Ever since it became clear in 2008 that we were in the midst of a financial crisis, we have been hearing dueling narratives over who or what was primarily to blame for the crisis: either greedy capitalists or government housing policy.

One of the most important voices in this dispute has now weighed in with the book Hidden in Plain Sight. Since the late 1990s, Peter Wallison of the American Enterprise Institute has been one of the most prolific commenters on the build-up of the housing bubble, the ensuing financial crisis, and its underlying cause. Back in the late 1990s, long before most people understood precisely what Fannie Mae and Freddie Mac did, he was raising red flags (including several articles in these pages) and warning that the market and political dominance of the pair would one day end badly.

Wallison was a member of the Financial Crisis Inquiry Commission (FCIC), the 10-member body that was tasked with examining the causes of the crisis, among other duties. The final report of the FCIC split along partisan lines, with the six Democratic Party members supporting the final report and the four Republicans dissenting. Wallison distinguished himself as a lone dissenter with his arguments that government housing policy was at the core of the causes of the financial crisis.

In 2013 AEI released his book Bad History, Worse Policy as an initial response to the FCIC majority’s findings. However, the book was simply a re-release of multiple policy pieces he had penned from 2004 to 2012, with some limited explanatory text integrated in. Hidden in Plain Sight, on the other hand, is all original writing, albeit citing much of the same source materials he has cited over the years, organized into a coherent summary of his arguments on the precise cause of the crisis. The depth of the research in the book is nothing short of extraordinary as he addresses all the potential causes, provides an amazing number of on-point documents to support his thesis, and responds to the arguments of his critics who cling to the idea that government housing policy played no or only a small role in the crisis.

Government and NTMs / Wallison’s first chapter sets forth the overarching arguments that he develops later in the book:

  • The financial crisis was the result of the government’s own housing policies or, more precisely, “the crisis would not have occurred without those policies.”
  • The “seeds of the crisis were planted in 1992” when Congress enacted affordable housing goals for Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that purchased loans in the secondary market.
  • Fannie and Freddie reduced their underwriting standards not only with regard to low-income borrowers, but also to high-income borrowers.
  • Because of the deterioration in underwriting standards, by 2008 half of all U.S. mortgages were “subprime” or “Alt‑A,” which means they were of below-prime quality (more on this below). Some 76 percent of the lower-quality loans were held on the books of government agencies or the GSEs.
  • The GSEs did not disclose the full extent to which they held such lower-quality loans.
  • When the bubble deflated, the financial crisis put at risk many of the largest financial institutions in the country.

Right out of the box after laying out his thesis, Wallison digs down into the data to support his core arguments, and his use of data, tables, and graphs bolsters his arguments throughout the book. The source of the data is research demarcating traditional and non-traditional mortgages (NTMs) undertaken by Edward Pinto, an AEI colleague. Traditional mortgages adhere to standards as adjudged under three key elements: a loan-to-value ratio of 90 percent or less, which indicates a material down payment; a debt-to-income ratio of 38 percent or less, which indicates the amount of a borrower’s income committed to debts; and a borrower’s credit record, which is the history of the borrower’s meeting of prior debts and should indicate no late payments (or, in rare cases, one). An estimated 85 percent of sampled loans met those standards between 1988 and 1991.

Growth in the segment of the market dedicated to NTMs—what Wallison derides throughout the book as “flexible” or “innovative” lending standards—was a good indicator of the deterioration in credit standards. At bottom, Pinto estimates the number of troublesome NTMs outstanding as of mid-2008, just at the onset of the major stress and panic of the financial crisis in the fall of 2008. Under Pinto’s analysis, the NTMs numbered 32 million of the total (balance of over $5 trillion) or 58 percent of the total 55 million U.S. mortgages as of mid-2008. Government agencies as a group were exposed to 76 percent of the NTMs, with Fannie and Freddie exposed to over half. Those data are especially significant because Fannie and Freddie did not begin to report their full exposure to NTMs until after they were taken into conservatorship by their regulator, the Federal Housing Finance Agency, in 2008. As a result, “analysts, regulators, academic commentators, rating agencies, and even the Federal Reserve were seriously misled about the scope of the NTM problem, believing that it was much smaller, and the number of traditional prime mortgages outstanding was much larger, than in fact they were.”

Finding what they wanted to find / Wallison settles a few scores with those who have criticized his analysis over the years (primarily those he derisively refers to throughout the book as being “of the left” or “on the left”) or that came to different conclusions than he did regarding the genesis of the crisis (primarily his fellow commission members and select staff of the FCIC). Wallison holds those “on the left” in greatest contempt and ire, noting that “they have no data, no policy arguments, just a virulent denial that anything other than the private financial sector could possibly be responsible for the financial crisis.”

Turning his attention to the FCIC, the official arbiter of the causes of the crisis, he cites a range of sins visible to him as an insider to the process: just one staff member from a total staff of almost 80 was provided to support the minority’s research; the executive director was on loan from the Federal Reserve and thus was potentially conflicted in her investigation of that agency’s role in the crisis; the chair of the commission did not solicit the views of the minority or keep them informed on details of the FCIC investigations; and Pinto’s work was never formally made available to the other members of the FCIC and the majority essentially dismissed his research out of hand.

I have always been of the opinion that the FCIC’s report included some useful information and that the interviews it conducted and the never-before-released emails it made available were some of the few avenues to get detailed information out of the financial agencies (which were not willing to release much information voluntarily). But Wallison’s conclusion about the politicization of the FCIC’s policy conclusions seems about right:

As far as I could tell from the witness interviews I was able to get, no one conducted any cross-examinations, and no one used any documents to question the witnesses’ statements or otherwise test their veracity. The process simply validated the conventional view of the financial crisis that the media had already accepted and repeated.

Federal policy / Wallison traces through an exhaustive review of the history of the build-up of the bubble, from the state of housing finance before the affordable housing goals were implemented; the ratcheting up of the goals; the political calculations regarding taking credit for homeownership increases (both during the Clinton and George W. Bush administrations); through the steady deterioration of credit standards during the 1990s and how that ultimately precipitated the crisis. The breadth of research throughout this history is incredible, including material from a Federal Housing Authority underwriting manual from the 1930s; internal Housing and Urban Development Department memos, reports, speeches, and testimony; homeownership strategies; and Fannie and Freddie 10K and 10Q reporting.

One truly unique chapter in the book is on fair-value accounting and its role in the dissemination of information regarding the financial position of financial institutions. I don’t recall any other book on the financial crisis going into such detail on this issue and it is an excellent summary of the topic. A discussion of each of these historical issues and related documents cannot be undertaken in this brief book review, but Wallison always seems to find just the right documented evidence to support his argument.

The last section of the book details the government response to the crisis, or what Wallison calls the “panic and bungling of the officials who handled it. Then, in trying to minimize or justify their own mistakes, these officials claimed that they had insufficient authority to deal with the crisis.” He walks through a number of the narratives put forth by the authorities to justify their response. The interconnectedness fallacy that was used to justify the bailout of Bear Stearns? He rightly speculates that it was “dreamed up in either the Federal Reserve or the Treasury to justify saving Bear Stearns, and it was easily swallowed by the media at the time.” The Federal Reserve’s authority to rescue Lehman? “It does not take much detailed analysis … to find that the story Paulson and Bernanke used to explain their failure to rescue Lehman has no basis in fact.” The dramatic zigs and zags of different and inconsistent policy responses? “Instead of a sense that the U.S. government knew what it was doing and had settled on a policy, there was now a sense that the government was winging it or simply incompetent.”

I believe this will be one of the best policy books of 2015, and one of the best books on the crisis since it ended. For readers who have been critical of government housing policy and response to the crisis, Hidden in Plain Sight will provide you with more ammunition than you can ever hope to use. For readers who bought into the narrative of the media and the FCIC and are in denial that government policy caused the crisis, get ready to become so frustrated by Wallison’s mountain of contrary evidence that your head may explode.