My new VDARE column: Quantifying the minority mortgage money question

The conventional wisdom that emerged from the crisis of the Great Depression dominated American ideology until almost 1980. Similarly, the reigning ideas that congeal in the next few weeks about the causes of this crash may determine the course of politics for decades to come.

The truth is, we were never as rich as we thought we were. The last decade’s growth was largely driven by huge flows of lending dollars to dubious borrowers. At the bottom of an unknown but frightening number of convoluted new-fangled debt instruments were homebuyers who had no chance in hell of paying the mortgages back when the music stopped and the price of houses in California (and a few similar states) stopped heading toward infinity.

Federal Home Mortgage Disclosure Act data dug up by Jack Hamilton suggests that the recent American Housing Bubble was, more than anything else, a Hispanic Housing bubble, as total mortgage dollars handed out to to Hispanics more than septupled from 1999 to 2006! (Is "septupled" even a word?)

Moreover, in 2006, according to Hamilton, 51% of subprime and other "higher priced" mortgages (for purchasing homes and for refinancing older mortgages) went to minorities. The higher priced mortgages are, of course, where most of the unexpected defaults have shown up.

UPDATE: Hamilton has added up all the subprime mortgage dollars for the entire disastrous 2004-2007 period. Among borrowers whose ethnicity is unambiguous, he comes up with $900 billion subprime dollars going to non-Hispanic whites, $887 billion to minorities. So, that's 50% of subprime dollars during the worst years of the Bubble went to minorities.

Someday, we'll get a count of defaulted dollars by race.

At their bubblicious peak, American homes were theoretically worth $24 trillion. The amount of wealth that has evaporated in the popping of the American real estate bubble so far appears to be in the $5 trillion range, to pick a very round number. Dr. Housing Bubble recently estimated the loss to be $4.68 trillion using Case-Shiller data. Another source estimates $6 trillion.

And we haven't necessarily hit bottom yet.

My very rough estimate is that half of the American loss in home values so far has occurred in California, with Florida being next in line.

How big is 5 trillion simoleons? How does it compare to the total wealth in the world?

At the peak, the total "assets under management" (i.e., financial instruments, but not including real estate, private businesses, and marketable luxury goods such as Van Goghs) globally reached $110 trillion, according to the Boston Consulting Group. In North America, "assets under management" were $39 trillion; let's figure $36 trillion in the U.S alone.

If we add $36 trillion in financial paper and $24 trillion in homes we get $60 trillion in wealth in America between them.

Compared to $60 trillion, a fall of $5 or $6 trillion doesn't sound so bad. But the problem is that literally countless trillions of these "assets under management" consisted of a mountain of leverage concocted by high IQ idiots on Wall Street balanced on a pebble of probability that recent mortgages handed out to Californians (and the like) would ever get paid back. 

The Clinton and Bush administrations were egging the lenders on to increase minority and low-income home ownership.

There were lots of other bubbles going on in the world, such as in Spain, England, and Iceland, but the California-centric American housing bubble was [Mixed Metaphor Alert!] the big enchilada that brought down the whole house of cards. [Actually, now that I think about it, the phrase isn't supposed to be Big Enchilada, it's supposed to be either Big Kahuna or Whole Enchilada. So, never mind ...]

The only way many recent borrowers could hope to get out from under their giant mortgages was if they found even Greater Fools to sell their houses to. In other words, California home prices had to grow to infinity for this movie to have a happy ending. CNN reported in 2006:

“More than 90 percent of homes in [Indianapolis] were affordable to families earning the median income for the area of about $65,100. In Los Angeles, the least affordable big metro area, only 1.9 percent of the homes sold were within the reach of families earning a median income for the city of $56,200.”

By 2007, a 500 square foot one-bedroom house in Compton, CA, the spiritual home of gangsta rap but now majority Latino, went for $340,000.

Thus, a year or two ago, when the interest rate on adjustable subprime mortgages started to reset after the typical two year "teaser" period of low interest rates began ending, housing prices slowed, then started to fall as everybody rushed for the exits.

Granted, trillions were also lost in the popping of the Internet stock bubble in 2000, but the collateral damage was milder because shares in Pets.com were considered "investments." Ever since the New Deal there have been certain limits on how much you could leverage stock investments "on margin" since the presumption is that "investments" go up and down in value.

In contrast, a half million dollar loan for a house in a slummy California neighborhood handed out to a drywaller from Chiapas who obviously must have added an extra zero to his undocumented annual income on his mortgage application is considered an "obligation" and the presumption is that it will be paid back. Defaults on "obligations" are assumed to be the exception rather the rule. After all, as they would say in the City of London when figuring out where to park some Kuwaiti oil money, mortgages for Californians were "safe as houses."

Obviously, in reality, investing in Pets.com and lending a half mil to the drywaller were both equally stupid financial transactions, but, traditionally, they've been considered different breeds of activity.

Therefore, the Wall Street geniuses felt justified in constructing vast Rube Goldberg schemes of leverage on the back of this kind of "obligation." They had data showing that borrowers in 2004 and 2005 weren't defaulting on ridiculous mortgages, but that's because there were still Greater Fools around to hand the hot potato houses to. Ignoring that, the financial wizards attempted to obtain Reward Without Risk.

Well, you can't do that. You just can't.

Of course, they were simply delaying the return of Risk until it all came rushing back in at once this autumn, just like the "portfolio insurance" schemes of the mid-1980s led to the October 1987 one-day crash.

Underneath too many of these market insurance schemes that would take a 300 IQ to understand was the assumption that out in the slums of California, laborers with fifth grade educations would pay back $4000 per month for most of the rest of their lives. Maybe they would quit their day jobs, learn to read English, go to medical school, and become doctors. 

(We wouldn't want to be guilty of the "soft bigotry of low expectations," now would we?) Either that, or they would find a Greater Fool who would pay even more for the privilege of living in the barrio.

Over the last year, the world's financial institutions started to wake up to the reality that underlying some uncountable but possibly terrifying fraction of all the baroque financial instruments they had been selling each other were pieces of paper "obligating" drywallers to pay each month more than their monthly income for their cruddy California houses.

Today, nobody in the financial world has much of a clue who is solvent and who will crumble tomorrow, so nobody wants to lend to anybody.

To find out how much in total mortgages (prime and subprime aggregated) were handed out by race to home purchasers in 2006, see my new VDARE.com column.

My published articles are archived at iSteve.com -- Steve Sailer

My Friday night VDARE.com article

I've dug up some crucial numbers on mortgage dollars by race that will answer a lot of the skeptics of my Diversity Recession theory who can't imagine that minorities could borrow enough money to matter.

My published articles are archived at iSteve.com -- Steve Sailer

For visitors from Michael Barone's blog

If you are coming here from Michael Barone's blog, my two main articles on "the diversity recession" are my recent one on the relationship between Karl Rove's primary political initiative and the lack of oversight of mortgage lending and my June article laying out the basic theory and going after both Democrats and Republicans.

My published articles are archived at iSteve.com -- Steve Sailer

Somebody else finally gets it

David Samuels New Republic article on Barack Obama's Dreams from My Father says, very well, what I've been saying for two years now:

... it seems right to mention that the Barack Obama who appears in Dreams, and, one presumes, in his own continuing interior life, is not a comforting multiracial or post-racial figure like Tiger Woods or Derek Jeter who prefers to be looked at through a kaleidoscope. Though there are many structural parallels between Dreams and Invisible Man, Obama believes in the old-fashioned, unabashedly romantic, and, in the end, quite weird idea of racial authenticity that Ellison rejected. He embraces his racial identity despite his mixed parentage through a kind of Kierkegaardian leap into blackness, through which he hopes to become a whole, untroubled person.

It's an excellent article. (Besides making the same overall argument, lots of supporting details in Samuels' article appeared earlier in this blog.)

My published articles are archived at iSteve.com -- Steve Sailer

Minority mortgage challenge

As I've been pointing out for a long time, much of the "diversity recession" theory does not rest on minorities per se defaulting on home loans, but on contortions to the market rationalized in the name of diversity, such as Bush's attack on down payments (for everybody) in the sacred name of raising minority homeownership by 5.5 million; or by the see no evil-hear no evil-speak no evil politically correct mindset about lending to heavily Hispanic states and black parts of town by fear of discrimination lawsuit discovery of intra-firm emails asking "Aren't we out of our minds to lend $340,000 on a 500 square foot house in Compton? Do you know who lives in Compton?"

Still, ideas have consequences, and these ideas, which both parties supported, no doubt led to higher defaults among minorities.

The federal government has created a vast apparatus of of race reporting on lending to make sure that minorities get their "fair" share of loans, but there doesn't seem to be as equally accessible data on defaults by race. Why not? Well, because the point is to badger lenders into giving more loans to minorities, not to call attention to problems that can cause.

One of my most insightful commenters started out assuming that minorities couldn't have comprised more than a tiny handful of percent of the defaulted dollars. Now, he's up to 10% to 15%, but doesn't think it could possibly be 30%. I'm willing to bet him that when it all gets counted up, it will be closer to 30% than to 15%.

A few methodology issues. The first is that, normally, recessions cause defaults. Eventually, the new recession will cause a lot of defaults, but what we are interested in is not the defaults caused by the recession of, say, 2008-2011, but the defaults that caused that recession. So, therefore, let's look at, say, calendar year 2007.

Second, lenders always have a baseline expectaton of default dollars per year due to random tragedies. What we are interested in is not the total dollar amount of defaults in 2007, but the amount incremental to the expectation. For example, if lenders expected due to random sad events that 1% of prime mortgages would default in 2007 and 3% of subprime mortgages, but the real numbers were 2% of prime and 20% of subprime, then the numbers of interest to us are not 2% of prime, but the unexpected increments: 1% of prime and 17% of subprime. (I just made these numbers up for illustrative purposes.)

Third, there are a variety of technical issues involving when something is foreclosure vs. default vs. severely stressed. And there's the complicating hybrid of short sales.

Fourth, a lot of sales in, say, 2005-2006 were fraudulent using straw buyers, so sorting out blame has its metaphysical aspects.

Fifth, I suspect, on no particular evidence, just a hunch, that more than few of the most enthusiastic speculators in the California housing markets were white immigrants from the Middle East and the ex-Soviet bloc.

I will leave all the details to disinterested researchers to handle in a fair manner.

My published articles are archived at iSteve.com -- Steve Sailer

Nobel Prize in Economics

My first suggestion is that rather than hand out a new Nobel Prize in Economics this year, they instead take away one they gave to some economist in the past who now looks like a prime nitwit.

If that's too radical, how about giving the Nobel to an economist who was actually, like, right? How about Robert Shiller who has been banging the gong about the coming housing crash for years?

My published articles are archived at iSteve.com -- Steve Sailer

"In Search of Bill Clinton: A Psychological Biography"

My wife is reading this new psychobiography about Bill Clinton by John Gartner, which she quite likes. Gartner specializes in "hypomania," that fortunate cousin of manic-depression. Hypomanics can maintain a controlled level of high-energy living for years on end. Teddy Roosevelt is probably the most famous American hypomanic.

One interesting thing about it is its realism about why Bill Clinton played an important role in recent American political history, which Gartner sees as having roughly the same causes as Shaquille O'Neal's large role in recent NBA history. Usually, biographers try to come up with some nonsense about how the leader embodied the Spirit of the Age or whatever, but part of Gartner's approach is more down to earth: Clinton was born with the tools to be a highly successful conventional politician.

Nobody is too sure who Bill Clinton's genetic father was, but Gartner makes a strong case that it was a hard-working local doctor whose legitimate children have grown up to be successful professionals as well. Bill's mom was of course a tramp, but a bright, charming tramp.

Clinton is a largely self-taught politician. He didn't have, say, George H.W. Bush around to imitate. But he taught himself lots of useful tricks. For example, when working the rope line, most politicians don't look into the eyes of the person they are currently shaking hands with because they are already looking for the hand of the next person to shake hands with. Clinton, however, makes solid eye contact with each person he shakes hands; meanwhile, he's using his left hand to feel blindly for the next hand he's going to shake. (Perhaps being left-handed helped him invent that trick.)

In one section, Gartner takes a psychometric approach to Clinton. Unfortunately, he lacks actual psychometric data on Clinton, such as an IQ score, but his rough estimates are of interest:

Hitting the genetic jackpot

Even the most virulent Clinton critics would not deny that Clinton is extraordinarily gifted. Before we even consider the effect of Bill Clinton’s childhood on the formation of his personality and career, we need to examine his genetic endowment., Like Secretariat, to whom he has been compared, Clinton was simply born with more God-given political talent than any of his contemporaries. Statistically, Clinton is a freak of nature.

In his profile of Clinton for GQ, George Saunders speculated: “My guess is that if you rated a million people on the basis of aptitude and verbal skills, and powers of persuasion and retention and simple physical energy, Clinton would come out near the top in all categories” I think Saunders is right in his intuition that Clinton wasn’t just born off the chart. He was born off multiple charts.

There are probably more, but I will discuss five of those traits. Two, mentioned by Saunders, are intelligence and energy (one component of his hypomanic temperament). In addition, Clinton is a statistical outlier on three core inborn dimensions of personality: intellectual curiosity, empathy. and extraversion.

There is an impressive body of research pointing to intellectual curiosity, empathy and extraversion as foundational dimensions of personality. For a hundred years, academic personality psychologists have been trying to identify and name the basic axes on which to map the human personality. In recent years, the Five Factor theory, developed by Paul Costa and Robert McCrea at The National Institutes of Health has won surprisingly unanimous degree of acceptance in the field. In searching to solve this old problem, they turned to an improbable source: the dictionary. Where past personality psychologists had started with abstract theories about human nature and then looked for data to validate it, Costa and McCrea built from the ground up. They reasoned that because we are social creatures, collectively, we have made many nuanced observations about personality traits that have become part of the language: Using a complex statistical technique called factor analysis, Costa and McCrea were able to boil down the 18,000 traits found in the dictionary to five basic mega-factors. I will argue that Clinton is extraordinary on three of them.

Research using the five factor model has shown that these basic building blocks of personality are largely innate, and family environment has surprisingly little impact. "It turns out that you get virtually identical results with identical twins reared apart and identical twins reared together,” said McCrea. And in turn, adopted children, who share the same family environment with their adopted siblings, but no genes, show no correlation in their personalities with their adopted siblings. “They are as similar to one another as any two people picked at random." In essence, then, these measures of personality are measures of temperament, genetically-based, inborn, fundamental predispositions. So if Clinton is exceptional, it is because he was born that way.

On three of the five dimensions of personality uncovered by Costa and McCrea all data converge to put Bill Clinton off the charts. From my questioning of people who known him at every stage if his life, it is clear that he had these tendencies since he was a toddler, and manifested them throughout his life. When we add to these three personality variables his astoundingly superior intelligence and his enormous hypomanic energy, we have our own five factor model to explain Bill Clinton.

That Clinton is an an outlier on so many traits is one clue as to why he is such a rare specimen. the odds of two independent events both taking place are equal to the odds of the first event multiplied by the odds of the second. For example, while the odds of flipping a coin and getting heads are 50 percent, the odds of flipping two coins and getting heads both times are 25 percent (1/2 multiplied by 1/2). Even if we estimate conservatively, and say Clinton i sonly one out of a thousand on each of these five dimensions, the odds of one person being that extreme on five independent traits is one thousandth to the fifth power, or one out of a quadrillion.

My published articles are archived at iSteve.com -- Steve Sailer

Names in the News

For my American Conservative review, I'm doing background research on the new Jonathan Demme movie "Rachel Getting Married," which is about sibling rivalry between two sisters, the sensible one who is getting married (to a gentlemanly black man from Hawaii ... hmmhmm ... sounds familiar ...) and the sexy irresponsible one (played by Anne Hathaway) who shows up to steal the spotlight from the bride. So, I start Googling on participants in the movie like the star Anne Hathaway and screenwriter Jenny Lumet to find out who her real life sister is. And ... holy moly, this is the funniest chain of Google connections I've ever seen, total high comedy synchronicity. It's like what Mickey Kaus calls The Undernews all rolled up in one.

If you've got the time, try Googling on various combinations of:

Anne Hathaway

Raffaello Follieri

Bill Clinton

Ron Burkle

Montenegro

John McCain

Jenny Lumet

Sydney Lumet

Lena Horne

Amy Lumet

National Review

I pointed to my John McCain hat

P.J. O'Rourke

Weekly Standard

500 beautiful women sailors

John McCain

There are actually two separate stories here, with McCain being the only common element in them. He does seem to get around.

My published articles are archived at iSteve.com -- Steve Sailer

Obama and est?

A reader speculates that Obama might have undergone some form of "est" training, or at least was an interested observer of it. That might explain some of the success of the Obama Campaign in 2008 in mobilizing the kind of people who fall for est and its various re-incarnations.

I don't see any evidence for this, but it's not impossible or even all that implausible. These "encounter" sessions, whether run under the original est banner by Werner Erhard or by its offshoots such as The Forum (run by Erhard's brother's Landmark company), were all the rage when Obama was a yuppie in Chicago in the 1980s and early 1990s.

Living in Chicago during roughly the same years as Obama, I had numerous encounters with est's tentacles. My cousin got roped in by a friend into attending an est sales pitch, so he wisely dragged me along to keep him from signing up for a four day session. My girlfriend's roommate was heavy into into it, so the cult leaders used her as their free office temp. The top management of the marketing research firm where I worked in The Loop got briefly infatuated with encounter sessions with each other that seemed clearly modeled on the est methodology. (Werner Erhard got tainted in some scandals in the mid-1980s, but his associates soldiered on.) My bosses all went to marathon soul-baring sessions for a few weeks and came back raving about their "breakthroughs." Me and the other junior executives were supposed to go next, but then all of sudden, they came to their senses and and the feeling around the Top Floor was: We Shall Never Speak of This Again.

If you don't know how est works, here is Tom Wolfe's all-time great 1970s article "The Me Decade and the Third Great Awakening." To Wolfe, est was just the commercial version of Yale's Skull & Bones sessions where every flaw in a new member's personality was publicly picked apart in front of the crowd:

But out of the fire and the heap of ashes would come a better man, a brother, of good blood and good bone, for the American race guerrière. And what was more . . . they loved it. No matter how dreary the soap opera, the star was Me.

This kind of thing can actually toughen people up (or screw them up royally). A fraternity works by picking on new pledges' weaknesses until they start insulting their brothers' back, and then everybody ends up laughting. (Obama might not been quite the head case he depicts in Dreams from My Father if he'd had the good sense to join a fraternity in college.)

The differences between Skull & Bones (of which five of the ten Presidential nominees from 1988-2004 were members) and est is that the former is self-governing and selective (each member only recruits one other member, on average). Skull & Bones has its pros and cons, but but it's essentially a mutual benefit society, while est tends to be exploitative of its members. Est is a pyramid, with a few rich people at the top putting endless pressure on the lower down folks to go round up more dupes.

Obama is self-absorbed and self-pitying enough to have been interested in Let's Talk About Me (after all, he published 150,000 words about himself when he was 33), but also cynical and analytical enough to have figured out how est works on other people.

A brief Google glance doesn't show any evidence of documented Obama connections to est, but we do know he underwent and even led Alinskyite-training sessions. I don't know much about what's involved in them. It would be interesting for anybody with any inside knowledge to describe the similarities and differences between Erhard's and Alinsky's cults. Alinsky was more outward-directed and rational, which may be why Obama became disenchanted with the effectiveness of Alinsky's Rules for Radicals recipe for radical community organizing. Alinsky's system was designed for outside agitators working among proles living Back of the Yards. It was all too Depression-era depressing for Baby Boomers like Obama and Hillary Clinton, who turned down Alinsky's job offer. Alinsky just didn't provide the ineffable self-actualization that the affluent Baby Boomer generation craved.

In my experience, est wasn't exceptionally sinister. It provided a service -- Let's talk about Me! -- that a lot of people were willing to pay for, and it held out the hope of change (hmmhmm, where have I heard those words before?). est was just the usual pyramid scheme where each initiate had to recruit more marks to be milked. After awhile, there's nobody left who hasn't paid yet and the bubble collapses until it can be re-inflated under a different name.

The wildly successful volunteer aspects of the Obama campaign bear a lot of similarities to est.

If the Obama volunteers movement is modeled on est, then Obama has switched the ostensible locus of transformation from self to world ("this was the moment when the rise of the oceans began to slow and our planet began to heal"). And he has flipped the focus from individual to communal ("We are the ones we've been waiting for. We are the change that we seek"). But it's still a cult with him at the top rather than, say, Werner Erhard.

(Perhaps, most successful mass movements organized around one man are going to look like a multi-level marketing scam, so maybe est didn't have to be directly involved in Obama's education in marketing himself as an Erhard-like Messiah, but it would be interesting to know more about it.)

Barack Obama would be too verbally agile to get caught using clearly est-ian verbiage, but his wife Michelle, who is much less facile with the English language, occasionally lets loose with classic "California Uber Alles" formulations of the Obama Cult that sound a lot like est:

"And Barack Obama will require you to work.

He is going to demand that you shed your cynicism, that you put down your division, that you come out of your isolation, that you move out of your comfort zones, that you push yourselves to be better, and that you engage.

Barack will never allow you to go back to your lives as usual - uninvolved, uninformed..."

My published articles are archived at iSteve.com -- Steve Sailer

Did Bill Ayers ghostwrite Obama's memoir? Or vice-versa?

Jack Cashill, author of the fine book What's the Matter with California?, speculates that terrorist and Obama colleague Bill Ayers ghostwrote Dreams from My Father based on stylistic similarities between Obama's memoir and Ayers's own memoir Fugitive Days, especially in the more literary flourishes.

Cashill counts up a lot of nautical verbiage in both books, which makes sense for Ayers because he had once served in the Merchant Marine. Perhaps, though, Obama just read a lot of Melville and Conrad (He read Heart of Darkness at Occidental.)

Having read a few pages in the excerpt of Ayers' book available on Amazon, Cashill's idea sounds less crazy than I first thought. Cashill underrates the literary quality of other things Obama has written. Moreover, most of Obama's paying jobs have been writing related -- copy editor at a newsletter shop, briefwriter at his civil rights law firm. Obama's tests for his law school classes were extremely lucid.

Still, I could imagine there is a connection between the two memoirs. Maybe it's there, maybe it's not, but it's a possibility.

Still, Ayers's prose style tends to be breezier and easier to read, while Obama's is more consistently verbose and poetic/pompous. Here are similar ideas on the unreliability of family anecdotes from the opening of each book expressed in somewhat characteristic language. Ayers writes:

As the journey to my birth was told and retold, stretched and exaggerated, it was as if the young couple had arrived by dogsled having crossed the Alps in a blinding blizzard.

The first half of Ayers' sentence sounds rather like Dreams, but the second half is too Erma Bombeckishly plain-spoken for Obama, whose literary dignity always accompanies him.

In contrast, Obama writes:

... as a child I knew [my father] only through the stories that my mother and grandparents told. They all had their favorites, each one seamless, burnished smooth from repeated use. ... That’s how all the stories went-compact, apocryphal, told in rapid succession in the course of one evening, then packed away for months, sometimes years, in my family’s memory.

On the other hand, it is the same thought.

So, I certainly wouldn't rule out that one influenced the other. But, if so, which way? Obama's book was published in the middle of 1995, after he had begun working with Ayers on the Chicago Annenberg Challenge money machine. So, Ayers might have influenced Obama's book in some way. Perhaps he read over the rough draft?

On the other hand, Ayers's book didn't come out until 2001, so it might seem more plausible that Ayers was more influenced by his old colleague and neighbor than vice-versa. After all, Ayers surely read the well-reviewed memoir published by Obama, the Chairman of the Board of the Annenberg Challenge boodoggle that Ayers more or less dreamed up. Obama was in charge of Ayers' plan of handing out 50 or 100 million simoleons to Chicago "community organizations," so certainly Ayers read Obama's book to help in the buttering up process. Heck, Ayres probably thought to himself, "My life is a lot more interesting than this guy's! If he can get his autobiography published, then I should write mine."

One test I would suggest is mimicry of dialect. Dreams displays a fair degree of talent for imitating how people of different backgrounds speak. If Ayers's memoir is lacking this gift, then Cashill's theory is decisively refuted.

My published articles are archived at iSteve.com -- Steve Sailer

Mortgage risk and the two kinds of bell curves

The NYT reports in "Pressured to Take More Risk, Fannie Reached Tipping Point:"

But by the time Mr. Mudd [son of newscaster Roger Mudd] became Fannie’s chief executive in 2004, his company was under siege. Competitors were snatching lucrative parts of its business. Congress was demanding that Mr. Mudd help steer more loans to low-income borrowers. Lenders were threatening to sell directly to Wall Street unless Fannie bought a bigger chunk of their riskiest loans.

So Mr. Mudd made a fateful choice. Disregarding warnings from his managers that lenders were making too many loans that would never be repaid, he steered Fannie into more treacherous corners of the mortgage market, according to executives.

For a time, that decision proved profitable. In the end, it nearly destroyed the company and threatened to drag down the housing market and the economy.

Dozens of interviews, most from people who requested anonymity to avoid legal repercussions, offer an inside account of the critical juncture when Fannie Mae’s new chief executive, under pressure from Wall Street firms, Congress and company shareholders, took additional risks that pushed his company, and, in turn, a large part of the nation’s financial health, to the brink.

Between 2005 and 2008, Fannie purchased or guaranteed at least $270 billion in loans to risky borrowers — more than three times as much as in all its earlier years combined, according to company filings and industry data.

“We didn’t really know what we were buying,” said Marc Gott, a former director in Fannie’s loan servicing department. “This system was designed for plain vanilla loans, and we were trying to push chocolate sundaes through the gears.”

No comment.

Last month, the White House was forced to orchestrate a $200 billion rescue of Fannie and its corporate cousin, Freddie Mac. On Sept. 26, the companies disclosed that federal prosecutors and the Securities and Exchange Commission were investigating potential accounting and governance problems.

Mr. Mudd said in an interview that he responded as best he could given the company’s challenges, and worked to balance risks prudently.

“Fannie Mae faced the danger that the market would pass us by,” he said. “We were afraid that lenders would be selling products we weren’t buying and Congress would feel like we weren’t fulfilling our mission. The market was changing, and it’s our job to buy loans, so we had to change as well.” ...

Fannie never actually made loans. It was essentially a mortgage insurance company, buying mortgages, keeping some but reselling most to investors and, for a fee, promising to pay off a loan if the borrower defaulted. The only real danger was that the company might guarantee questionable mortgages and lose out when large numbers of borrowers walked away from their obligations.

So Fannie constructed a vast network of computer programs and mathematical formulas that analyzed its millions of daily transactions and ranked borrowers according to their risk.

Those computer programs seemingly turned Fannie into a divining rod, capable of separating pools of similar-seeming borrowers into safe and risky bets. The riskier the loan, the more Fannie charged to handle it. In theory, those high fees would offset any losses.

With that self-assurance, the company announced in 2000 that it would buy $2 trillion in loans from low-income, minority and risky borrowers by 2010.

A trillion here, a trillion there, pretty soon you are talking about real money.

Look, the problem with Fannie Mae's computer models can be summed up like this: They were looking at the wrong bell curve. They assumed that the risk of mortgage defaults were normally distributed along a bell curve, so you could use all the usual tools of statistical reasoning to diversify away this purely random risk.

Instead, they should have been looking at The Bell Curve. The homeownership rate had been stuck around 64% for a quarter of a century. Then the Clinton and Bush Jr. Administrations pushed it up, by hook and by crook, to 68 or 69% (published figures differ on what was the precise peak). Bush announced in 2002 that he wanted to add 5.5 million more minority homeowners, which would have pushed the rate above 70%.

In other words, the national policy was to keep pushing homeownership farther down toward the left tail of The Bell Curve (in less technical terms, further scraping the bottom of the barrel) by debauching traditional credit standards for everybody. This movie doesn't end well.

But, can you imagine what longtime Fannie Mae CEO Franklin Raines' response would have been if one of his modelers had tried to inject insights from The Bell Curve into their bell curves of mortgage default risk? Heck, nobody -- public, private or hybrid -- would be allowed to do it because it would show up in discovery of discrimination lawsuits. ACORN and La Raza would have a field day.

... The ripple effect of Fannie’s plunge into riskier lending was profound. Fannie’s stamp of approval made shunned borrowers and complex loans more acceptable to other lenders, particularly small and less sophisticated banks.

Between 2001 and 2004, the overall subprime mortgage market — loans to the riskiest borrowers — grew from $160 billion to $540 billion, according to Inside Mortgage Finance, a trade publication. Communities were inundated with billboards and fliers from subprime companies offering to help almost anyone buy a home.

Within a few years of Mr. Mudd’s arrival, Fannie was the most powerful mortgage company on earth.

Then it began to crumble. ...

Shortly after he became chief executive in 2004, Mr. Mudd traveled to the California offices of Angelo R. Mozilo, the head of Countrywide Financial, then the nation’s largest mortgage lender. Fannie had a longstanding and lucrative relationship with Countrywide, which sold more loans to Fannie than anyone else.

But at that meeting, Mr. Mozilo, a butcher’s son who had almost single-handedly built Countrywide into a financial powerhouse, threatened to upend their partnership unless Fannie started buying Countrywide’s riskier loans.

Mr. Mozilo, who did not return telephone calls seeking comment, told Mr. Mudd that Countrywide had other options. For example, Wall Street had recently jumped into the market for risky mortgages. Firms like Bear Stearns, Lehman Brothers and Goldman Sachs had started bundling home loans and selling them to investors — bypassing Fannie and dealing with Countrywide directly.

“You’re becoming irrelevant,” Mr. Mozilo told Mr. Mudd, according to two people with knowledge of the meeting who requested anonymity because the talks were confidential. In the previous year, Fannie had already lost 56 percent of its loan-reselling business to Wall Street and other competitors.

“You need us more than we need you,” Mr. Mozilo said, “and if you don’t take these loans, you’ll find you can lose much more.”

Then Mr. Mozilo offered everyone a breath mint.

Investors were also pressuring Mr. Mudd to take greater risks.

On one occasion, a hedge fund manager telephoned a senior Fannie executive to complain that the company was not taking enough gambles in chasing profits.

“Are you stupid or blind?” the investor roared, according to someone who heard the call, but requested anonymity. “Your job is to make me money!”

Capitol Hill bore down on Mr. Mudd as well. The same year he took the top position, regulators sharply increased Fannie’s affordable-housing goals. Democratic lawmakers demanded that the company buy more loans that had been made to low-income and minority homebuyers.

“When homes are doubling in price in every six years and incomes are increasing by a mere one percent per year, Fannie’s mission is of paramount importance,” Senator Jack Reed, a Rhode Island Democrat, lectured Mr. Mudd at a Congressional hearing in 2006. “In fact, Fannie and Freddie can do more, a lot more.”

Yes, that is kind of a problem, isn't it? Obviously, the solution to home prices rising faster than incomes is lend more money!

Now, over the last couple of weeks there has been a lot of fingerpainting over who is to blame. And that's a good thing. But the efforts to pin the positive blame on one party or another seem fairly hopeless, since they were all in on it. Sure, the Bush Administration raised qualms about Democrat-infested Fannie Mae in 2003, but Bush was simultaneously pushing zero down payment mortgages to promote minority homeownership, so the Bushies were not interested in dealing with the real problem, just in fighting Democrats over the spoils.

More realistically, there's a lot of negative blame to hand out because nobody in a position of power or influence -- Bush, Clinton, Greenspan, Frank, Dodd, etc. -- was willing to be seen as to stand athwart history, yelling Stop. What if the federal government had imposed a minimum 5% down payment on mortgages right after the 2004 election? That doesn't seem like too much to ask, but it was, because the "promoting minority homeownership" narrative was crucial in dissuading anybody from yelling Stop because that would be, in effect, yelling that minorities were lousier credit risks on average. And that's racism (because it's true, which is what make it so intolerable to mention in public), so that's unthinkable, so nobody thought about it.

So, here we are.

[By the way, Mr. Mudd is now out of a job. I guess his name is now mud, kind of like his ancestor, the Dr. Mudd who set the leg John Wilkes Booth broke while leaping from Abraham Lincoln's box to the stage of the Ford Theatre.]

My published articles are archived at iSteve.com -- Steve Sailer

Real Borrowers of Genius

A reader sends in a script for what should be a new Bud Light commercial. The main announcer has a deep, authoritative voice, like the guy who narrates the NFL Films highlight reels. The italicized parts are sung a capella by a very masculine gospel singer.

Real men of genius

Real men of genius

Today, we salute you, Mr. broke-no-money-down-home-loan-borrower.

Mr. broke-no-money-down-home-loan-borrower!

Your credit card maxed out on your cable bill, but that $500,000 questionably located house just had to be yours.

It was French Colonial!

Yes, you knew you might have to pay later, but who lives for later really?

No one in this country!

Who would have thought that in the long run, you would have traded living in a rented house, for living in a rented car?

Short ride home!

A car that gets less mileage than a highly leveraged mortgage-backed security...

Fill it up on my Visa!

After all, you bought the Brooklyn Bridge; you might as well live on it.

Sell high!

So pop open a nice, cool Bud Light Mr. broke-no-money-down-home-loan-borrower; and consider it investing in you!

Mr. broke-no-money-down-home-loan-borrower!

Of course, we could also do one for Real Mortgage Brokers of Genius, Bank Presidents, Investment Bankers, Sovereign Wealth Funds, Wall Street Rocket Scientists, Federal Reserve Board Chairmen, Congresscritters, and Presidents.

My published articles are archived at iSteve.com -- Steve Sailer

Wall Street Quants and the inherent failures of risk management

Obviously, there has been a gigantic failure by Wall Street rocket scientists at "risk management." This isn't my area of expertise, but I think I can point out a basic mistake. Going back decades to Burton Malkiel's book "A Random Walk Down Wall Street," sophisticated financial thinking (e.g., the "efficient markets theory" of the 1970s) has been dominated by the concept of randomness: events are distributed on a bell curve-shaped probability distribution.

For example, to take a simplistic example, people tend to default on mortgages when they have bad luck: dad gets cancer and dies and then mom gets depression and loses her job. The bank forecloses. If you hold 1,000 mortgages, that kind of bad luck happens to, say, 15 each year. Of course, your 1000 people might have worse luck than normal. Say you study millions of mortgage and determine the standard deviation is 5 per 1000. So, for 99.75% of the bundles of 1000 mortgages, the number of defaults in a year will range from 0 to 30.

Here's the problem: human life really isn't all that random. That's because human beings respond to incentives. If you treat human beings as if they are just mindless probabilistic events, whose risks you can diversify away by dealing with large numbers of them at a time, they will outsmart you. They will put down inflated incomes on their mortgage applications. They will claim to be owner-occupiers when they are just speculators who will rent out the property to Section 8 tenants when they get into a cash flow bind. They will bribe appraisers to report a higher than actual value.

Another common pattern in life is that things build to a climax of the greatest risk and reward, where predictability is at a minimum. The events that we are most interested in are those that are hardest to predict. We know exactly when the sun will set on December 21, 2008. That is a hugely important fact, but it's not a very interesting one to us because it has already been taken into account. We're more interested in things like who will win the World Series or be elected President or whether the stock market will go up or down ... because those are so hard to predict.

Let's look at a sports example of risk vs. reward. Say you are an Olympic boxer, one of 32 contenders in your weight class. You have a particular power punch that you are fond of which requires you to drop your defenses for a fraction of a second as you wind up to deliver it. In the first round, against a boxer from Sikkim, you throw it seven times with no bad results for you. In the second round, against the Ghanian fighter, you use it five times with no ill effects. In the third round against the Slovenian fighter you throw it six times and suffer one glancing blow. In the semifinal round against the Korean boxer, you throw it seven times and suffer two glancing blows.

Okay, so, in the first four matches, you've thrown it 25 times and suffered three glancing blows. Only a 12% problem rate, and those problems aren't that bad: just glancing blows. You run a 1000 Monte Carlo simulations, and using that punch pays off in 973 of them. You like those odds!

Now you are in the final against the Cuban, who is the World Champion and defending Olympic gold medalist. You immediately rear back to throw your power punch ... and wake up in the infirmary with your silver medal on the bedside table.

What happened?

Non-randomness. The whole Olympics were set up to pit the two best boxers in the final round. The Cuban, who might be the professional champion of the world if he were allowed out of Castro's paradise, is just plain better than anybody you fought before. In hindsight, you can see a trend in the data but you simply couldn't predict from it how hard you'd get hit.

A lot of things in real life work out roughly along the same lines as in organized tournaments, building to a climax. First, Hitler conquers Czhecoslovakia, then Poland, then Denmark and Norway. So, feeling lucky, he invades France. Then in 1941, with all that positive data on the high rewards and low risks involved in starting wars available to him, he invades the Soviet Union and declares war on the United States. Notice a pattern?

In retrospect, things tend to evolve toward maximum unpredictability. The pre-1914 alliance system of Europe tended, because the weaker side at any point had the incentive to offer more to neutrals to join them, tended to evolve

This doesn't mean that this has to happen. There are lots of periods without that kind of disastrous evolution. But things like World Wars or financial crashes are what catch our eye in hindsight, and with good reason.

This suggests that there is no way to avoid disasters permanently. That's no doubt true. But we can make them rarer and less catastrophic just by being less stupid. Consider two economies, both of which either grow 5% per year or shrink 5% per year. The first economy is more bubble-prone, so it grows for seven years then shrinks for three years. The second economy grows for ten years, then shrinks for two years. Over the course of sixty years (six cycles for the first economy, five for the second), the second economy will end up over twice as big.

The Albanian economy collapsed in 1997-98 due to the entire population, who had only been introduced to capitalism less than a decade before, becoming entranced by simple pyramid scams. That was so stupid that it probably won't happen again in Albania for a long time.

Americans don't fall for simple pyramid schemes. We need more complicated scams.

My published articles are archived at iSteve.com -- Steve Sailer