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Community Reinvestment Act had nothing to do with subprime crisis

Posted by: Peter Coy on October 2, 2008

Excellent piece by BusinessWeek’s Aaron Pressman over at Investing Insights, another one of our blogs. I’m republishing it here in full, but I recommend checking it out in the original.

Posted by: Aaron Pressman on September 29
Fresh off the false and politicized attack on Fannie Mae and Freddie Mac, today we’re hearing the know-nothings blame the subprime crisis on the Community Reinvestment Act — a 30-year-old law that was actually weakened by the Bush administration just as the worst lending wave began. This is even more ridiculous than blaming Freddie and Fannie.

The Community Reinvestment Act, passed in 1977, requires banks to lend in the low-income neighborhoods where they take deposits. Just the idea that a lending crisis created from 2004 to 2007 was caused by a 1977 law is silly. But it’s even more ridiculous when you consider that most subprime loans were made by firms that aren’t subject to the CRA. University of Michigan law professor Michael Barr testified back in February before the House Committee on Financial Services that 50% of subprime loans were made by mortgage service companies not subject comprehensive federal supervision and another 30% were made by affiliates of banks or thrifts which are not subject to routine supervision or examinations. As former Fed Governor Ned Gramlich said in an August, 2007, speech shortly before he passed away: “In the subprime market where we badly need supervision, a majority of loans are made with very little supervision. It is like a city with a murder law, but no cops on the beat.”

Not surprisingly given the higher degree of supervision, loans made under the CRA program were made in a more responsible way than other subprime loans. CRA loans carried lower rates than other subprime loans and were less likely to end up securitized into the mortgage-backed securities that have caused so many losses, according to a recent study by the law firm Traiger & Hinckley (PDF file here).

Finally, keep in mind that the Bush administration has been weakening CRA enforcement and the law’s reach since the day it took office. The CRA was at its strongest in the 1990s, under the Clinton administration, a period when subprime loans performed quite well. It was only after the Bush administration cut back on CRA enforcement that problems arose, a timing issue which should stop those blaming the law dead in their tracks. The Federal Reserve, too, did nothing but encourage the wild west of lending in recent years. It wasn’t until the middle of 2007 that the Fed decided it was time to crack down on abusive pratices in the subprime lending market. Oops.

Better targets for blame in government circles might be the 2000 law which ensured that credit default swaps would remain unregulated, the SEC’s puzzling 2004 decision to allow the largest brokerage firms to borrow upwards of 30 times their capital and that same agency’s failure to oversee those brokerage firms in subsequent years as many gorged on subprime debt. (Barry Ritholtz had an excellent and more comprehensive survey of how Washington contributed to the crisis in this week’s Barron’s.)

There’s plenty more good reading on the CRA and the subprime crisis out in the blogosphere. Ellen Seidman, who headed the Office of Thrift Supervision in the late 90s, has written several fact-filled posts about the CRA controversey, including one just last week. University of Oregon professor and economist Mark Thoma has also defended the CRA on his blog. I also learned something from a post back in April by Robert Gordon, a senior fellow at the Center for American Progress, which ends with this ditty:

It’s telling that, amid all the recent recriminations, even lenders have not fingered CRA. That’s because CRA didn’t bring about the reckless lending at the heart of the crisis. Just as sub-prime lending was exploding, CRA was losing force and relevance. And the worst offenders, the independent mortgage companies, were never subject to CRA — or any federal regulator. Law didn’t make them lend. The profit motive did. And that is not political correctness. It is correctness.

Reader Comments

Rick Zepeda

October 5, 2008 9:38 PM

It was pure money motive that pushed realtors and mortgage brokers to manipulate the market. Don't forget about the late night calls we all got from telemarketers telling us they can get us more cash out of help move us up into a bigger home all with no money down and no proof of income needed.

jim haughey

October 7, 2008 10:11 AM

Get your head out of the sand. the bad loans got made when the CRA mandated reviews of banks forced them to do more "affordable" mortgages. At the same time, affordable housing advocats forced Fannie and Freddie to buy them. It was a great idea. Private mortgage lenders started farming the taxpayers as well, using the implied Government guarantees of Fannie and Freddie to price junk bonds as investment grade.

Rick Zepeda

November 27, 2008 2:56 PM

Sure your right Jim but as a mortgage broker, nobody including government can force you to do these loans. You can specialize in whatever you want ( A paper, Subprime, Government loans, option arms, etc...) Also, nobody can force a mortgage broker to use fannie or freddie to get approvals. As a broker you can choose the wholesaler with the best products and most competitive rates for your client. Wholesalers were popping up everyday with new attractive loan products backed by Wall Street raising capital anyway they could including private investors and international. Everybody got into the business. Every car company, insurance company, and donut shop invested in these instruments (this is why our economy is screwed now). Everybody thought the hammer would never come down. Wake up. Nirvana is dead. What I'm saying here is that on the front lines realtors and mortgage brokers had a big influence in this economic crisis. Nobody is really talking about this part of the fraud spectrum which is huge. In other words, the back end you're talking about would not have the portfolio of loans to sell if the brokers didn't provide the bulk of meathead loans they put on the market. Get your head out of the sand. Check yourself before you wreck yourself. There needs to be an accountability on both sides. Brokers will always do what's in there best interest and not the clients unless there is an eye on them. What's best for the client ethics ends at the real estate exam. Commission and greed moves markets and in this case here (lowest rates in 40 years ) pushed equity through the roof, clients cash out to stimulate economy but got higher payments each time they did it. Everybody did this! It was the perfect storm.

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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