraordinary near-term compensation for Fannie and Freddie’s controlling officers,so it is no surprise that the CEOs’ decided in favor of the path that made them wealthy – and produced disaster for Fannie, Freddie, and the government.

Perverse Executive Compensation Systems are Criminogenic

Each of the discussions (and that includes the SEC complaints) is faulty because it proceeds as if Fannie and Freddie suddenly began engaging in accounting and securities fraud late in the crisis.  That is objectively false.  The SEC (and eventually Fannie and Freddie’s regulator – then OFHEO, now called FHFA) documented that Fannie and Freddie had long engaged in accounting and securities fraud – no later than the beginning of the decade that would eventually produce the crisis.  The SEC detected Freddie’s and then Fannie’sfrauds in 1983.  Indeed, the SEC explicitly charged that Fannie’s senior managers caused it to commit accounting fraud for the purpose of maximizing their executive compensation.  I was an expert witness for OFHEO against Raines, et al. in the agency’s enforcement action arising from this earlier fraud.  The SEC and OFHEO’s actions led to Freddie appointing a new CEO in December 2003 (Richard Syron, the most senior defendant in the new SEC suit arising from Freddie’s operations) and Fannie appointing a new CEO in December 2004 (Mr. Mudd, Fannie’s COO during its endemic accounting fraud from 2000-20003). Mudd is the most senior defendant in the SEC suit arising from Fannie’s operations.

One of the delightful acts of unintentional self-parody arising from the crisis is that when the Business Roundtable (the 100 largest U.S. corporations), eventually decided that they needed a spokesperson to respond to the Enron-era epidemic of “accounting control fraud,” they selected Frank Raines (Fannie’s CEO).  BusinessWeek dutifully asked Raines why the fraud epidemic occurred.  Raines responded:

“Don’t just say: ‘If you hit this revenue number, your bonus is going to be this.’ It sets up an incentive that’s overwhelming. You wave enough money in front of people, and good people will do bad things.”

Raines knew of what he spoke, for his predecessors and he had devised such a bonus system (tied largely to, non-GAAP, earnings per share (EPS) targets purportedly designed to be “stretch” goals).  Fannie’s compensation system produced exactly the perverse results that Raines predicted and explained to Business Week.


“Remember, Frank has given us an opportunity to earn not just our salaries, benefits, raises,ESPP, but substantially over and above if we make 6.46.  So it is our moral obligation to givewell above our 100% and if we do this, we would have made tangible contributions to Frank’s goals.”  (Mr.Rajappa, head of Fannie’s internal audit, emphasis in original.)

I call internal audit the anti-canary.  Miners took canaries into coal mines because the birds are more susceptible than humans to carbon dioxide and monoxide.  If the canary loses consciousness the humans can survive by exiting the mine. Internal audit is supposed to the least susceptible unit in a firm.  The mantra of internal audit is“independence” from the senior managers. If internal audit is suborned by executive compensation then the rot is pervasive in other units.  In considering the import of Rajappa’s speech to his internal audit troops, consider the fact that it was a written speech and that Rajappa provided the text to Raines – and got favorable suggestions to make it even stronger.  Raines knew and approved of the fact that the rot at Fannie was pervasive.

Ireland Imports U.S. Executive Compensation and Produces a Similar Crisis

A word about “stretch goals.”  Consider this exceptionally naïve passage from a Nordic banker (Nyberg) recently asked to write a report on the failed Irish banks.  He is discussing earning targets that maximized executive compensation.

“Targets that were intended to be demanding through the pursuit of sound policies and prudent spread of risk were easily achieved through volume lending to the property sector.” (Nyberg 2011: 30)

The bonus targets, of course, were not “intended to be demanding through the pursuit of sound policies.”  The senior managers chose stretch goals,impossible to reach through prudent lending, because such goals were “easily achieved” by ignoring asset quality (which they proceeded to do).  As George Akerlof and Paul Romer aptly observed in their 1993 article (“Looting: the Economic Underworld of Bankruptcy for Profit”), accounting control fraud is a “sure thing.”   Whether one is in Ireland or the U.S., the fraud recipe for a lender (or loan purchaser) has four ingredients.

  1. Grow like crazy
  3. Employing extreme leverage, and
  4. Providing grossly inadequate allowances for loan and lease losses (ALLL)

Indeed, Ireland provides a superb natural experiment that helps us determine why banks make or purchase exceptionally bad loans with grossly deficient underwriting and trivial ALLL.  The fraud recipe is so perverse because it is mathematically guaranteed to produce record (albeit fictional) short-term reported income, huge compensation, and catastrophic losses.  If a material number of banks (or a small number of very large banks) follows the same fraud recipe in an asset category it will hyper-inflate a bubble in that asset. Accounting control frauds often lend into teeth of a glut.

Ireland is so useful because it had no equivalent ofa Community Reinvestment Act (CRA) and no material secondary market (noe quivalent of Fannie and Freddie – hence, no requirements to purchase a subset of below median-income home mortgages). Nevertheless, its real estate bubble was roughly twice as large (in relative terms) as the U.S. bubble and it had twin bubbles in commercial and residential real estate.  Its banks exhibited a collapse of loan quality driven by perverse executive compensation.  Irish bank CEOs followed the same fraud recipe as Lehman, Merrill Lynch, Countrywide, WaMu, Fannie,Freddie and their ilk and produced the same catastrophic losses.

“All of the covered [failed]banks regularly and materially deviated from their formal policies in order to facilitate rapid and significant property lending growth. In some banks, credit policies were revised to accommodate exceptions, to be followed by further exceptions to this new policy, thereby continuing the cycle.”

“Occasionally,management and boards clearly mandated changes to credit criteria. However, in most banks, changes just steadily evolved to enable earnings growth targets to be met by increased lending.” (Nyberg 2011: 34)
“The associated risks appeared relevant to management and boards only to the extent that growth targets were not seriously compromised.” (Nyberg 2011: 49)

That’s right; let nothing get in the way of making it simple to meet the bonus target – even though doing so will destroy the bank.

Fannie and Freddie’s CEOs Led them in Serial Accounting and Securities Fraud

Fannie and Freddie’s accounting frauds in the earlier part of the decade, however, followed a different recipe.  Their managers’ were then “skimmers” instead of “looters.”  We should not be too kind to them.  Their earlier accounting fraud recipe put Fannie and Freddie (and therefore the government) at risk of loss and their phony (“dynamic”) hedging posed a systemic risk.  Fannie and Freddie’s original fraud scheme sought to maximize the senior managers’ income by taking substantial interest rate risk.  This required Fannie and Freddie to grow their portfolios massively.

“[F]rom 1998 to 2003,Freddie Mac’s retained portfolio grew at an annual average rate of about 21 percent. Over the same period of time, Fannie Mae’s mortgage holdings increased by an annual average rate of 17 percent. By 2003, Freddie Mac’s retained portfolio ($661 billion) was about 72 percent as large as Fannie Mae’s ($920billion.)”

The Rise and Fall of Fannie Mae and Freddie Mac: Lessons Learned and Options for Reform.  Richard K. Green and Ann B. Schnare (November 19, 2009: p. 18).

Fannie and Freddie’s controlling officers made the opposite bet on the direction of interest rates.  Fannie lost its bet, so it hid it losses by calling them “hedges.”  This accounting fraud turned Fannie’s real losses into fake profits, maximizing the officers’bonuses.  This bit of accounting and securities fraud caused the SEC to required Fannie to restate its financial statements and recognize millions of dollars in losses.  Naturally, Fannie’s officers did not give back their bonuses.  Freddie won its beton interest rates and, after recognizing enough income to maximize current executive bonuses, it created “cookie jar” loss reserves so that it could draw on them if it failed to meet the targets that maximized future bonuses.  The SEC was not amused and required Freddie to restate its financial statements.

Here is the crazy thing – the SEC, OFHEO, and Department of Justice all failed to demand that Fannie and Freddie end their perverse executive compensation system that made the executives wealthy through fraud and put the entities and the government at risk.  The Bush White House took no action and made no criticism of the compensation system. The Congress (both parties) made no criticism of the compensation systems.  Remember, we had seen these perverse compensation systems blow up the S&L industry and the Enron-era accounting control frauds.

OFHEO even allowed Mr. Mudd, Fannie’s COO during the period of its extensive accounting and securities fraud, to replace Raines’ as CEO in December 2004.  None of this was due to any weakness in OFHEO’s regulatory powers.  The problem was an unwillingness to regulate.  The unwillingness was ideological.  OFHEO’s senior managers did not consider it legitimate to regulate executive compensation or to block Fannie’s choice of its new CEO.  The new SEC suit names Mudd as a defendant.

OFHEO had its maximum leverage over Fannie and Freddie when the SEC discovered their accounting and securities frauds and its own examinations confirmed those frauds in the middle of the critical decade.  OFHEO used its leverage to fight the last war – ensuring that Fannie and Freddie did not take excessive interest rate risk.  It sharply limited the amount that Fannie and Freddie could grow their portfolios and cracked down on hedging abuses.  Unfortunately, the first of these actions, while completely appropriate, helps explain the new accounting and securities fraud that are (or should be in a better complaint and prosecution) the subject of the new SEC action.

Fannie and Freddie’s New Controlling Insiders become Looters

By December 2004, the SEC and OFHEO had forced out Fannie and Freddie’s controlling managers who led the accounting control frauds in the first part of the decade, but they left in place Fannie and Freddie’s exceptionally perverse executive compensation systems that promised that the new senior officers could attain vast wealth if they could cause Fannie and Freddie to report high, short-term profits. Their old scam, interest rate risk plus hedge/cookie jar accounting fraud could no longer be used when Fannie and Freddie’s new controlling officers took power.  There was only one alternative means of creating (fictional) outsized reported profits.  They could not grow their portfolio significantly, but OFHEO failed to require them to divest those portfolios –and those portfolios were massive because of the earlier fraud scheme.

In 2005, Fannie and Freddie’s new controlling officers led them into an orgy of purchasing nonprime loans (liar’s loans, subprime loans, and subprime liar’s loans) – the loans sure to generate the largest short-term nominal yield.  This had the intended effect on the controlling officers’ executive compensation. Fannie and Freddie’s controlling officers increasingly moved prime loans out of portfolio by securitizing and selling them.  Their portfolios increasingly became littered with nonprime loans.  Fannie and Freddie’s controlling officers followed the classic recipe for looters using accounting control fraud.  The difference between Fannie and Freddie and some of its counterparts is that Fannie and Freddie’s risk and (some) underwriting officers mounted considerably greater opposition to the fraud recipe than many other accounting control frauds.  This explains why Fannie and Freddie’s losses (relative to the amount of nonprime loans they purchased) were smaller than many of their counterparts.

It is only by taking into account Fannie and Freddie’s earlier accounting fraud and the SEC and OFHEO’s reactions to those frauds that one can understand why Fannie and Freddie made radical changes in their purchase of nonprime loans in 2005. It is only by taking into account the (moderately) superior professional culture of its risk professionals that one can understand why their losses were not far worse (given the enormous amounts of nonprime loans they purchased from 2005-2007).  Wallison implicitly assumes that if Fannie and Freddie had not purchased these nonprime loans their competitors would not have done so.  That assumption is extraordinary and requires heavy proof.  Wallison provides none.  It was Fannie and Freddie’s competitors who purchased the same nonprime loans so eagerly in 1998-2004 that they eviscerated Fannie and Freddie’s once dominant market share in the secondary market for mortgage loans.  Fannie and Freddie’s combined share of the secondary market fell from well over 90% in 1990 to under one-half by 2004.  Indeed, many of Fannie and Freddie’s losses come from investing in or guaranteeing the financial derivatives issued by its competitors where the underlying asset was nonprime assets, particularly liar’s loans and subprime liar’s loans.

“Private label securities accounted for 56 percent of Fannie Mae’s total mortgage-related security purchases from 2004 through 2006, and 54 percent for Freddie Mac. (See Exhibit 4.) Most of these purchases involved securities backed by subprime or Alt-A mortgages. (See Exhibit 9.) In 2006, the GSEs’ purchases of such securities represented 9.8 percent of the total volume of subprime and Alt-A originations made within the year.” (Green & Shnare 2009: 23)

“Alt-A” is one of the many euphemisms for liar’s loans.  The term is a double lie.  It purports that the loans are prime quality (“A” grade) and it purports that the loans are underwritten through “alternative” means.  In reality, the capacity of the borrower to repay the loan was not underwritten.  Typically, the lenders and their agents fraudulently inflated the borrower’s income. 

Fannieand Freddie were Late to Purchasing Huge Amounts of Nonprime Paper

Fannie (which predated Freddie), created the concept and standard of the “prime” home loan decades ago when it was an independent government agency before it was privatized. When it was a government agency, it was the principal source of desirable market discipline ensuring high mortgage quality.  Nonprime home loans include three primary categories – liar’s loans (loans made without prudent underwriting of the borrower’s capacity to repay the loan), subprime (loans made to borrowers with known, serious credit defects), and subprime liar’s loans (combining both problems).  One of the easy tests of competence is to find whether a writer knows so little that he believes that subprime and liar’s loans are dichotomous. Credit Suisse reports that, by 2006, 49% of the loans called “subprime” were also liar’s loans.

Prior to 2005, nonprime loans were sold overwhelmingly to large investment banks. These banks were not subject to any governmental requirements to purchase such loans.  The investment banks purchased the nonprime loans because doing so maximized their controlling officers’ compensation.  Fannie and Freddie lost enormous market share because of this competition. 

Wallison’s Thesis has been Repeatedly Falsified

The indisputable fact that it was the non-regulated sector (mortgage banks, mortgage brokers, investment banks, and non-bank affiliates that led the epidemic making and purchasing fraudulent nonprime loans has not prevented multiple, major analytical failures about the role that Fannie and Freddie played in the crisis. The historical quibble is that Fannie and Freddie reduced their loan purchase standards well before 2005. That is true, but it does not explain why Fannie and Freddie suffered huge losses on nonprime loans.  Fannie and Freddie’s definition of “prime” created an exceptionally safe standard in which credit losses were minimal.  It was possible to reduce that standard without creating a criminogenic environment and the data review by FCIC demonstrates that the loans that Wallison has lumped together (relying on Pinto’s work) and labeled “subprime” are extremely disparate.

Fannie’s original definition of “prime” was equivalent to an A+.  The loans that themortgage industry called “subprime” were a C-. Liar’s loans were a D-.  Subprime liar’s loans were an F.  There is a large range in credit quality between the original definition of prime and loans the industry called “subprime.”  FCIC showed that the loans that Pinto (but not the industry) classified as “subprime” had dramatically lower default rates than the loans that the industry classified as subprime.  As Charles Calomiris, one of Fannie and Freddie’s most virulent critics has emphasized, the proof as to who is correct in this argument about categorization rests on the performance of the loans.  The loans at Fannie and Freddie that Pinto (but not the industry) termed subprime performed far better than the loans the industry termed subprime.

Nocera’s December 23, 2011 column calls Pinto and Wallison’s work a “big lie” because it categorizes loans that Fannie and Freddie would not have considered “prime” (circa 1982) as “subprime” even when these loans were not considered “subprime” by the industry (circa 2006).

This is unduly harsh.  Pinto and Wallison (and Joshua Rosner and Gretchen Morgenson) are correct that the credit quality of some loans considered prime deteriorated for over a decade.  The real problem is the authors’ lack of consistency.  At root, their point is that differences matter.  Specifically, they argue that making nonprime loans is far riskier than making prime loans.  The same logic, however, requires them to evaluate whether differences matter withinthe vast category that they created and labeled as “subprime.”  They failed to conduct this evaluation.  The FCIC conducted one aspect of the evaluation and found that the differences within the Pinto/Wallison category had enormous consequences for relative performance.  The bulk of Fannie and Freddie’s loans that fall within Pinto/Wallison’s unique and far broader categorization of “subprime” loans perform far better (have much lower default rates) than the narrower, commonly used categorization of subprime.

Second, all the authors advancing this meme failed to evaluate the difference between liar’s loans and non-liar’s loans for the purpose of their real thesis – “the government” caused the crisis by forcing Fannie and Freddie to purchase bad loans. This argument has many factual weaknesses, but one fatal weakness is the fact that there was never any governmental requirement for Fannie and Freddie to purchase liar’s loans.  This provides a natural experiment that allows us to test, and reject, the thesis that Fannie and Freddie purchased bad loans because of governmental mandates.  The CEOs of Fannie and Freddie caused them to buy vast amounts of liar’s loans because the higher nominal yield maximized near-term executive compensation.  The CEOs of Fannie and Freddie acted like the CEOs of Bear Stearns, Lehman, and Merrill Lynch and they did so for the same reasons and with the same fatal consequences.  Akerlof and Romer captured the dynamic in the title of their article (“Looting: the Economic Underworld of Bankruptcy for Profit”).  The firm fails, but the CEO walks away wealthy because accounting control fraud is a “sure thing.”

Remember, the FBI has already warned (in September2004) and the mortgage industry’s own anti-fraud unit (MARI) has warned in early 2006, respectively, that an “epidemic” of mortgage fraud will produce a financial “crisis” if it is not stopped and that liar’s loans are 90% fraudulent.  No honest, financially sophisticated entity would make or purchase liar’s loans (or CDOs backed by liar’s loans) knowing these facts.  Yet, several of the leading investment banks, hundreds of mortgage bankers, WaMu, Countrywide, IndyMac, and Fannie and Freddie rushed to make or purchase endemically fraudulent mortgage paper. This would be irrational for any honest CEO, but it would be optimal for a CEO directing an accounting control fraud.  Fannie and Freddie’s losses on liar’s loans paper are extreme – and note that the authors of the study make the common error of assuming that liar’s loans and subprime loans are dichotomous.  If one examined separately the losses on Fannie and Freddie’s subprime liar’s loans (and CDOs where such loans were the bulk of the underlying) the losses would be catastrophic.

“In 2008, for example,Alt-A mortgages represented just 9.7 percent of Fannie Mae’s book, but accounted for almost 40 percent of the company’s credit losses. The experience at Freddie Mac tells a similar story: the serious delinquency rate on FreddieMac’s Alt-A book (which is 8 percent of the portfolio) is more than three times higher than the total portfolio’s rate.” (Green & Schnare 2009: 24).

Sadly, the SEC fails to exploit this natural experiment involving liar’s loans. Indeed, the SEC complaint appears to have been drafted by someone so poorly informed that he believes that liar’s loans and subprime loans are dichotomous categories.  Nocera is also critical of the SEC complaint, but his criticism arises from his erroneous belief that the complaint rests on Pinto and Wallison’s unique categorization of “subprime” loans.  Nocera is guilty of what he accuses Pinto and Wallison of doing, writing “I still maintain that the S.E.C.’s charges are weak, and that the agency brought the case in part for political reasons: how better to curry favor with House Republicans than to go after former Fannie and Freddie executives?” This is a strong charge requiring at least some proof, but Nocera provides no support.

Nocera (and Wallison) miss entirely the key aspect of the SEC complaint that refutes Wallison’s thesis that Fannie and Freddie bought bad loans because “the government” made them buy bad loans.  Wallison’s facially implausible claim is that Fannie and Freddie were weak political actors forced by crazed Democrats to purchase suicidal loans in order to subsidize poorer minorities that support Democrats.  Fannie and Freddie were exceptionally powerful political entities with strong support from both parties, e.g., Newt Gingrich, but ignore this aspect of unreality solely for the purpose of testing the internal logic of Wallison’s hypothesis.  Wallison’s claim is that Fannie and Freddie were so weak politically that they were forced to take on suicidal loans in order to curry political favor with the Democrats.  If that were true, then Fannie and Freddie should have consistently been leading the purchase of subprime loans from 1993 on (which was when HOEPA became law).  In reality, Fannie and Freddie lost tremendous market share because they (generally) refused to purchase loans the industry categorized as subprime until roughly 2005.  Their rivals, the investment banks (who were not subject to any affordable housing mandates), rushed to purchase massive amounts of these subprime loans.  That is the conventional (compelling) reason to reject Wallison’s thesis.  I have added another reason – Fannie and Freddie would never have purchased liar’s loans under Wallison’s thesis because “the government” never compelled them to purchase liar’s loans and doing so would be suicidal.

The SEC complaint adds an additional reason why Wallison’s thesis fails.  Under Wallison’s thesis Fannie and Freddie should have been exaggerating the amount of subprime loans they were making in order to curry favor with the despicable Democrats.  But the SEC complaint (and Wallison and Pinto’s own work) prove that Fannie and Freddie did the opposite.  Fannie and Freddie’s controlling managers consistently cooked their financial statements and financial disclosures to make it appear that Fannie and Freddie purchased vastly fewer subprime loans than they actually purchased.  (They did the samething with their liar’s loans – for the same reasons.)  Nocera (incorrectly) assumes that the SEC complaint relies on Pinto/Wallison’s unique, ultra-broad categorization of “subprime” loans, but Fannie and Freddie’s documents show that they understated both the number of liar’s loans and subprime loans they purchased (as categorized by conventional industry norms). This makes perfect sense for managers running an accounting control fraud, but it makes no sense under Wallison’s thesis.

We need to be blunt about the source of Wallison’s thesis.  Wallison is one of the leading architects of the global financial crisis in his capacity as AEI’s long-time co-director of their financial deregulation program.  He pushed the criminogenic three “de’s”:  deregulation, desupervision, and de facto decriminalization.  He criticized Fannie and Freddie for notmaking greater amounts of nonprime loans. He is desperately seeking to escape accountability for his major role in creating a global crisis.  He is an ideologue who would have been fired by AEI had he supported financial re-regulation.  His thesis that the crisis was really caused by the government forcing the politically powerless Fannie and Freddie to make suicidal loans is a desperate effort to save himself and his ideology.

Wallison’s thesis cannot survive the laughtest.  It requires that, for over a decade in which the Republicans had control over the Congress and/or the White House Fannie and Freddie’s CEOs knew they were purchasing loans that would eventually prove catastrophic for Fannie and Freddie, the lenders (loan sales to Fannie and Freddie are made with recourse back to the seller), and for the (poorer minorities) purchasing the homes. No one at Fannie and Freddie leaks this to the Republican Congress or the Bush White House even though such leaks would have (under Wallison’s thesis) provided the mother of all Democrat-bashing congressional hearings.  No one at OFHEO, including Bush’s old friend, and strong Republican, James Lockhart (the guy running OFHEO), informs Bush that Fannie and Freddie are headed for catastrophe because the Democrats have forced them to purchase suicidal loans to poorer minorities (i.e., the base of the Democratic Party).

The thesis also requires that, knowing of the coming catastrophe, Fannie and Freddie’s controlling officers, for over 15 years, decided to provide only trivial accounting allowances for the inevitable catastrophic losses – even though GAAP would mandate that they provide massive allowances in such circumstances and even though the controlling officers’ failure to do so could be prosecuted as securities fraud.  The failure to provide massive allowances makes no sense under the Wallison thesis, but it is the standard “fourth ingredient” for an accounting control fraud. Had Fannie and Freddie’s controlling officers appropriate allowances for losses their financial reports would have shown the truth – that the actual long-term yield on liar’s loans was negative.  Fannie and Freddie would have reported substantial losses from 2005 on had they established the allowances required by GAAP, which would have eliminated their bonuses.

Wallison is the Problem and Placing him on FCIC was Scandalous

The Wall Street Journal editorial on the SEC complaints against Fannie and Freddie claims that FCIC should be embarrassed that it ignored the key role that Fannie and Freddie played in the crisis.  Wallison has a new piece in The Atlantic in which he claims “the government” caused the crisis.


Placing Wallison on FCIC was like placing the Don’s consigliere on a panel that is supposed to investigate the mafia.  What was Wallison going to say as a FCIC member? “Mea Culpa, I’ve been wrong for a quarter-century about everything important and I have come to admit that deregulation, desupervision, and de factodecriminalization are disastrous.” There was a reason no other Republican appointee to FCIC was willing to sign on to Wallison’s dissent.  His dissent is a screed that is devoted to protecting his theoclassical economic ideology.  FCIC did not ignore Pinto’s work, it refuted its analytics. Wallison’s real complaint is that FCIC took Pinto’s work seriously enough to do the analytical work that Pinto and Wallison should have done to determine whether Pinto’s unique categorization of “subprime” produced a category of loans with similar (terrible) performance results.  What Wallison cannot forgive the FCIC staff and other commissioners for is that they did treat his claims seriously despite his obvious self-interest and the logical inconsistency of his claims.  It was taking his claims seriously and evaluating his data that he failed to evaluate that put the final nail in the coffin of his claims.  Wallison and Pinto have had a year to point out any data errors in FCIC’s demonstration that the loans Pinto categorized as “subprime” had greatly superior loan performance compared to loans the industry categorized as “subprime.”

There is no point criticizing the Wall Street Journal’s editorial staff.  They know that FCIC concluded that Fannie and Freddie played a major role in the crisis.  FCIC was correct that Fannie and Freddie were late to the party in terms of purchasing the loans and CDOs that eventually caused the catastrophic losses.  The question was why Fannie and Freddie suddenly began to buy enormous amounts of largely fraudulent nonprime paper in 2005. They did so, as the repeated investigations have found, for the same reason that Fannie and Freddie engaged in accounting control fraud earlier in the decade – it makes the controlling officers wealthy.  It is a “sure thing.”  What I have added is the relevant time line explaining the role that Fannie and Freddie’s earlier accounting control frauds, and the modest sanctions levied by the SEC and OFHEO, played in explaining why they went so heavily into fraudulent nonprime paper around 2005.

Wallison has been conspicuously silent in demanding that elite CEO frauds that drove this crisis be prosecuted.  I ask him, and I ask reporters who discuss any story with him, whether he will now demand that we end the de facto decriminalization of the fraudulent CEOs who drive our financial crises and become wealthy through their frauds.  Does Wallison believe that Fannie and Freddie’s controlling officers would be a good place to begin prosecuting?



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Did OFHEO Fix Fannie and Freddie’s Compensation Systems after discovering their Frauds?

By William K. Black

I have been chastised by a friend and former colleague forwriting:

“Here is the crazy thing – theSEC, OFHEO, and Department of Justice all failed to demand that Fannie andFreddie end their perverse executive compensation system that made theexecutives wealthy through fraud and put the entities and the government atrisk.”

My friend notes that Fannie, under pressure from OFHEO andwith its prior approval, changed its compensation system after the initialaccounting fraud.  

My sentence would beclearer if it was revised to read as follows:

“Here is the crazy thing – theSEC, OFHEO, and the Department of Justice all failed to prevent Fannie andFreddie from using perverse executive compensation systems that made theexecutives wealthy through fraud and put the entities and the government atrisk.”

The new compensation systems at Fannie and Freddie remainedexceptionally perverse after the changes. Their CEOs continued to cause them to engage in systematic accountingfraud by not providing remotely adequate loss reserves and allowances for loanlosses despite purchasing massive amounts of fraudulent liar’s loans andfraudulent subprime liar’s loans.  The samescam that made the officers rich was certain to destroy Fannie and Freddie.

I have alsoexamined a number of statements by both of OFHEO’s leaders during the relevantperiod, concerning compensation and the initial Fannie accounting fraud.  James Lockhart issued a hard hitting releaseon May 23, 2006 accompanying OFHEO’s report on its investigation of Fannie entitled:  “FANNIE MAE FAÇADE: Fannie MaeCriticized for Earnings Manipulation.” The release begins with this passage that directly ties the accountingfraud to the controlling officers’ desire to trigger bonuses.  

“The report details an arrogant andunethical corporate culture where Fannie Mae employees manipulated accountingand earnings to trigger bonuses for senior executives from 1998 to 2004. Thereport also prescribes corrective actions to ensure the safety and soundness ofthe company.”

Note that the release emphasizes that the OFHEO report “prescribescorrective actions.”  The purpose of therelease, of course, is to emphasize the most important aspects of the lengthyOFHEO report.  The release makes it clearthat executive compensation drove the fraud.

 “The combination of earnings manipulation,mismanagement and unconstrained growth resulted in an estimated $10.6 billionof losses, well over a billion dollars in expenses to fix the problems, andill-gotten bonuses in the hundreds of millions of dollars.”    

“By deliberately andintentionally manipulating accounting to hit earnings targets, seniormanagement maximized the bonuses and other executive compensation theyreceived, at the expense of shareholders. Earnings management made asignificant contribution to the compensation of Fannie Mae Chairman and CEOFranklin Raines, which totaled over $90 million from 1998 through 2003. Of thattotal, over $52 million was directly tied to achieving earnings per sharetargets.”

When it comes to the steps that Lockhart consideredcritical, however, executive compensation was not specifically mentioned.

The report ends with recommendations fromOFHEO’s staff to [Lockhart], which he has accepted. Some of the keyrecommendations include:

Fannie Mae must meet all of its commitments forremediation and do so with an emphasis on implementation – with dates certain –of plans already presented to OFHEO.

Fannie Mae must review OFHEO’s report todetermine additional steps to take to improve its controls, accounting systems,risk management practices and systems, external relations program, dataquality, and corporate culture. Emphasis must be placed on implementation ofthose plans.

Fannie Mae must strengthen its Board ofDirectors procedures to enhance Board oversight of Fannie Mae’s management.

Fannie Mae must undertake a review ofindividuals currently with the Enterprise that are mentioned in OFHEO’s report.

Due to Fannie Mae’s current operational andinternal control deficiencies and other risks, the Enterprise’s growth shouldbe limited.

OFHEO should continue to support legislation toprovide the powers essential to meeting its mission of assuring safe and soundoperations at the Enterprises.

Similarly, on June 6, 2006, Lockhart testified before theHouse on Fannie’s fraud.  He explainedhow Fannie’s executive compensation system created the perverse incentives thatdrove the massive accounting fraud.  Heended by listing how OFHEO responded to the frauds by ordering changes atFannie.  None of these changes discussedexecutive compensation.  The failure ofthis excerpt to discuss executive compensation is particularly striking.

“Fannie Mae must takeadditional steps to improve its internal controls, accounting systems,operational and other risk management practices and systems, data quality, andjournal entries. Emphasis must be placed on implementation with dates certain.”

Executive compensation, the most critical problem at Fannieand Freddie, the problem that drove their accounting control frauds, receivedminimal attention from OFHEO’s head. Fannie and Freddie’s CEOs proceeded to become wealthy through bonuses“earned” through business strategies that were sure to destroy Fannie andFreddie.  OFHEO took no effective actionto remove these perverse incentives.

Armando Falcon, Lockhart’s predecessor as head of OFHEO,achieved the remarkable – his revulsion for Fannie’s controlling officersexceeded Lockhart’s.  “While all of thispolitical power satisfied the egos of Fannie and Freddie executives, itultimately served one primary purpose: the speedy accumulation of personalwealth by any means.”  Testimony ofArmando Falcon, submitted to the Financial Crisis Inquiry Commission (April 9,2010).  His testimony details howFannie’s controlling officers used accounting fraud to attain massive bonuses.

TheTerrible Cost of Failing to Understand Accounting Control Fraud

The sad irony is that immediately after Falcon explained theperverse incentives arising from Fannie’s compensation system he went on to beonly half right in his analysis of Fannie and Freddie’s eventual failure.  The half he got wrong stemmed from hisfailure to understand the interplay of accounting control fraud and perverseexecutive compensation. 

“Your letter also asked me about the impact of the affordablehousing goals on the enterprises’ financial problems. In my opinion, the goalswere not the cause of the enterprises demise. The firms would not engage in anyactivity, goal fulfilling or otherwise, unless there was a profit to be made.Fannie and Freddie invested in subprime and Alt A mortgages in order toincrease profits and regain market share. Any impact on meeting affordablehousing goals was a byproduct of the activity.”

In addition, OFHEOmade it very clear to both enterprises that safety and soundness was always ahigher priority than the affordable housing goals. They should not take onexcessive risk in order to meet any one of the goals.”

Falcon almost gets this right, but his failureto understand the most destructive financial fraud mechanism leads him to misswhat happened at Fannie and Freddie even with the benefit of hindsight.  His analytical failures exemplify OFHEO’scentral analytical failure.  He iscorrect that only the exceptionally naïve could believe that Fannie andFreddie’s controlling officers based their business decisions on meeting theaffordable housing goals.  He isgrotesquely incorrect in assuming that their controlling officers only engagedin an activity if “there was a profit to be made.”  His error is bizarre given the fact that hehad explained that Fannie’s controlling officers engaged in activity thatcaused large losses and then used accounting fraud to transmute real lossesinto fictional gains in order to maximize their bonuses. 

Falcon is correct that Fannie’s controllingofficers had “one primary purpose” at all times – “thespeedy accumulation of personal wealth by any means.”  What he fails to understand is thataccounting control fraud is a “sure thing” and that the formula for maximizingfictional income (and real bonuses) maximizes real losses.  Fannie and Freddie’s controlling officers“one primary purpose” was making themselves wealthy.  Accounting fraud was their “weapon of choice”to produce great wealth very quickly. Purchasing large amounts of “liar’s” loans guaranteed that Fannie andFreddie would suffer massive losses. Purchasing large amounts of subprime liar’s loans guaranteed that theywould suffer catastrophic losses.  Liar’s(home) loans create such intense “adverse selection” that they have a sharplynegative “expected value.”  In plainEnglish, the purchaser will lose money. It’s equivalent to betting against the House, except that the odds areso bad that the expected value is more negative than playing the lottery.  Liar’s loans can only fail to produce obvioussevere losses temporarily while the bubble is expanding.  Refinancing hides the losses during the rapidexpansion phase of the bubble.  Thesaying in the trade is that “a rolling loan gathers no loss.”  Bubbles, however, are only temporary andliar’s loans will begin blowing as soon as the bubble starts inflating, whichcan be over a year prior to the bubble bursting. 

Fannie and Freddie’s CEOs chased higher nominal yields, notreal “profit” for the firms.  Theirstrategy exemplified the logic of George Akerlof and Paul Romer’s famous 1993article, captured in their title (“Looting: the Economic Underworld ofBankruptcy for Profit”).  The firm fails,but the controlling officers walk away rich because the frauds they leadproduce fictional income and real bonuses. (Akerlof and Romer’s use of the word “profit” is ironic.  It refers to gains to the controllingofficers from fraudulent business strategies that cause fatal losses to thefirm.)  Akerlof and Romer aptly termedthe accounting control fraud strategy a “sure thing.”

Fannie and Freddie’s risk officers alerted their CEOs to thefact that nonprime loans were likely to produce far greater losses, that therapid rise in home prices was temporarily suppressing default rates, and thatthe rapid rise in home prices could not continue indefinitely.  It is inconceivable that Fannie and Freddiedid not know of the FBI’s September 2004 warning that there was an “epidemic”of mortgage fraud and their prediction that the fraud epidemic would cause aneconomic “crisis” if it were not contained. Fannie and Freddie’s purchase of liar’s loans that cause severe lossesoverwhelmingly occurred after the FBI’s warning.  “The government” never required any entity tomake or purchase liar’s loans.  Most ofthe liar’s loans that caused Fannie and Freddie’s severe losses were purchasedafter MARI’s five-part warning to the mortgage industry in April 2006.  “The Mortgage Asset Research Institute’s(MARI) EIGHTH PERIODIC MORTGAGE FRAUD CASE REPORT TOthe MORTGAGE BANKERS ASSOCIATION.”  (Itis inconceivable that Fannie and Freddie’s controlling officers, or OFHEO, wereunaware of these warnings.  Louis Freeh,former head of the FBI, joined Fannie’s board of directors in mid-2007.) 

MARI paired it first two warnings:

“Stated income and reduceddocumentation loans speed up the approval process, but they are open invitationsto fraudsters. It appears that many members of the industry have littlehistorical appreciation for the havoc created by low-doc/no-doc products thatwere the rage in the early 1990s. Those loans produced hundreds of millions ofdollars in losses for their users.”

MARI’s third warning quantified the incidence of fraud insuch loans.  It paired these data withits fourth warning dealing with the revealing label the industry usedinternally for such loans.

“One of MARI’s customersrecently reviewed a sample of 100 stated income loans upon which they had IRSForms 4506. When the stated incomes were compared to the IRS figures, theresulting differences were dramatic. Ninety percent of the stated incomes wereexaggerated by 5% or more. More disturbingly, almost 60% of the stated amountswere exaggerated by more than 50%. These results suggest that the stated incomeloan deserves the nickname used by many in the industry, the “liar’s loan.””

MARI’s fifth warning reported the views of federal bankingregulators.

Federal regulators of insuredfinancial institutions have expressed safety and soundness concerns over theseloans with lower documentation requirements and other “nontraditional” loans.

To summarize, MARI warned every member of the MortgageBankers Association (MBA) in writing in early 2006 that so-called “statedincome” loans:

  1. Were “open invitations to fraudsters”
  2. Had produced hundreds of millions of dollars of losses when they became common in the early 1990s
  3. Had a fraud incidence of 90%
  4. Deserved the industry term for such loans:  “liar’s loans”
  5. Were opposed by federal banking regulators because of safety and soundness concerns
It was in this context that (1) lenders moved massively toincrease their origination of fraudulent liar’s loans and to sell such loansthrough fraudulent “reps and warranties” (2) Fannie and Freddie (and theirinvestment banker counterparts) moved massively to purchase these endemicallyfraudulent loans, and (3) OFHEO did nothing meaningful to prevent Fannie andFreddie from purchasing fatal amounts of fraudulent liar’s loans. 

Fannieand Freddie (and the FHFA) still get it wrong

Indeed, even after the second wave of accounting controlfraud caused the failure of Fannie and Freddie, OFHEO failed to end theirperverse executive compensation practices. Steve Linick, the FHFA’s Inspector General (FHFA is the successor agencyto OFHEO) reported:

“Linick said the FHFA rejected his recommendationthat it test and independently verify the annual pay packages, which are set bythe boards of Fannie and Freddie and approved by the agency in consultationwith the Treasury Department.

The FHFA “lacks key controls necessary to monitorthe enterprises’ ongoing executive compensation decisions under the approvedpackages,” the inspector general wrote. “FHFA has neither developed writtenprocedures to evaluate the enterprises’ recommended compensation levels eachyear, nor required FHFA staff to verify and test independently the means bywhich the Enterprises calculate their recommended compensation levels.”

Further, the agency “lacks independent testingand verification of the Enterprises’ submissions in support of executivecompensation packages,” the report said.”

The federal “pay czar” heavily criticized all but one of theexecutive compensation plans submitted by the bailed-out firms still subject tospecial regulation.  Executivecompensation is so typically perverse that it is one of leading causes ofcriminogenic environments for accounting control fraud.  The intellectual father of modern executivecompensation, Michael Jensen, has decried the results, which he concedesincludes rampant earnings manipulation. Fannie and Freddie are simply the most expensive failures to date causedby accounting control fraud.   


Where We Can Go from Here

I have asked the reader to follow me through a lengthyseries of reflections and thought experiments on the nature and role of moneyin modern economies.   Some might ask whythis issue is so important.  How canthese ruminations on the nature of modern monetary systems help guide ourthinking on the task of building a more fair and decent society of democratic equals?   How can they help us create a society inwhich democratic solidarity trumps self-regarding and avaricious greed, and inwhich broad and shared prosperity replaces the concentrated economic privilegeand supremacy of the few?

It is important to keep the political problem of money inproper perspective.  No one needs to bereminded that money plays an incredibly significant role in modernsocieties.  But it is also important notto overrate the role of money.  The mostimportant reason to reflect on the nature of money is that by doing so webetter understand all those things that are notmoney, all of the sources of real and non-instrumental value in the world thatare the ultimate ends we seek and the ultimate sources of our happiness.  And as we improve our understanding of thepurposes served by money and monetary systems, our improved understanding canhelp liberate us from our dependency on monetary systems controlled by thepowerful.

Clearly money is just an instrument:  a tool that helps us to organize our economiclives.  It is used for assigningquantitative values to the real goods and services we produce.  It assists in the production, distributionand exchange of those goods and services, and in the prudent storage of valueand purchasing power over time.   Amonetary system cannot be separated from the larger economic and social orderof which it is a part.   A moredemocratic monetary system will therefore be part of a more democratic economicsystem and a more democratic society.

The cause of genuine democracy will, of course, requiresteps that go well beyond reform of the monetary system.  If we seek a more democratic society, one inwhich decision-making power over our everyday lives and common futures is moreevenly distributed among all of our people, it will be necessary for all of usto embrace the demanding responsibilities of democratic governance.   This can be hard to do in the face of somany decades of governmental failure, where government itself has sometimes seemedto have become nothing but a tool of the plutocracy.  Some of the tendency in recent history amongdissidents and reformers has been to pull away from one another other ratherthan pull together.   Some of us hopeonly to liberate ourselves from government and from one another in order to beleft alone to pursue our individual happiness on our own terms.

This thoroughly individualistic approach cannotsucceed.   The cravings for ever morepersonal freedom, and for ever more liberation from the responsibilities ofdemocratic government, will only lead to the eventual dissolution of democraticgovernment and the triumph of authoritarianism. Either we work together as equals to govern our lives and govern oursocieties, or ambitious and ruthless people commanding great stores of wealthwill take advantage of the vacuum to seize control and govern our societies forus.   The urge for freedom is natural andpraiseworthy, but the dream of a real and durable freedom that can existoutside the cooperative efforts of a democratic people practicing vigilant andindustrious democratic governance is not the dream of a free people, but thetwilight illusion of a defeated and alienated people who have given up on thekinds of freedom and well-being that can only be achieved through socialsolidarity and teamwork.   In the end, we are dependent and socialcreatures, built by nature for social and community life, and for relationshipsbased on love, fellowship and friendship.

We have been living in recent decades through an anti-socialera of greed, separation and inequality.  Those of us who have lived this way for a long time might have becomeaccustomed to the norms and practices of this era, and might even haveconvinced ourselves that these norms and practices are appropriate and healthy.   But the rising generation of young people,whose natural and healthy sociality and friendliness has not yet been toodamaged and disfigured by the ruthless demands of the system of greed know thatsomething  is wrong.  They know that our present way of economiclife is disordered and out of balance.

The anti-social era has been marked by a fatalisticpassivity in the face of unregulated commerce and market behavior.    But the forlorn era of low socialexpectations is dying; we can feel it.  People are tired of being on their own.  The defeatist dogma about social change characterizing this dying era isthat we can’t choose our society’s future, because people are too weak andstupid and selfish and limited for collective effort to succeed on a largescale.  The future can only emerge in an entirely unpredictablefashion from the crisscrossing patterns of individuals pursuing their own personalgoals without any significant degree of social cooperation orcoordination.   The result of this trendin thinking has been a withering of the social imagination and the enfeeblementof the democratic practices of our people.  

In the neoliberal world of the past few decades, politicshas become small, unambitious and managerial.  This dispirited managerial government presides over a society in whichpathologies of social living are promoted as virtues: radical individualism,greed, ambitions of supremacy, cravings for isolation, hatred of community, anda debasement of healthy human relationships into commercial and exploitativetransactions come to be seen as normal.  But the gloomy religions of self-seeking isolation are not justdebilitating; they are dispiriting.  AsDavid Graeber has written, “the last thirty years have seen the construction ofa vast bureaucratic apparatus for the creation and maintenance of hopelessness,a giant machine designed, first and foremost, to destroy any sense of possiblealternative futures.”

The fading era of market fundamentalism andhyper-individualism was trumpeted as the “end of history.”   But history is starting up again.   In theshadow of the current recession, we are beginning to recapture the optimistic sensethat the future is something we can envision and choose.  We can work to build a social consensus aboutthe future we want, make large and ambitious choices about the shape of thatfuture and then work with one another in the task of creating the future we haveenvisioned.   We need not sit back, wait,and just see what turns up.  Thepossibility of a mass democratic movement for profound social change beginswith the recognition that the machine of despair is a lie, and that success isactually possible.

It is starting.   Peopleall over the world, frustrated by the dismal and meaningless pursuit ofindividual achievement and material gain alone without larger social purpose, andfatigued by the insecurity, stresses and manic busyness that afflict the neoliberalindividual, are reaching out to re-forge the social contract, establish a newsense of justice based on teamwork and equality, and articulate visions of thehuman future that are a match for the inherent human dignity we sense inourselves and recognize in our fellows.  The world that we have passively allowed to be built around us bycommercial frenzy devoid of higher purpose is an assault on that dignity.

It is notable and inspiring that as the Occupy Wall Streetmovement took shape around the United States and other parts of the world, theparticipants in the occupations organized themselves as communities of equals,in which every voice is equally prized and harmonious consensus is avidlysought.  The hunger for democraticcommunity and self-determination is palpable. This is not the laissez faire form of self-determination, in which eachindividual strives only to determine the course of one individual life, but amore encompassing phenomenon, in which people strive to build and sustain communitiesand then work together as equals in order to make well-founded, democratic decisionsto determine the direction of the community.  It’s hard work.    But the work is inspiring and ennobling, andpeople are naturally drawn to it.

In both the United States and Europe, policy-making elites –whose allegiances are to the plutocrats who are responsible for funding andsustaining the political operations of these elites – are aggressively workingto take advantage of the stress and confusion caused by the present globaleconomic crisis to dismantle progressive social systems.  They are targeting systems of publicownership and organized social cooperation, and are working to undermine thecapacity for democratic governance.   Forthe very wealthy, democratic governments represent nothing butcompetitors.   These governments have sometimesacted in the past to diminish some of the formidable power the wealthy wouldotherwise possess over entire societies, and they sometimes even strip them ofsome of the wealth that they have earned from the sweat of others.  Plutocrats would like nothing better than toput real democracy out of business, and to leave behind nothing but a toyfacsimile of democracy – something like a high school student government thatis allowed to engage in a little democratic role-playing inside an adult socialinstitution that the students really don’t control.

So the plutocrats have put out a stark and coordinatedmessage through the media channels they control, and through the opinion-leadersthey own and influence.  It is a messagedesigned to invoke fear and panic, and to achieve democratic surrender:   The message is that we are out of money,that our governments are bankrupt, that they must opt for austerity anddownsizing and contraction, and that we must hand over even moredecision-making to bankers, bond markets and technocrats – the functionaries ofthe plutocracy.

This message is preposterous.   Societies build their futures and commonwealth out of the real resources they possess, not out of money.  Money is only a tool, and it is the simplestand most inexpensive tool we can make.  Modern democracies are very rich in human, material and technologicalresources.   We are not “out of” anythingimportant of real and fundamental value. The plutocrats might be out of ideas; and they are running out oftime.   But the democratic peoples overwhom the plutocrats are trying to reassert control are only out of patiencewith the plutocracy.
And this brings us back to the issue of monetarydemocracy.  The time has come to considersome specifics:  What role can money playin building a more democratic society? How should we organize our monetary system so that the public’s money isruled by the public and made to serve public purposes, and is not instead pervertedinto an instrument that primarily serves plutocrats in their drive to rule overthe public?   In the final installment inthis series I will propose six tasks for democratic economic reform, each ofwhich has some dependence on the democratic reform of our monetary system.

Thisis Part Five of a six-part series. Previous installments are available here: OneTwoThree, Four