Goldman Sachs helped to blow up a 33-year-old social engineering project; now it must pay

Why is the Obama administration pursuing Goldman Sachs for enabling financial transactions between sophisticated, consenting adults?

Because the financial instruments at issue blew up a 33-year-old social engineering project that destroyed markets in pursuit of an unreachable liberal objective: universal home ownership.
Goldman Sachs devised those complex investments.

The campaign for universal home ownership began in 1977, when President Jimmy Carter secured enactment of the Community Reinvestment Act, which prohibited lenders from red-lining, a practice that denied home mortgages to residents of high-risk neighborhoods.

Over time, the CRA movement spilled out of its original constituency, the conspicuously compassionate, as radicals from ACORN and other activist organizations joined the fray, gaining legal sanction to browbeat bankers and picket lenders who refused to confirm to the growing demands for mortgage accomodation.

Still, the CRA remained a modest effort by federal government standards, From 1977 through 1991, only $8.8 billion was committed under the CRA. Then Democrat Bill Clilnton became president and business picked up. From 1992 through 2005, the first year of George Bush's second term, $4.2 trillion in CRA loans went out the door.

The concept of risk apparently had been erased from the mortgage industry. Local lenders could bend to pressure for loans and then wash their hands of risk by immediately selling those loans to Freddie Mac or Fannie Mae, which were backed by the federal treasury and supported by the political class. That was the first step in the process of bundling mortgages as securities, a process that resulted in mortgages from Pequot Lakes and Tuscaloosa finding eager buyers in Madrid.

The U.S. housing market sizzled.

But one savvy investor, a hedge fund operator in New York, wasn't buying it. John Paulson studied records of the bundled mortgages and made a list of the ones he considered most likely to go bad through default. Then he persuaded Goldman Sachs to craft securities based on the suspect mortgages and bet against the market by selling them short. That is, he sold securities without first buying them.

Paulson's trading was prophetic. When the housing market collapsed, Paulson earned billions of dollars, closing out his transactions by buying back the Goldman Sachs securities for pennies on the dollar. He sold high, then bought low, reversing the usual process.

What troubles sophisticated observers is this. The securities that Paulson shorted were bought by sophisticated, willing investors. Neophytes don't participate in short sale transactions. So what's the problem? Why did the Securities and Exchange Commission vote, 3 to 2, in favor of legal action  against Goldman?

Here's a thought. In essence, the CRA was a colossal social engineering project. When it was enacted, and for many years thereafter, a high-risk borrower could get a loan only by paying a higher-than-average interest rates. In recent years, however, the CRA and subsequent legislation, court decisions and rabble rousing tactics reduced the reliance on interest rates as compensation for high risk.

During the Bush administration the Federal Reserve kept interest rates so low that more and more high-risk borrowers could get loans. As social engineering, the CRA was a success story.

Now, the Obama agenda is largely made up of social engineering projects designed to overcome market forces and make scarce resources available to all, whether they want them or not, whether they can afford them or not. Obamacare, for instance, would force the young and healthy to buy health care insurance even though many would prefer to take their chances and spend their money on something else. One result will be more generational theft, with the young forced to buy insurance they will not need.

Coming soon: cap and trade, which will require consumers to alter preferences and manufacturers to bear increased costs, even though the science behind global warming theory has been thoroughly discredited. In recent years, global warming has become the most powerful social engineering project of our time.

But that project runs counter to market forces, which require least cost solutions. Cap and trade would raise costs, and prices, for many of the things people buy and use. To secure enactment, the Obama administration will have to use thuggish tactics, as it did to pass Obamacare, bribing members of congress to vote against the desires of their constituents.

The SEC's lawsuit against Goldman Sachs may cause opponents to think twice about going up against the White House.