The CRA Scam and its
Defenders
Wednesday, April 30, 2008
by Thomas J.
DiLorenzo
"Liberal" economists are overjoyed by the bursting of the
housing bubble, for it provides them with what they believe is another
"market failure" story. "Most analysts see the sub-prime
crisis as a market failure," Robert Gordon gleefully declared in the
April 7 online edition of The American Prospect magazine, edited
by Robert Kuttner.
Gordon does not define what an "analyst" is, and does not cite
any survey to support his claim. One suspects that his opinion is based
on an informal survey of his like-minded, left-wing friends.
Gordon is a defender of the federal government's 1977 Community
Reinvestment Act (CRA) under which the Fed and other financial regulators
have pressured/extorted banks into making more loans to
less-than-creditworthy borrowers than they would normally be willing to
risk. As such, Gordon believes in the following propositions:
- runaway greed ("market failure") on the part of lenders is
the cause of the subprime crisis;
- these same greedy lenders routinely ignore billions of dollars in
potential profits in lower-income communities because of their systemic
racism, stupidity, or both hence the need for the CRA; and
- no government agency, especially not the Fed, had anything to do with
either the creation or bursting of the housing market bubble and the
subprime crisis.
(If you think I'm establishing a straw-man argument,
read Gordon's article for yourself.)
The first two propositions flatly contradict each other, whereas the
third is unequivocally false. Fed policy which is not even mentioned by
Gordon in an article that is ostensibly about the cause of the subprime
crisis is the cause of the boom-and-bust cycle that has caused the
housing bubble and its bursting. Not "market failure" but Fed
policy.
Gordon is incensed that a few "analysts," including myself and
Professor Stan Liebowitz of the University of Dallas, have argued that
the bursting of the housing bubble has caused the chickens to come home
to roost, so to speak, after thirty years of government policy pressuring
banks to make tens of billions of dollars in bad loans to people with low
(or nonexistent) credit ratings. Neither Liebowitz nor I have argued that
every last bad loan out there is a CRA loan, but Gordon implies that we
do in a rather feeble attempt to construct a straw-man argument.
Gordon cites Fed bureaucrat Janet Yellen as the source of a "killer
statistic" that absolves the government of all guilt:
"Independent mortgage companies" which are not covered by the
CRA made many more "high-priced loans" to borrowers with bad
credit than did CRA-regulated banks, she says. Well, so what? Even if
Yellen is correct, that does not mean that CRA-regulated loans have not
caused tens of billions of dollars in defaults.
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.
By ignoring the role of the Fed in creating the whole housing-market
mess, Gordon's pronouncement that it is entirely a result of "market
failure" is laughable on its face. He also flatly denies that CRA
lending has had anything to do with why so many uncreditworthy borrowers
have defaulted now that the Fed-generated housing bubble has burst. This,
too, is an untenable position.
When the CRA was created during the Carter administration, the
administration also funded with tax dollars numerous "community
groups" that have helped the Fed, the Comptroller of the Currency,
and other federal regulatory agencies to enforce the act. Under the CRA,
if a bank wants to make virtually any change in its business operations
merging, opening up a new branch, getting into a new line of business
it must first prove to regulators that it has made "enough"
loans to the government's preferred borrowers. The (partially) tax-funded
"community groups" like ACORN (Association of Community
Organizations for Reform Now) can file petitions with regulators that
stop the bank's activities in their tracks, perhaps defeating them
altogether. The banks routinely buy off ACORN and other "community
groups" by giving them millions of dollars as well as
promising to make even more dubious loans.
In order to try to diversify the risk of these loans, the Federal Home
Loan Mortgage Company ("Freddie Mac") pioneered the
"securitization" of bundles of these high-risk loans so that
they could be sold on secondary markets. Such "securitization"
exploded during the 1990s as a result of government regulation. As Fed
Chairman Ben Bernanke himself stated in a March 30, 2007 speech entitled
"The Community Reinvestment Act: Its Evolution and New
Challenges"
(
published online by the Fed),
- Securitization of affordable housing loans expanded, as did the
secondary market for these loans, in part reflecting a 1992 law that
required the government-sponsored enterprises, Fannie Mae and Freddie
Mac, to devote a large percentage of their activities to meeting
affordable housing goals. (p. 3)
In 1994 the Riegle-Neal Interstate Banking and Branching Efficiency
Act loosened up the regulatory barriers to bank mergers. Consequently,
said Bernanke, "As public scrutiny of bank merger and acquisition
activity escalated, advocacy groups [like ACORN] increasingly used the
public comment process to protest bank applications on CRA grounds."
In other words, there was a burst of additional legalized extortion
perpetrated by the Fed and its pet "activist organizations"
beginning in the mid-1990s. As a result, says Bernanke, "banks began
to devote more resources to their CRA programs." What an
understatement.
Also in 1995, the US Treasury Department created the multibillion-dollar
"Community Development Financial Institutions" fund to
"provide banks with access [i.e., taxpayers' dollars] to new
opportunities to finance community economic development" as
"encouraged" by the CRA, said the Fed chairman.
The government also "streamlined" the regulatory requirements
for CRA loans in 1995, allowing and indeed pressuring banks to
make such loans without the benefit of many traditional credit-worthiness
criteria, such as the size of the mortgage payment relative to income,
savings history, and even income verification! Instead, the Fed told
banks that participation in a credit-counseling program, many of which
are federally funded, could be used as "proof" of a low-income
applicant's ability to make his mortgage payments. In other words,
federal bank regulators required banks to make bad loans based on
nonexistent credit standards.
In his April 26 New York Post article on the CRA entitled
"The Real Scandal," Professor Liebowitz explains how the
government's Fannie Mae Foundation singled out one bank in particular as
the role model for all other banks in America in terms of its commitment
to CRA lending: Countrywide, the nation's largest mortgage lender, had
committed to $600 billion in low-income or "subprime" loans as
of 2003. Today, Countrywide is essentially bankrupted and has been merged
with Bank of America.
The myth that the CRA would not be harmful to bank-industry profits was
hidden for years by the Fed-created housing bubble, which allowed for
easy refinancing of all the bad debt. "[The] CRA increased lending
and homeownership in poor communities without undermining banks'
profitability," Robert Gordon proudly proclaims. But now that the
bubble has burst, all those unqualified borrowers whom the government
calls "subprime," as though their credit ratings are only a
tiny, tiny smidgen below "prime" borrowers with the very best
credit ratings are defaulting on their mortgages in droves.
Bank profitability has been extremely "undermined," to put it
mildly. The bursting of the Fed-generated housing bubble is the reason
why the CRA scam was not exposed until now, despite having been in
operation for some thirty years.
Thomas DiLorenzo is professor of economics at Loyola College and
a member of the senior
faculty of the Mises Institute.
http://mises.org/daily/2963
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