What was the Federal Reserve Bank of Kansas City doing as the housing market went insane?

The Federal Reserve Bank of Kansas City loves to tell its story.

Last summer, the bank’s public affairs department published a commemorative history, Confidence Restored. The bank also commissioned a film. It’s a fancy production. In addition to generic images of Midwestern values (horseback riding, ball games), local actors portray the long-dead governors and businessmen who made Kansas City seem like a sensible place to put a branch of the nation’s central bank.

The book and film stress that the Federal Reserve System has gained wisdom for having a presence in rock-solid middle America. In the book’s foreword, Thomas Hoenig, the president of the Kansas City Fed, says community input ties “the Federal Reserve to the nation’s Main Streets, preventing it from becoming an isolated, insulated, Washington-based institution.” In the film, a KC Fed official gets out of her car and meets a farmer in his field.

Yet here we are: the age of confidence destroyed.

The Federal Reserve has come under criticism for fueling the housing bubble. As home prices soared, the Fed kept interest rates low, enticing homebuyers to take on vast quantities of debt. Alan Greenspan, former chairman of the Federal Reserve, even encouraged borrowers to take out adjustable-rate mortgages, the personal-finance equivalent of running with scissors.

An economy built on people selling houses to one another doesn’t hold much future. Borrowers began to default on their tricked-out mortgages in 2006. Eventually, the credit market seized up as the mortgages, which had been bundled and sold as “collateralized debt obligations,” spread toxins throughout the financial system.

In Greater Kansas City, signs were evident that real estate and lending had taken turns for the unsustainable. Mortgage sharps were getting dragged into court. Newspapers carried stories about subdivisions where foundations cracked not long after moving trucks had left.

A few notable moments:

March 1, 1999: The Kansas City Star publishes a lengthy story about the proliferation of subprime lenders. According to the findings, 15 of the top 20 lenders in Kansas City’s minority neighborhoods specialize in nonconforming loans.

August 15, 2000: Missouri Attorney General Jay Nixon accuses an Overland Park homebuilder, Jeffrey Miller, of doing shoddy work and misleading buyers. Nixon’s lawsuit also asserts that Miller forged documents and operated without a license.

February 27, 2003: TheStreet.com publishes a column by Herb Greenberg questioning the health of NovaStar, a Kansas City-based subprime mortgage lender. Greenberg notes that the company lacks a chief financial officer and uses aggressive accounting to pad its earnings. In the March 31 issue of Fortune magazine, Greenberg details NovaStar’s reliance on opaque financial instruments, like “swaps.”

May 22, 2003: A cover story in The Pitch describes the activities of Brent Barber, a property flipper who obtains loans based on phony home appraisals. A lawyer for one duped investor calls Barber’s schemes “fraud with a capital F.”

April 12, 2004: The Wall Street Journal publishes an unflattering story about Nova­Star’s culture of aggressive growth. The article describes how the company gave mortgage brokers a flier encouraging them to “ignore the rules” and qualify more borrowers with NovaStar’s “credit score override program.”

August 12, 2004: A federal grand jury indicts Barber on charges that he and three others defrauded Ameriquest Mortgage. Barber will be indicted twice more in the next six months. After one case brings a guilty verdict, Barber eventually pleads guilty to more than 100 felony counts.

January 2005: Three in 10 mortgages issued in Greater Kansas City in 2004 carried adjustable rates, according to statistics gathered by the Federal Housing Finance Board. Kansas City borrowers take out larger loans (relative to sale price) than homebuyers in all but four major metropolitan areas — Houston; Little Rock, Arkansas; Dallas; and Rochester, New York.

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February 17, 2005: A Raytown appraiser, Peggy Jo Snodgrass, pleads guilty in federal court to participating in a mortgage-fraud conspiracy. Snodgrass made false appraisals supporting more than $4 million in loans. In one instance, she deemed a home on East 32nd Street to be worth $73,000, even though it was on track to be demolished.

June 28, 2005: In a lawsuit filed in Kansas City, the Dutch bank ABN AMRO accuses a Mamet-like cast of characters — speculators, frontmen, mortgage hustlers, appraisal inflaters — of participating in a massive fraud scheme. A few weeks earlier, two house flippers and a mortgage broker named in the suit had pleaded guilty to federal wire-fraud and money-laundering charges.

May 2006: Michael Hudson, a professor at the University of Missouri-Kansas City, publishes an article in Harper’s magazine titled “The New Road to Serfdom.” Using graphs, charts and even stick figures, Hudson describes how the real-estate bubble came to be and its consequences (“a modern equivalent of peonage, a lifetime spent working to pay off debt on an asset of rapidly dwindling value”).

May 17, 2006: Miller and eight others are charged, in federal court in Kansas, with conspiracy to commit bank fraud and money laundering. What prosecutors term a “machine” allegedly obtained $25 million in loans.

August 24, 2006: H&R Block announces that it’s setting aside $102 million for loans issued by a subsidiary, Option One Mortgage. Block reports that the potential losses reflect high numbers of borrowers who are unable to make even the first payment.

August 27, 2006: The Star reports that Saundra McFadden-Weaver, a Kansas City, Missouri, councilwoman, bought a $400,000 home in Lee’s Summit with no money down. A jury later finds McFadden-Weaver guilty of mortgage fraud.

November 19, 2006: A grand jury indicts Miller and three defendants on separate fraud charges. The government lists two Sea Ray pleasure boats (one named Bling Bling) and a Piper airplane among the assets that Miller accumulated in the course of his conspiracy.

February 21, 2007: Shares of NovaStar fall almost 43 percent.

Over the next few months, a host of subprime lenders announced staggering losses, fired their former hotshot executives or sought bankruptcy protection. In August 2007, President George W. Bush called on Congress to pass legislation that addressed “disturbances” (a delicate way to put it) in the subprime market.

If Hoenig saw trouble — trouble he could have reported to insulated Washington — he kept pretty quiet about it.

I contacted Tim Todd, a spokesman for the KC Fed, to ask whether Hoenig had missed seeing a sign in what was happening all around him.

“An instance of criminal activity is not evidence of a housing bubble or other issues with the broader market,” he wrote in an e-mail. “Fraud can happen in any environment.”

Delivering remarks in Tucson, Arizona, in 2006, Hoenig took a cautionary tone, recalling the greed and recklessness that contributed to the banking crisis of the 1980s.

But the speech hardly sounded an alarm. Hoenig concluded by saying his purpose “in reviewing these stories with you today is not that I think a return to a 1980s-style crisis is imminent.”

He was right, in a sense: Today’s crisis is far more destructive.

Each year since 1978, the KC Fed has hosted an economic symposium in Jackson Hole, Wyoming. The 2007 session focused on housing. The final speaker, Martin Feldstein, then president of the National Bureau of Economic Research, congratulated Hoenig on his “prescience.”

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But at that moment, more than $1 trillion in subprime loans was already sloshing around the economy. Hoenig’s foreknowledge amounted to thinking about shutting the door of a barn consumed with fire.

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