Mortgage Mess Part 7--The CRA on Steroids

Okay, blame the Democrats and poor people for the financial crisis. Some people may believe you. Most will NOT believe you.
 
Even if it were true that the Democrats ALONE were behind the vast increase in loans to the poor, you would still have to show that it was mainly loans to the poor that caused the crisis. In fact, the Bush administration also increased loans to the poor, and the main cause of the crisis was the Real Estate Bubble (remember the bubble, when thousands of people, mainly middle-class people, were “flipping” houses?).  The cause of the Real Estate Bubble was NOT sub-prime mortgages. It was low interest rates. Indeed, some investment banks were able to borrow money to make loans at virtually no interest expense to them, by borrowing on the Japanese market in the so-called “carry trade.”

To be sure, in the recent past a lot of poor people have defaulted on their mortgages, but they constitute only a small percentage of the defaults (after all, they got fewer loans and smaller loans than the average). And, it is to be expected that when the economy turns poor, poor people will default more than richer people. This has always been the case, and the Community Reinvestment Act (CRA) does not force any bank or any institution to lend to people with bad credit ratings.

But this is not the cause of the crisis. What about the banks and investment banks that took on billions of dollars in mortgage-backed paper? They did NOT do it because they were forced to, or because they are Democrats, or because they love the poor. For example, the Bank of China took $9 billion in sub-prime paper, and Switzerland’s UBS lost $30 billion (so far) on sub-prime paper. To some extent, they did this because the rating agencies (such as Moody’s and S&P may have rated that paper higher than they should have) but they did it to make money. There’s nothing wrong with making money, but neither the Democrats nor the US government were involved in these investment decisions.

What about the Auction-rate Securities that caused several money-market funds to fail. What about the trillions of dollars in Credit Default Swaps that no one regulates and apparently no one in government knows much about. All the regulators in these cases had their chairmen appointed by President Bush.

What about the regulator of Bear Sterns, Lehman brothers (and for that matter the late unlamented Enron), the SEC. Why didn’t they catch the off-balance sheet items? Why didn’t the rating agencies like Moody’s and S&P catch the enormous debt that these companies had? For that matter, why did Moody’s and S&P rate some of the mortgage backed securities, that are now nearly worthless as AAA, when they were more like DDD? We don’t know yet, but obviously there is a lot of blame to go around. And, not in the USA only. Reading up on the crisis last night I read that last year the Bank of China admitted to having bought some $9 billion worth of sub-prime mortgage paper. The Swiss investment bank UBS has already lost some $30 billion – and on and on.

Where this relates to the debate about Fannie and Freddy and about the Democrats is to remember that NO ONE forced UBS or Deutsche Bank or Bear Sterns or anyone to buy sub-prime mortgages. They did so out of the normal investment motive: They thought that they could make money on the investment. They were mistaken, much like the folks who in September 1929 (one month before the crash) bought stock. They might be blaming their broker for having advised them to buy, or Moody’s and S&P for having missed something. But ultimately it was their decision. This plus the practice of investment banks of holding their suspect sub-prime investments off the balance sheet plus ENORMOUS leverage (lousy debt-equity ratios), were main causes of the crisis.

There are those that think that the crisis was mainly caused by Democrats pushing banks to make loans in minority areas. It is true that Democrats did this, but so did the Bush Administration, and indeed, Bush helped expand home ownership among minority groups. Here he is when signing the “American Dream Downpayment Act of 2003.” (Begin quotes)

President Bush Signs American Dream Downpayment Act of 2003

I am here today because we are taking action to bring many thousands of Americans
closer to owning a home. Our government is supporting homeownership because it is
good for America, it is good for our families, it is good for our economy.

One of the biggest hurdles to homeownership is getting money for a down payment.
This administration has recognized that, and so today I'm honored to be here to sign
a law that will help many low-income buyers to overcome that hurdle, and to achieve
an important part of the American Dream.

This administration will constantly strive to promote an ownership society in
America. We want more people owning their own home. It is in our national interest
that more people own their own home. After all, if you own your own home, you have a
vital stake in the future of our country. And this is a good time for the American
homeowner. Today we received a report that showed that new home construction last
month reached its highest level in nearly 20 years.

  The reason that is so is because there is renewed confidence in our economy. Low
interest rates help. They have made owning a home more affordable, for those who
refinance and for those who buy a home for the first time. Rising home values have
added more than $2.5 trillion to the assets of the American family since the start
of 2001.

The rate of homeownership in America now stands a record high of 68.4 percent. Yet
there is room for improvement. The rate of homeownership amongst minorities is below
50 percent. And that's not right, and this country needs to do something about it.
We need to -- (applause.) We need to close the minority homeownership gap in America
so more citizens have the satisfaction and mobility that comes from owning your own
home, from owning a piece of the future of America.

Last year I set a goal to add 5.5 million new minority homeowners in America by the
end of the decade. That is an attainable goal; that is an essential goal. And we're
making progress toward that goal. In the past 18 months, more than 1 million
minority families have become homeowners. (Applause.) And there's more that we can
do to achieve the goal. The law I sign today will help us build on this progress in
a very practical way.

Many people are able to afford a monthly mortgage payment, but are unable to make
the down payment. So this legislation will authorize $200 million per year in down
payment assistance to at least 40,000 low-income families. These funds will help
American families achieve their goals, and at the same time, strengthen our communities.

End quotes.

The Community Reinvestment Act does NOT require that banks make loans in any particular case. There is nothing in any law that says to a bank: “You must make a loan to this guy even though he does not have a job and puts nothing down.” If banks made more loans to the poor than might have been prudent, it was not the law that required them to do so.

Why then did they do so? Not to fight racism. It was simply TO MAKE MONEY.

In retrospect, it seems absurd that increasing lending in poor areas might be considered a good risk-reward investment. But, you have to remember that the banks involved thought that they could get rid of the risk through the practice of “securitizing” the loans (dividing them up, bundling them with hundreds of other loans, getting them rated by Moody’s or S&P, and selling them off to some other jerks, like maybe the Bank of China, or maybe Washington Mutual and Citibank.)

Certainly it was this idea that a securitized package of loans was a highly secure investment that lead to the gigantic investments in sub-prime loans, NOT a desire to help the poor or to expand lending in redlined areas.