Did the Community Reinvestment Act Lead to the Present Financial Crisis?

With the U.S. credit crunch gone global and the $700 billion bailout package now looking like a small drop of water in a tidal wave of woe, the question of blame is now all over the media.

Who caused this mess?

If you read the Wall Street Journal you could easily come away thinking that the whole problem started when Jimmy Carter decided to sell houses to minorities.

Jimmy Carter did sign legislation that required retail banks to make an effort to make loans to minority groups. The Community Reinvestment Act or CRA was passed in 1977 under Carter’s watch and was a bipartisan attempt to address the real and serious issue of housing discrimination based on racial or ethnic heritage.

The policies initiated under Carter in the CRA were supported by both Bill Clinton and George W. Bush, as pointed out in a recent Floyd Norris column in the New York Times entitled “Who’s to Blame?”

Norris quotes a speech given by Bush not long before the housing bubble burst, in which the president underscores the government’s policy of aggressively lending to minority groups and other Americans who could not formerly afford home ownership. This policy even had a name under the Bush Administration: “The Ownership Society,” the idea being that a person who owns something has more of a stake in supporting the free enterprise system than a person who feels left out of the loop.

The Republican embrace of Bush’s “Ownership Society,” itself an outgrowth of the Carter and Clinton years and the CRA, was taken to extremes never imagined by the authors of the original legislation. In an excellent Newsweek feature entitled “Subprime Suspects” reporter Daniel Gross explains that the CRA only applied to retail deposit banks and said nothing about forcing these institutions to provide subprime lending; it only stated that lending had to be fair and had to include reasonable attempts to lend to all groups regardless of race or ehtnicity.

Gross points out that the while some major retail banks did make subprime loans to minorities in an attempt to satisfy the requirements of the CRA, the problem didn’t become truly cancerous until unregulated financial firms like Argent and American Home Mortgage began to sell “creative financing” to subprime borrowers, many of whom were actually professional people with shaky credit, real estate speculators, and middle class buyers in “bubble” states like California and Florida who were looking to purchase homes priced well beyond their means, egged on by real estate agents who were on a roll.

Gross goes on to say that

…lending money to poor people and minorities isn’t inherently risky. There’s plenty of evidence that in fact it’s not that risky at all. That’s what we’ve learned from several decades of microlending programs, at home and abroad, with their very high repayment rates. And as the New York Times recently reported, Nehemiah Homes, a long-running initiative to build homes and sell them to the working poor in subprime areas of New York’s outer boroughs, has a repayment rate that lenders in Greenwich, Conn., would envy. In 27 years, there have been fewer than 10 defaults on the project’s 3,900 homes. That’s a rate of 0.25 percent.

On the other hand, Gross remarks,

…lending money recklessly to obscenely rich white guys, such as Richard Fuld of Lehman Brothers, or Jimmy Cayne of Bear Stearns, can be really risky. In fact, it’s even more risky, since they have a lot more borrowing capacity. And, here, again, it’s difficult to imagine how Jimmy Carter could be responsible for the supremely poor decision-making seen in the financial system. I await the Krauthammer column in which he points out the specific provision of the Community Reinvestment Act that forced Bear Stearns to run with an absurd leverage ratio of 33:1, that instructed Bear Stearns hedge-fund managers to blow up hundreds of millions of their clients money, and that required its septuagenarian CEO to play bridge while his company ran into trouble.

Poor regulation and oversight and the repeal of interstate banking laws that enabled fly-by-night mortgage brokers and retail banks to sell bad loans immediately to investment banks who then chopped these loans up into creatively-conceived investment vehicles which were then sold and resold and resold again with leveraged money – none of these issues have anything to do with poor people buying houses.

It appears that there is plenty of blame to go around, but the blame ultimately rests not with the understandable and noble desire for home ownership, but rather with the very human tendency towards greed during boom times. The refusal of the government to enforce existing regulations or to maintain proper oversight fed this greed. Many financial firms in turn completely ditched any voluntary adherence to fiduciary responsibility, overthrowing such archaic notions easily and quickly when faced with the promise of enormous profits. Stockholders were loathe to stop this runaway train while their returns were still spiking, and soon they came to expect these consistently ridiculously-high returns no matter what the market conditions.

What was so terrible about the boring old days when lending institutions had to stand by the mortgages they wrote? Wells Fargo, one of the few big subprime lenders that actually kept and serviced its own mortgages, is still in fairly decent shape. Underwriting a mortgage you have to keep on your books is bound to be a more serious process than underwriting one you intend to sell to a glorified gambler minutes after closing the loan. This makes such simple sense it is hard to believe today that it was overlooked.

But that’s what happens when people catch boom fever. Reason goes right out the window.

Right now, one out of six American homeowners is upside down on their mortgage, with no end in sight to the downward spiral. Blame Jimmy Carter if you must. But don’t expect any of those homeowners, many of whom probably live right on your block, to take you seriously.

13 comments to Did the Community Reinvestment Act Lead to the Present Financial Crisis?

  • Ray

    Seem all booms are accompanied by all sorts of shady characters. Remember the pump-and-dump stock brokers
    of the internet boom?

    I won’t be surprised if a normally responsible homeowner feel tempted to simply walk away from their mortgage. Maybe he can also stand in line for the reward, er, bail out money :)

  • Hi Ray,

    Yes, I asked to be considered for the $700 billion bail-out–all of it–but they gave it to Paulson instead. So unfair! I’m trustworthy!

    Seriously I think lots of homeowners are indeed just walking away because they don’t know what else to do. That’s part of the problem. Getting some options in place to prevent that would be a good thing, but I don’t see too many of them on the immediate horizon.

    Thanks for your thoughts!

  • J.D. Seagraves

    Ray – There’s no point to “walk away.” Just stay in your house and stop paying. That’s the way to get the bailout. Of course, if you were responsible and made a hefty down payment, you’re out of luck — because in that case, it makes sense for the bank to foreclose. Only the reckless receive help in a bailout. The good and smart consumers who are in trouble now are just suckers… Just like the good and smart lenders, like Wells Fargo.

  • Roger

    I think this is the concept people don’t understand that caused the problems in sub prime lending. It was primarily mortgage and finance companies and not actual banks that caused the crisis. It’s a small, but important distinction because banks fall under CRA and the mortgage or finance companies that originated most of the sub prime loans do not. After states began passing predatory lending laws, they couldn’t charge the overblown rates and fees and all of a sudden sub prime lending wasn’t as profitable. That’s what led to the crisis; it had nothing to do with CRA.

    “Poor regulation and oversight and the repeal of interstate banking laws that enabled fly-by-night mortgage brokers and retail banks to sell bad loans immediately to investment banks who then chopped these loans up into creatively-conceived investment vehicles which were then sold and resold and resold again with leveraged money – none of these issues have anything to do with poor people buying houses.”

    One other thing I’d like to note is that while minority borrowers benefit from CRA, the law itself has nothing to do with ethnicity or race. It’s strictly based on banks serving the communities the banks are located in and serving low and moderate income (LMI) census tracts or borrowers in their lending areas. Under CRA a bank cannot create lending areas that look like a doughnut on a map and exclude the LMI census tracts.

    I have a fundamental disagreement with the Republicans (I am one by the way) who are trying to blame the problem on CRA. However I don’t think it’s fair that many are blaming racism for wanting to change or do away with CRA. I also have zero respect for those on the far right who are blaming the problem on forcing banks to give loans to minorities when nothing could be farther from the truth.

    Banks are required to serve the communities by accepting applications from LMI borrowers or borrowers who live in LMI tracts and treat them as any other loan. Many banks participate in programs or work with community organizations to assist low income borrowers and they’re given CRA credit for it, but they’re certainly not forced to give bad loans.

  • J.D. Seagraves

    What do you mean by “finance” companies?

    Mortgage companies typically only originate and/or service mortgages. If they’re not members of the Fed System, they have to use real capital and not fractional-reserve money to make loans, and thus they’re at a huge disadvantage. What’s more, most mortgages, particularly these bad ones, are packaged as mortgage-backed securities, and it wasn’t “mortgage companies” buying these up.

    The CRA is a horrible interventionist policy. But blaming the problem on the CRA or on negligence of the credit-rating firms, etc., is like blaming a guy who comes and punches a guy when he’s down, already the victim of 1000 stab wounds. The Federal Reserve System, in this case, was wielding the knife, and they’re getting away (like they always do) scot free!

  • MannyfromNYC

    It never ceases to amaze me how some people can actually write about the the subprime mortgage crisis and not even mention the role of Freddie Mac and Fannie Mae as well as that of the community activist groups such as ACORN. Professor Stan Leibowitz of University of Texas, Dallas and wrote better articles in the New York Post.

    Of course, the CRA advocates would deny that this law didn’t force banks to make bad loans, but no article I’ve read suggests that the CRA in its original form was solely responsible. But when you take into account a number of different factors,-such as the requirements that the banks must collect racial data on those they provide mortgages to that they were under pressure to make sure that they had sufficient numbers of minority borrowers. Otherwise, ACORN, the NAACP, and other activist groups would come down on them with accusations of racial discrimination in lending. What lending institution would welcome that? Ah, but congress gave them a way out. Comply with the racial numbers and just sell your mortgage to Fannie Mae and Freddie Mac! I must admit-before this year, I only had a vague notion about what Freddie Mac and Fannie Mae did. When I found out that they bought up mortgages from the banks, I knew right away that this spelled trouble….We you mix those two with the CRA, racial and social agenda politics, plus pressure from activist groups, you had a sure fire recipe for disaster!
    I am strongly opposed to the existence of Fannie Mae/Freddie Mac and the CRA for philosophical and economic reasons.

    The federal government should not be in the business of requiring banks to provide loans to anyone who does not possess a sufficient credit rating, especially to advance a social or political agenda. Otherwise, injecting politics will only invite trouble and that’s exactly what happened. Okay, accepting applications is one thing, but then the banks have to show that they are meeting certain numerical targets in terms of lending by race and income level. That was bound to happen.

    The responsible way to conduct business in a sound manner would be to do so with your depositors in mind. Requiring that mortgage funds be made available to certain groups demonstrates a certain level of irresponsibility on the part of the feds.

    So now we have Fannie Mae/Freddie Mac buying up all these mortgages (good or bad) and then selling them to investors and other financial institutions, as mortgage-based securities.

    Yup, what a sure fire road to disaster…

  • J.D. Seagraves

    MannyfromNYC is absolutely correct in everything he says, but to write about the subprime mortgage crisis and not even mention the Federal Reserve System, fiat-money fractional-reserve central banking, is the true faux pas.The CRA, horrible legislation, is just a tick on the elephant that is the Fed System. The tick might give us lime disease, but the elephant has been trampling us for 95 years.

  • Evelyn Black

    Wow, lots of strong words here.

    Thank you for all your comments. It’s clear that feelings run high on this issue. I appreciate J.D.’s points about the Federal Reserve System.

    I do think that the people who made these mortgages and sold them immediately were also a big part of the problem though. There’s blame to be had at practically every level of the process.

    Two guys from the city I live in bought over 60 slum properties in 2006 & 2007 for a combined profit of $1.75 million–what they did was, they got an appraiser to overvalue the homes, took out subprime loans with out of state lenders saying they intended to fix the houses up and rent them, then resold them to EACH OTHER, walked away, and split and pocketed the profits. That’s only two guys, 60 houses, and that had nothing to do with the CRA.

    I’m no lawyer, but that sounds like mortgage fraud to me, and it has been rampant.

    And that’s only two guys, and as yet they’ve been charged with nothing. Multiply these two guys by God knows how many others and already, at the most basic level, you have a mess. The more I read, the more it appears that that kind of greed occurred at each level up the chain all the way up to the packaging and faulty rating of mortgage backed securities and it’s no wonder we’re in a mess.

    There’s an interesting book on some of the insane goings on with mortgage brokers during the boom called, “Confessions of a Subprime Lender” by Richard Bitner. I’ve got it on order. Seen the guy on TV and it sounds like a good read–plus, I have a daughter who briefly worked as a mortgage broker in 2006 and she has stories that would curl you hair. She quit after only three months. She said, “Mom, I think half this stuff is illegal.” No one cared yet.

    I just wrote about the CRA here because I’ve seen so much of this idea lately that “…poor people (blacks) bought houses because the government made banks let them buy houses and now the whole system is broken because of that.” Intelligent people who know better are out in front of the press making that claim with a straight face. That’s just way too simple and too loaded an idea, and I don’t think they even believe it themselves, it’s just politically expedient. The CRA may or may not be a good idea–that’s a separate topic. But it definitely didn’t bring down the U.S. financial system.

    Part of the problem with this issue right now, as I see it, is that it’s horrendously complex and it’s all happening right before a Presidential election. So soundbytes rule. But it’s not a soundbyte issue.

    Thanks again for all your excellent comments and for reading the post. I appreciate all of your insights.

  • J.D. Seagraves

    Yes, Evelyn, but what those guys did would be impossible under a sound monetary system. Tweaks here and there, little regulations, Community Reinvestment Acts, etc., are only incremental in nature. The entire system is unsound and that is the cause of the current crisis.

  • MannyfromNYC

    J.D. is right, it is indeed unsound. I’ve often been leery of the Federal Reserve System, myself, what with its power to influence the money supply. 1913…a year that will live in infamy….The birth of the Federal Reserve System, and the federal income tax….

    Now, regarding the CRA, here’s an excellent piece by Vern McKinley from back in 1994. Please check below for the link. This is really an eye-opener! According to McKinley, Sen. William Proxmire was the force behind its passage, but the original language was watered down among other things, because opponents -including then Federal Reserve chairman Arthur Burns felt that the government might use this law to eventually push for “mandatory credit allocation” and that’s where it it led to.

    As I said before, I have not come across any critical article that simply names the Community Reinvestment Act-in its original form, as the sole culprit. There were a lot of cooks that stirred this nasty-tasting cauldron and a lot of bad ingredients!

    Social activists and other supporters of the CRA were successful in pushing for changes (based on that highly controversial and often criticized 1992 Boston Fed study) that weakened mortgage eligibility requirements so that more minorities could qualify under revamped CRA guidelines. Not doing the bidding of regulators and activist groups could prove costly to banks who were seeking government approval for for major changes in status-such as the merging or acquiring of another entity.

    Here’s a very revealing quote from McKinley:

    “The CRA sets up conditions for a classic case of handing out other people’s money. Bankers distribute loan dollars for a living, taking on risks that could get them fired, cost them their investments as stockholders, or subject them to lawsuits from the FDIC. No similar discipline constrains the community groups or regulatory agencies. Coercion enters the picture because these community groups know that time is of the essence in merger transactions, and that any source of delay means more time, and thus, money, is consumed.”

    Ah, but the Feds offered the banks an escape hatch: Fannie Mae and Freddie Mac. There would have been far more resistance against the Feds if lenders were forced to carry potentially risky mortages on their books. Fannie Mae/Freddie Mac were only too happy to take these mortgages off the hands of the lenders. When all this was happening, hardly anyone assumed that large numbers were going to eventually default on their mortgages. That way of thinking is what fueled the subprime mortgage phenomena that evolved into a major financial crisis. Fannie Mae/Freddie Mac were supposedly raking in mega profits until congressional investigations revealed major discrepancies in their reported earnings.
    Ultimately, social agenda economic and financial policies often lead to catastrophe because market principles are ignored.

    Eventually, the CRA was going to evolve into something much bigger and more dangerous because in its original form, it did not achieve its intended goals. But once out of the bag, it was only a matter of time before racial and social politics played a more prominent role in using it to further advance a very risky agenda. In my opinion, removing one or more of these factors would have changed this situation, dramatically.

    The federal government should simply get out of the business of social engineering and promoting social agendas.

    Please refer to the link below.

    http://www.cato.org/pubs/regulation/regv17n4/vmck4-94.pdf

  • Evelyn Black

    Hi Manny,

    Thanks for the links and for your you opinions on the CRA. I’m not afraid of the CRA. I’m not even convinced the Federal Reserve is a unsound banking system, although believe me, LOTS of people share J.D.’s view and I do respect it–I’m just not sure I share it. The Fed certainly isn’t popular this year, that’s for certain, and I can see why.

    My view is that the free market is not the beautiful wild self-regulating animal right wing think tanks like the make it out to be, and that historically the free market has proved again and again that, if given a chance, it will eat its own young and anything else it can find. I think regulation is sane and necessary, and that free market will always look for ways around regulation and find them. Someone has to be enforcing the regulations, watching the free market, and preventing it from devouring Main Street.

    I see the CRA as one of many tools designed for that purpose and I still think its a decent piece of legislation. I also disagree with your sentence, “The federal government should simply get out of the business of social engineering and promoting social agendas.” I’m more on the other end of the spectrum. Due to the popularity of that statement for the past eight years (well, longer really–I’d count in the Reagan years) the U.S. now ranks 29th in infant mortality amongst all the developed nations. We have a higher prison population than any nation on earth. Our health care system is less effective and more expensive than any of the socialist systems run by any other European country. And so on–I think you get my drift.

    Anyway, I see the current meltdown as a logical consequence of 1) a free market ideology which made government comfortable with gutting regulation and not enforcing the regulations that did remain, 2) a free market ideology that gutted all trade sanctions so U.S. corporations could take their jobs overseas and leave the American economy moving money around and pumping up what few assets remained–mainly real estate.

    I also think that if we don’t start promoting a social agenda that cuts ordinary Americans in for a piece of the pie we’re going to prove Marx right very shortly here. But that’s just my opinion.

    I totally understand that at this moment, other people have strongly held other opinions.

    Thank you for taking the time to share your views.

  • J.D. Seagraves

    The Federal Reserve System is very “sound” if you love unending war, unearned profits for big business, a government that’s completely unlimited, and the redistribution of wealth from the poor and middle class to the super rich. These are the things the system was designed to make happen, and in achieving its objectives, it is very sound.

  • MannyfromNYC

    You’re welcome. I am glad I found this site. Now, on to my response. Regarding the CRA, I stand by my views because I have thoroughly examined that law and I have found it wanting. The main problem with it was not its intentions, but its consequences. Yes, the CRA-in its original form, did not cause this major financial crisis. No responsible writer has ever claimed that, but it would be grossly inaccurate to discuss this issue without taking the CRA to task. After all, a law which mandates that lending institutions offer mortgages in order to fulfill a social agenda rather than to benefit bank depositors, has the potential to fail-with catastrophic results, because it often ignores potential costs and consequences. You speak of promoting a “social agenda,” but that’s not the same thing as achieving its desired results. Isn’t that what got us into this mess in the first place? A couple of days ago, the New York Times published what a consider one of the most important articles on the subprime lending fiasco. Written by David Streitfeld and Gretchen Morgenson, it chronicles the role of Henry Cisneros, President Clinton’s Secretary for Housing and Development. It’s something that we’ve all read before especially from conservatives (but often ignored by liberal and progressive writers who to try to put a different spin on things), but it’s still very compelling because he is revealing a liberal publication, what he did that helped trigger this financial crisis.
    Here’s some quotes:
    “As the Clinton administration’s top housing official in the mid-1990s, Mr. Cisneros loosened mortgage restrictions so first-time buyers could qualify for loans they could never get before.”
    “But until recently getting a mortgage was a challenge for low-income families. Many of these families were minorities, which naturally made the subject of special interest to Mr. Cisneros…”
    ——–That’s when I immediately recalled what you referred to as “trying to cut ‘ordinary Americans’ in on a piece of the pie.” (Well, I guess this article takes Phil Gramm and a lot of conservatives off the hook, then. President George W. Bush is no “conservative.” He’s too “compassionate!” Heheheheh).
    More quotes:
    “He insists that the worst problems developed only after “bad actors” hijacked his good intentions but acknowledges that ‘people came to homeownership who should not have been homeowners.’

    ———-Gee, Henry. You should have consulted with me first before you did this. I would have told you that you were crazy to not have foreseen the problems that would occur. That’s what happens when people are so blinded by “agenda” or “idealism” that they don’t take into consideration the possible costs and consequences. That’s basic economics, right there: taking into account these factors.
    It’s like opening your house wide-open in the middle of the night-to provide easy access to relatives and friends, and then being surprised when thieves, murderers, and other riff-raff come in, ransack your home, and kill off all your family members!
    Another quote:
    “It was, he argues, impossible to know in the beginning that the federal push to increase homeownership would end so badly. Once the housing boom got going, he suggests, laws and regulations barely had a chance.”

    ————–Impossible, he says. It appears to me that Cisneros is in complete denial. The fact is, there were those who saw this crisis coming, but they were often accused of being “racist” or “lacking in compassion,” or of “depriving low and middle-income people of their rights,” as in the “right” to a mortgage or the “right” to affordable housing. That’s funny…I couldn’t find any of that in the Bill of Rights, the last time I looked. Seriously, this is not to say that access to a mortgage or having affordable housing are not good things, but let’s subject them to the laws of economics, and not promote them merely as lofty goals that have to be achieved-while ignoring potential costs.
    I’ve included the link to the entire article, below.

    http://www.nytimes.com/2008/10/19/business/19cisneros.html?partner=permalink&exprod=permalink

    Now, to answer your comments about the “free market,” I consider myself a “free market advocate,” but that to me, is like saying I “support” the laws of physics. Those laws exist whether I like them or not. That’s the way I feel about the “free market.” It’s more of an acknowledgement rather than an “advocacy.” An economic or financial decision has to take into consideration market principles-and not just mere desires or goals. We ignore these principles at our own peril. It seems to me that progressive thinkers and social agenda advocates often loathe the “free market” because they cannot simply twist it to achieve desired outcomes. So they use the political process to push their goals-with little or no concern for the potential costs and consequences to others. That’s why I distrust government and social/ political activism, for the most part.

    Now, I regard the market not as some monster “ready to swallow its young.” Instead, I liken it to the sea…teeming with life, teeming with possibilities, but also very unpredictable and potentially dangerous. If you don’t know how to swim or if you don’t know the proper way to traverse those waters, you’ll likely drown. The fact is, disregarding the market process does not insulate you from its effects. Failure to understand it or to appreciate it isn’t going to make an iota of difference. We are all subject to market forces-just by our very existence. Thank you for the opportunity to express my views in this forum.

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