I have a Tea Party-leaning friend. He says the Community Reinvestment Act (CRA) is an important contributor to the housing bubble. He believes the CRA "pushed" banks to lower their lending standards in order to allow otherwise unqualified borrowers (usually minorities) to pursue the American Dream of home ownership. Thus, this 33-year old law is significantly culpable for the ensuing Great Recession.
I spent literally half of my adult career in the commercial banking industry. I have extensive experience in understanding and complying with the requirements of CRA as a:
- commercial lender,
- an assistant chief credit policy officer, and
- a loan workout manager.
It is, of course, just silly.
CRA does not impose or even encourage ANY reduction in credit underwriting standards. It actually requires banks to operate in a safe and secure manner. CRA merely requires fairness in the application of the bank's credit underwriting, and an effort to try to serve the legitimate commercial & consumer credit needs of low-income and minority communities within the bank's markets. Mostly, CRA simply prohibits the practice of "redlining". Mark Sumner writes:
The Community Reinvestment Act and other red lining laws weren't passed to force banks to make loans to African-Americans and other minorities. They were there to make the rules consistent. Previous to the passage of the CRA, minorities were often required to have better credit, and make larger down payments to get loans equivalent to those awarded whites. Nothing in these laws required that banks lower their lending standards, only that they be fair, consistent, and operate in a "safe and secure" way. There was no evidence then, and no evidence now, that minorities with the same initial credit rating as whites tend to default on their loans at any greater rate.
The assertion is further refuted by American economist & professor Janet Yellen, currently the Vice Chair of the Board of Governors of the Federal Reserve System. In her foreword to "Revisiting the CRA: Perspectives on the Future of the Community Reinvestment Act", she unequivocally states:
There is no empirical evidence to support the claim that the CRA is responsible for the crisis, as several authors in the volume make clear. First, former Federal Reserve Governor Randall Kroszner argues in a speech included in this volume that the CRA did not contribute to any erosion in safe and sound lending practices. He specifically cites an analysis by the Federal Reserve Board that revealed that 60 percent of higher-priced loans went to middle- or higher-income borrowers or neighborhoods not covered by the CRA, and only six percent of all higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas. Moreover, a research paper by the Federal Reserve Bank of San Francisco in this volume finds that loans originated by CRA-covered lenders were significantly less likely to be in foreclosure than those originated by independent mortgage companies not covered by the CRA.
Randall Kroszner details the facts more fully in "The Community Reinvestment Act and the Recent Mortgage Crisis". Prof. Kroszner states:
Two key points emerge from all of our analysis of the available data. First, only a small portion of subprime mortgage originations are related to the CRA. Second, CRA- related loans appear to perform comparably to other types of subprime loans. Taken together, as I stated earlier, we believe that the available evidence runs counter to the contention that the CRA contributed in any substantive way to the current mortgage crisis.
If CRA is not responsible for the mortgage crisis, then what is?
There were a number of contributing factors. The CRA is not one of them.
In a nearly 2-year old posting to the Daily Kos (Down the Republican Rabbit Hole), award-winning author Mark Sumner points to unregulated Wall Street financial engineering:
... the banks have some self-inflicted problems that make those mortgages an afterthought.
For example, the wonderful credit default swap. In essence, credit default swaps are (or were) nothing but insurance policies for loans. And yet in 2007 the total number of credit default swaps traded far exceeded the value of all loans. In fact, it may have touched $70 trillion dollars, which puts it above the gross domestic product of the entire planet.
His summary of the evolution of credit default swaps is funny as hell. And right on.
Now that people are paying attention, it turns out that the value of most credit default swaps is not just bupkis, it's Bupkis Plus. More computer power went into modeling these things than has been invested in predicting climate change, but everyone overlooked the giant "and then a miracle occurs" at the center of all the equations that allowed credit default swaps to generate revenue ex nihilo.
Trying to blame the 1977 Community Reinvestment Act for the current fiscal crisis is like blaming a spot on your windshield for engine failure while ignoring the gaping wound in you head gasket. Republicans are scribbling hard to create their new version of reality, and you never know what's going to sell. After all, people bought a "Book of Virtues" authored by Bill Bennet.
But in this case, even the Mock Turtle and the March Hare think the GOP line is too outlandish.
Read it and weep, oh spewers of factless turd-polishing conservative opinion commentators. Opinions are great, but facts sweep away cognitive dissonance (or should, eventually). When that happens, be welcome back into the light.
Until then... To Tea Party sympathizers who are willing to consider evidence: Stop drinking the Kool Aid. There are real problems to deal with, and we need your help to solve them.
Other significant contributing factors (not in any order of priority, degree or significance):
- [Moderate to Major Factor?] Lax Regulatory Oversight: A recklessly "hands off" regulatory philosophy - primarily Republican-driven, but abetted by the Clinton administration - led to:
- Rrepeal of the Glass-Steagall Act.
- Larry Summers' stifling Brookslee Born @ CFTC from considering regulating derivates.
- An empirically-unjustified belief that rational self-interests would make markets self-correcting caused policy makers to avoid even considering systemic risks until near the brink of financial system collapse. Earlier consideration & investigation of the potential magnitude & inter-dependency of the derivatives markets would [I hope] have led to earlier intervention.
- [Minor to Modest Factor?] The Greenspan 'Put': Excessively low interest rates for too long, encouraged banks & investors to seek superior returns in riskier asset classes. Low debt rates simultaneously incentivizes more borrowing/debt.
- Had interest rates been higher, perhaps more capital would have remained out of riskier speculative asset classes?
- If so, to whatever extent it did, reduced demand for "emerging bubble" assets should take some air out of the bubble...
- And reduce the impact of the landing.
- [Moderate to Major Factor?] Moral Hazard: Privatization of profits combined with making losses public, allowed Fannie Mae & Freddie Mac executives to take excessive risks - risks they would not otherwise take - to satisfy shareholders' desires for returns."Too Bid To Fail" belief encouraged Wall Street to gamble with leverage, something they would do relatively less if only because of higher capital costs in the event no government-guarantee were inferred.
- [Major Factor?] Incomplete and Asymmetric Information: Market participants did not have co-equal information (the price is not all that matters!).
- Mortgage-backed securities investors believed the investment-grade credit ratings, but were not fully aware of the flaws in ratings agencies' models.
- Ratings agencies were not aware of flaws in the underwriting investment banks' default models, and had/have an inherent conflict of interest in getting paid to rate the debt of the party who is paying for the rating.
- Banks unloaded reams of packaged mortgage loans to investment banks without adequate documentation, faulty credit underwriting, and just plain stupid products (no doc? really?).
- Mortgage originators sold fraudulently originated & clearly inappropriate/unaffordable loans to the banks, and convinced inexpert home buyers they could afford the debt.
- Naive, ignorant and/or gullible home buyer-wannabes foolishly assumed more debt than they could afford.
- Better information, disclosure, better ethics & ethics enforcement, better underwriting, better products, better incentives.
- [Major Factor?] Irrational Expectations: By all actors in the market place.
- Irrational Confidence. Consumers, bankers, ratings agencies, and financial engineers all assumed that residential real estate would continue to appreciate in value indefinitely. Having all made the same mistake favoring an unsustainable run up in housing prices over a short term, the bubble was bound to form and burst (they always do!).
- Irrational Ignorance: The bursting of the smaller dot com bubble at the very beginning of the decade should have been a warning to speculation-chasing investors. Invest, not speculate. And to government: Markets are not always rational.
- This is Mark Sumner's big miracle in the center of all the equations.
- [Moderate to Major Factor?] Wealth Inequality: Excess accumulation of financial capital assets increasingly concentrated in the hands of the very wealthiest segment of society (esp. American society).
- The result is excessive capital allocated to speculative financial activities offering above-normal returns.
- Not allocated for widespread consumption or investment in productive capacity. [Stagnating middle-class household wages during the decade is [partial] confirmation, IMO; record income & wealth inequality is further [partial] confirmation.]
- Excessive money chasing a narrowed band of higher risk assets causes those assets to inflate rapidly.
- Especially in conjunction with the [false] belief that risk was overstated because housing values would always grow ad infinitum.