Sage Counseling

Peter J. Wallison didn’t need a crystal ball to foresee the train wreck that was approaching.

For years, the former White House counsel and general counsel to the U.S. Treasury in the 1980s had been focusing on deregulation of the financial markets — paying particular attention to GSEs Fannie Mae and Freddie Mac.

By the late ’90s, it became obvious to him that the rise of Fannie and Freddie would spell calamity for the U.S. financial system.

“It was a prescription for disaster, as I said in 1999. And by 2007, the deed was done. Here were two shareholder-owned institutions, seen as backed by the government that could raise as much money as they want and take as much risk as they want because nobody worries about it. And that, of course, is what happened,” says Wallison, 67, now a scholar at the American Enterprise Institute for Public Policy Research.

He continues. “If you’re going to create a government-backed program in which a private-sector organization is raising money to do something the government wants them to do, you’re creating [a virtual] thrift industry. Even though the thrift industry failed, we were watching a new thrift industry grow right before our eyes. Fannie Mae and Freddie Mac were two gigantic S&Ls.”

Thus, government’s “destructive policies” are at the root of the housing crash, which led to bad loans, the credit crisis — and finally to an unprecedented financial cataclysm, says Wallison, who, at the Treasury, worked on creating legislation that would eventually allow bank holding companies to enter other areas, like the securities business.

A Republican since age 14 working as a page in the House of Representatives, Wallison’s current role, at conservative think tank AEI in Washington, D.C., is academic reformer on a variety of financial market issues. Mainly, he concentrates on deregulation of the securities and insurance industries; and he is perhaps the best known critic of Fannie and Freddie.

To the oft-posed question — “Where were the regulators when this terrible chain of financial events was building?” — he has this to say:

“Banks are the most heavily regulated institutions in our society — and it was the banks that brought all this stuff on. When institutions are regulated — especially banks, where deposits are seen as insured by the government — there’s a great deal of moral hazard. It’s a mistake to think the regulators would have stopped this from happening…Regulators don’t have any idea what they’re looking for — and it’s a shameful thing.”

Growing up in Queens, New York, the Brooklyn native was told regularly: “You should become a lawyer!”

“Guess I sounded like I knew what I was talking about!” he says, with a friendly chuckle.

Christopher DeMuth, AEI president from 1986 through December 2008, calls Wallison “a man of high principle who’s not afraid to take on controversial issues. The work he did on Fannie Mae and Freddie Mac was very penetrating — and, as we now know, all too prescient.”

Wallison’s way to clean up the whole financial-economic mess? Part I: “It’s very distasteful to me, but getting out of where we are today requires government action. It has to take much more risk and take more of the bad assets onto its balance sheet, and refinance many mortgages,” he says.