The CRA and the Credit Crisis

I got a comment on another post about the Community Reinvestment Act and its relation to the current credit crisis. Here is the comment and my response.

The CRA applies only to depository institutions, such as banks and savings and loan associations. According to Michael Barr’s February testimony to the House Financial Committee, problems in the subprime lending industry were a driving force behind the housing crisis, BUT he estimated that only 20 percent of subprime mortgages were issued by depository institutions under the CRA.

Here’s a quote:

“More than half of subprime loans were made by independent mortgage companies not subject to comprehensive federal supervision; another 30 percent of such organizations were made by affiliates of banks or thrifts, which are not subject to routine examination or supervision, and the remaining 20 percent were made by banks and thrifts.”

http://www.house.gov/apps/list/hearing/financialsvcs_dem/barr021308.pdf

So, explain how if only 20% of the subprime mortgages were CRA related the CRA is somehow the major cause for the economic crisis? I’m not seeing the dots connect here.

For starters, that’s an estimation, so it’s not an exact number; I’d take it with a grain of salt.

Secondly, those “independent mortgages companies” can still lend through banks.

Moreover, Yellen and Gordon don’t seem to understand what an “independent mortgage company” is. Many of these companies are like the one in which my next-door neighbor is employed: they are middlemen who arrange mortgage loans for borrowers — including “subprime” borrowers — with banks, including CRA-regulated banks. Some killer statistic.

Thirdly, no one is claiming, including myself, that the CRA was the only reason for the credit crisis. However, it is a very large reason.

It really doesn’t matter how many subprime mortgages were CRA related or not, the problem is the CRA set off a domino effect that sparked massive government intervention in many sectors of the housing market.

It started with the CRA which forced certain banks to lend to unqualified borrowers in the name of fairness. That obviously failed, Countrywide is a great example. They had $600 billion in subprime loans, and now they’re owned by Bank of America.

Then we said that if a CRA bank wanted to merge with another bank, they would have to prove that they were doing a good job lending to borrowers the government wanted them to lend to. This sparked petitions from groups like ACORN against bank mergers. Which then forced banks to pay off groups like ACORN to get off their backs, and then lend more subprime mortgages.

Then in 1994 we loosened those regulations, but we had already created a mess. Once those regulations were loosened ACORN (who is partially funded by taxpayers) and other groups took it upon themselves to intimidate banks into lending to subprime borrowers. This lead to bank sit ins and other means of intimidation.

Then we had Fannie Mae and Freddie Mac back up these subprime loans to diversify their risk. Fannie and Freddie, of course, are GSE (government sponsored enterprises) and the taxpayers basically have their back if anything goes wrong; and, predictably, something went wrong.

So while the CRA certainly isn’t to blame for every single subprime loan, it certainly isn’t in the clear at all. The CRA sent a big government thrill up everyone’s leg and we got a little carried away with government intervention.

And that’s the source of the credit crisis, government intervention.

UPDATE: Another response to my post, here is my response, the full comment can be view in the comment section of this post.

That’s simply not true. 80% of the subprime mortgages were completely outside the CRA. Where’s the domino effect?

You completely ignored the fact that the 80% figure is a deception because it includes subprime mortgages loaned through “independent mortgage companies” who are just middle men for banks, including CRA banks.

The domino effect of the CRA has nothing to do with the amount of subprime mortgages through the CRA, it has to do with the mindset. After the CRA was signed and expanded it pushed this mindset that the government had to make sure everyone had a house, and that owning a house was darn near a right in this country. That mindset lead to Fannie and Freddie backing these bum mortgages and the government restricting mergers of banks through CRA standards.

You need to do some additional research into the CRA. Countrywide was a lending business, not a bank that required FDIC insurance… therefore had NO OBLIGATION under the CRA and indeed set it’s own standards that were often LESS cautious than the standards in the CRA that you keep saying forced them to make bad loans.

Countrywide is (or was) an FDIC insured bank, hence why they have a website dedicated to their banking sector, and on that website they have a nice scrolling graphic that advertises “maximize your FDIC coverage.” And at the bottom of their website they have a fun little graphic that says “Member FDIC.”

The CRA didn’t force any non FDIC insured lending company to do anything. Check out the Home Mortgage Disclosure Act. 84.3% of the “subprime” or “high-cost” loans in 2006 were NON-CRA. The Federal Reserve clearly states that non-CRA lenders were twice as likely as CRA lenders to issue subprime loans to “vulnerable” lenders.

As I’ve stated before, and as you pointed out in your original comment, a lot of those loans were through “independent mortgage companies” who are simply middle men for banks, including CRA banks. So that statistic is very deceiving.

Non-CRA lender’s standards were often LOWER than those required in the CRA, so if they HAD used those standards, they would’ve be better off today.

I’m not sure where the heck you’re getting that statistic, when the CRA was revised in 1995 it basically made the lending requirements as low as you can get.

In the revised version of the act, the lenders were told that proof of income, source of down payment and credit history of a person would no longer be required for qualifying criteria. Boston Federal Reserve made sure that the banks end up giving loans to people with poor credit records.

Meanwhile in 2007 43% of banks tightened their mortgage lending standards.

Government intervention is not the source of the credit crisis. There’s plenty of blame to go around, from predatory lenders, to deregulation, to greedy trading of credit default swaps… but emphasizing the CRA as a “talking point” for why the housing bubble burst seems like blaming a drop of water for the size of the ocean.

Government intervention is the source of the credit crisis, as I’ve laid out. From the CRA to Fannie Mae and Freddie Mac, the government was pressuring banks to lend to borrowers who would otherwise not be qualified. On top of that when these banks fail, mainly because of government intervention although greed is a factor, we don’t let them fail. We buy them out, we nationalize them, we buy off their bad loans. The only way the free market works is if we allow failure.

It certainly wasn’t deregulation that caused this mess. The Bush Administration has actually done little to deregulate the financial markets. It has been more of a “hands off” approach, he hasn’t increased regulation and he hasn’t decreased regulation.

When it comes to financial regulation, for example, until the crisis of the last few months, the administration did little to alter a regulatory structure that was built over many decades. Banks continue to be governed by a hodgepodge of rules and agencies including the Office of the Comptroller of the Currency, the international Basel accords on capital standards, state authorities, the Federal Reserve and the Federal Deposit Insurance Corporation. Publicly traded banks, like other corporations, are subject to the Sarbanes-Oxley Act.

Furthermore the democrat’s idea that Wall Street cannot regulate itself is absurd. Any free market system can regulate itself if you allow failure. By taking out failure you take out the built in regulation that free markets provide. I’m not saying the government have no oversight, but we certainly have to allow institutions and companies to fail once and a while.

Democrats love to point to the greed on Wall Street for causing this mess. And I agree, greed was a factor, but the only way to correct greed is by letting the greedy fail at their game. Let me ask this, who got punished in this mess? Did the greedy on Wall Street get punished? Nope. Did the government, who forced banks, or at least promoted the mindset, of giving out subprime mortgages, get punished? Nope. The taxpayers got punished. That’s unfair.

–jb

2 Comments