Potter's Revenge

Henry F. Potter is a rich banker. He demands collateral for the loans he extends. He is coldly rational in his lending standards, lacking even the hint of a “heart.” He expects to be repaid in a timely fashion. His concern is only to make money. He “puts profits over people.” Henry F. Potter is an evil man.

George Bailey is a big-hearted, smiling banker who “puts people before profits.” His main concern is to help you buy a house. He seeks only to help the “rabble” that Mr. Potter won’t lend a dime to. If you fall short in your mortgage payments, he tells you to “pay me when you can.” He is motivated primarily by the belief that every family deserves to be able to buy a home. He never thinks of himself. He is struggling financially. George Bailey is a good man.

Potter and Bailey, of course, are the protagonists in the classic 1946 James Stewart movie, It's a Wonderful Life. I thought of that movie, which I have enjoyed watching many times, as I observe the unfolding financial crises in America today. In essence, we are witnessing the culmination of the battle between Henry F. Potter and George Bailey.

Since before the middle of the last century, it has been official U.S. government policy to promote and encourage home ownership. This policy has led to massive government intervention into the mortgage and housing markets. The goal has been, and is, driven by the preposterous idea that it is every American’s “right” to own his own home. The result has been a myriad and growing array of subsidies, mandates, loan guarantees, tax preferences, etc., designed to make houses more “affordable.” John R. Lott, Jr. writes;

The federal government gives all sorts of subsidies to encourage home ownership. The mortgage deductibility in the income tax is a big subsidy, but that is not the only one. The Federal Housing Administration guarantees mortgages against default. Subsidies given to Fannie Mae and Freddie Mac allow them to charge less in repackaging private mortgages that are then sold to financial institutions.

There are also subsidies to certain types of mortgages. The Community Reinvestment Act bans so-called "red lining" -- requiring banks to offer mortgages in the entire geographic area in which they operate, not just to do business in suburbs. Loans in profitable areas were then used to subsidize loans in areas where banks were losing money.

In the 1990s, using its regulatory powers over the banking industry as a club, the government began imposing weak lending standards on banks via the Community Reinvestment Act. Intended to “encourage” home ownership among low income folks who couldn’t meet the traditional 20% down, 28%-of-income housing cost limit, these Clinton-era rule changes quickly became a tool of community activist groups. Howard Husock writes at Citi Journal in 2000;

The Clinton administration has turned the Community Reinvestment Act, a once-obscure and lightly enforced banking regulation law, into one of the most powerful mandates shaping American cities—and, as Senate Banking Committee chairman Phil Gramm memorably put it, a vast extortion scheme against the nation's banks. Under its provisions, U.S. banks have committed nearly $1 trillion for inner-city and low-income mortgages and real estate development projects, most of it funneled through a nationwide network of left-wing community groups, intent, in some cases, on teaching their low-income clients that the financial system is their enemy and, implicitly, that government, rather than their own striving, is the key to their well-being.;

As a result, many high-risk borrowers received mortgages that they would not have received otherwise, including the now infamous no-down-payment, no documentation loans. This was destined, according to Husock, to destabilize neighborhoods and penalize responsible borrowers;

A no-down-payment policy reflects a belief that poor families should qualify for home ownership because they are poor, in contrast to the reality that some poor families are prepared to make the sacrifices necessary to own property, and some are not. Keeping their distance from those unable to save money is a crucial means by which upwardly mobile, self-sacrificing people establish and maintain the value of the homes they buy. If we empower those with bad habits, or those who have made bad decisions, to follow those with good habits to better neighborhoods—thanks to CRA's new emphasis on lending to low-income borrowers no matter where they buy their homes—those neighborhoods will not remain better for long.

The predicted consequences of this George Bailey-like policy are now coming true in many communities across America…the result of banks making loans that they would not have made in a free market, had they acted on their own judgements according to their own rational self-interest and long-term profitability.

The 800 pound gorillas, though, are the twin government-created and backed Fannie Mae and Freddie Mac. Their roles expanded by both the Clinton and Bush Administrations, their mortgage purchasing activities created a virtual conveyer belt for unsound mortgages. Outfits like Countrywide were able to latch onto the CRA-inspired “relaxed underwriting standards” and apply them to loans beyond the low-income market because they could simply sell many of the mortgages to Fannie and Freddie. Fannie and Freddie, in turn, packaged the mortgages…good and bad…for sale throughout the financial industry. The implicit government backing lent these securities an air of quality they did not deserve. Some firms, like Bear Stearns and Lehman Brothers, emulated the mortgage-backed securities strategy pioneered by the quasi-government behemoths. The disease began spreading through the system.

It must be remembered that the US financial system is a creature of the government, as I discussed in my post of 7/28/08. So it should be no surprise that many in the financial industry took the lead of government as a reason to throw caution to the wind, in pursuit of the short-term quick buck. A hint of what was going on under the surface comes from this piece by Michael Lewis of Bloomberg News. Thrown in almost as an aside, Lewis, speaking of “Stan O'Neal…the chief executive officer of Merrill Lynch, Dick Fuld…the CEO of Lehman Brothers, James Cayne…the CEO of Bear Stearns. [Who] each took home tens of millions of dollars in pay for making the decisions that destroyed his firm,” states;

But interestingly, if any of these men had behaved well and resisted the pressures and temptations of the moment, his firm would have, for several years, dramatically underperformed the competition. He probably would have lost his job.

Those firms had been around for decades and were clearly built by people who properly saw their own self-interest as consistent with a long-term perspective. For decades, borrowers had to meet strict criteria before being approved for a mortgage. What changed so dramatically that the normal workings of the marketplace became inverted to favor short-term financial strategies over long-term prudence? The only answer…the common denominator…is government intervention. That government intervention grew out of the conviction by politicians and much of the public that the selfish pursuit of profitable lending did not “serve” those who could not afford a home and, thus, lenders should be made to act in defiance of their long-term best interests.

To be sure, there are banks that did resist “the pressures and temptations of the moment” and adhered to sound lending standards despite being at a competitive disadvantage for a time. But the quick-buck artists who rose up through some of America’s great financial powerhouses to overwhelm those prudent folks who would resist those temptations are as much victims as they are villains. They were turned loose and given the blessing of their own government.

Hadn’t these men performed a public service by abandoning the cold and heartless policies of Henry F. Potter and allowed untold thousands of people to achieve “the American dream”? Is this not what their own government, which regulates them, called for? Is this not exactly what the Left-wing shakedown artists…AKA “community organizers”…demanded? Weren’t they following to the letter President Clinton’s 1994 clarion call that “more Americans should own their own homes”? Weren’t they, in fact, complying fully with the implicit premise as expounded in It’s a Wonderful Life…that the purpose of the banks are not their own profitable self-interest but to “serve” the public?

I realize that my tying the popular James Stewart movie to this mess is akin to attacking motherhood and apple pie. After all, isn’t Potter a mean and callous old man who treated people like dirt and who stole the money that Uncle Billy sought to deposit into his bank, while building a fortune for himself? And isn’t George Bailey the “selfless” hero who gave up his dreams of college and “building sky scrapers” to run the Building & Loan, so he can build for people “the prettiest little houses” while scraping by on 45 bucks a week? But all of that is window dressing. The message of the movie is to attack the prudent, profit-seeking banker. It is a symbol of the unjust tarring of what is, in essence, a highly virtuous lending doctrine…that neither need nor desire constitute valid criterion for extending credit. We see now the results of policies that are designed to invert that principle.

The graveyard in the sleaze-ridden town of “Pottersville” is portrayed as the symbol of the selfish, profit-driven banker, as if the financing of homes and thriving businesses for credit-worthy borrowers is not in the self-interest of that banker. But it must be said. The blame for the graveyard of failing financial firms and foreclosed homes spreading across America cannot be laid at the feet of the Potters of the world, but squarely at the hands of the George Baileys. The altruistic congressional champions of “affordable” housing who now rail against some undefined “greed” and “excesses” of Wall Street…those same politicians whose field of vision never extends beyond the next election…should not be shocked that so many in the financial industry have taken them at their word, and acted accordingly. It is the politicians, primarily liberal democrats, who unleashed George Bailey on a national scale.

It’s a Wonderful Life appeared in 1946. In 1960, point five of Democrat JFK’s “economic bill of rights” declared “The right of every family to a decent home.” The two are connected. The private banker who denies a mortgage to a prospective homebuyer who doesn’t meet his lending standards is, in effect, violating that person’s “right…to a decent home.” He is “greedily” pursuing his own profits at the expense of the “people.” The movie depicts the battle of this alleged choice between profits and people. But this is a false choice. The profit motive of the “hard-nosed” banker who acts on his own judgement and in his own self-interest by focusing on the long term is the best protection we have against the kind of calamity we have now. The sound lending principles that lead to profitable, solid financial institutions are in the self-interest of both banks and the “people.”

It is the government’s policies of the hitching of George Bailey banking to the fascist doctrine of the “right” to a home that is at the root of the sub-prime crisis. The only proper emergency solution is to end the reign of both.