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Community Reinvestment Act not to blame?

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brian0918

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I pointed to the CRA as being part of the problem that led to this crisis, and was sent this study which appears to claim the opposite. Has anyone seen this study or its conclusions?

The Community Reinvestment Act: A Welcome Anomaly in the Foreclosure Crisis

Conclusion:

Our study suggests that without the CRA, the subprime crisis and related spike in

foreclosures might have negatively impacted even more borrowers and neighborhoods.

Compared to other lenders in their assessment areas, CRA Banks were less likely to make a high

cost loan, charged less for the high cost loans that were made, and were substantially more likely

to eschew the secondary market and hold high cost and other loans in portfolio. Moreover,

branch availability is a key element of CRA compliance, and foreclosure rates were lower in

metropolitan areas with proportionately greater numbers of bank branches.

Prior to the foreclosure crisis, some had suggested that the boom in subprime mortgage

lending, by easing access to credit for LMI borrowers, rendered the CRA irrelevant or obsolete.16

However, the demise of subprime lending, even if only temporary, and the lower proportion of

high cost loans made by CRA Banks even when the subprime market was thriving, suggest that

the CRA still has a vital role to play.

Of course, CRA Banks, even in their own assessment areas, have a relatively small

portion of the mortgage market. In the 15 metropolitan areas analyzed, the CRA Bank market

share of all loan originations was less than 25 percent, limiting the law’s impact on the subprime

crisis.

Because the vast majority of mortgage lending is done by other entities, some have

suggested extending CRA-like obligations to other lenders as a way of limiting the volume of

high cost loans and the problems associated with them. While extending the CRA to bank

affiliates and subsidiaries that lend in the bank’s community may have some merit, we believe

that the presence of local brick and mortar branches was as important a reason for CRA Banks’

better performance than fear of a less than satisfactory CRA evaluation.

Branches demonstrate a bank’s commitment to and investment in a community. The ongoing

interaction between bankers and residents that occurs at a deposit-taking branch provides

insight into credit needs that may enable banks to make more reliable assessments of borrowers’

creditworthiness and to avoid making loans that are likely to default. In addition, by providing

borrowers with a convenient location at which to apply for mortgage loans, branches may serve

as a magnet for attracting creditworthy borrowers. Without a branch nexus, it is doubtful

whether the same benefits can be realized for other lenders.

Edited by brian0918
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Here is the most crude version of the argument that says the CRA was the cause: because banks were forced to lend to poor people, those people are now defaulting.

Here is the problem with this argument: Bear Stearns, Lehman, and AIG did not make mortgages directly. They bought the the paper, and related derivatives. They did so voluntarily. Here is how one would expect this to operate: the bank giving the poor loan is stuck with the cost. People would be willing to buy the mortgage-paper from them, but only at (lower) prices that account for poorer quality.

As I said in this post, I have not yet seen anyone demonstrate that CRA was the primary cause of the current crises, at least in the direct way assumed by the argument above. Therefore any argument that traces CRA as a cause has to be more subtle than that.

However, that "study" does not show much that is unexpected. Basically, it says that the CRA banks lent money to the poor at lower rates than other lenders. (This is as expected, because they were forced to lend. The non-CRA lenders would want to charge more.) It tries to make a follow-on argument that because these banks were forced to lend at lower rates, there is less chance that their borrowers defaulted. That's possible, but the study does not explore this, except with the final data relating foreclosures to the prevalence of bank-branches. That is too highly aggregated for any conclusions to be drawn.

Basically, it's like the government forced a set of relatively responsible drug-dealers to go into some areas, and then shaddier operators began to flourish, promising more than the staid government-sponsored vendors.

Finally though, the CRA is only one element in the government's milieu of home-ownership incentives.

Fannie and Freddie are a big part of it too. Originally, these institutions were aimed at the middle class. If you were sub-prime, or if your home was over the $400K range, Fannie/Freddie would not buy that mortgage. However, around 2004, these government-sponsored firms started buying sub-prime based paper. (It was a special type, which was rated AAA.) I think they were buying about 20% of the paper. Again, here too you can ask: why were others voluntarily buying the other 70-75% of it?

Low interest rates in the post-dot-com years was another factor. The Fed wanted to stifle the effects of the dot-com bust. Interest rates were kept low. Recently hit by the stock market, some people started to see housing as a good investment (which it rarely is). Around 2003, apartment rental companies were giving big discounts because there was a move to home ownership. A bubble like this can be started by the government, but people get carried along. In essence, the government is distorting the price-mechanism in the market, and leading people into incorrect calculations. For example, for the home-building companies, seeing the rush of orders, it becomes difficult to untangle how much is a true shift and how much is caused by temporary government impetus.

With no presumption of equal weighting, I see the intellectual roots as coming from two sources: socialism/government intervention and "modern finance theory". These two things lead people astray. Added to that, one has the charlatan Cinderellas (both on Main Street and on Wall Street) who are happy to play along, hoping to leave the ball just before the clock strikes midnight (to borrow a Buffett analogy). The CRA is just one aspect of the government-intervention portion.

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Here is the most crude version of the argument that says the CRA was the cause: because banks were forced to lend to poor people, those people are now defaulting.

Here is the problem with this argument: Bear Stearns, Lehman, and AIG did not make mortgages directly. They bought the the paper, and related derivatives. They did so voluntarily. Here is how one would expect this to operate: the bank giving the poor loan is stuck with the cost. People would be willing to buy the mortgage-paper from them, but only at (lower) prices that account for poorer quality.

As I said in this post, I have not yet seen anyone demonstrate that CRA was the primary cause of the current crises, at least in the direct way assumed by the argument above. Therefore any argument that traces CRA as a cause has to be more subtle than that.

However, that "study" does not show much that is unexpected. Basically, it says that the CRA banks lent money to the poor at lower rates than other lenders. (This is as expected, because they were forced to lend. The non-CRA lenders would want to charge more.) It tries to make a follow-on argument that because these banks were forced to lend at lower rates, there is less chance that their borrowers defaulted. That's possible, but the study does not explore this, except with the final data relating foreclosures to the prevalence of bank-branches. That is too highly aggregated for any conclusions to be drawn.

Basically, it's like the government forced a set of relatively responsible drug-dealers to go into some areas, and then shaddier operators began to flourish, promising more than the staid government-sponsored vendors.

Finally though, the CRA is only one element in the government's milieu of home-ownership incentives.

Fannie and Freddie are a big part of it too. Originally, these institutions were aimed at the middle class. If you were sub-prime, or if your home was over the $400K range, Fannie/Freddie would not buy that mortgage. However, around 2004, these government-sponsored firms started buying sub-prime based paper. (It was a special type, which was rated AAA.) I think they were buying about 20% of the paper. Again, here too you can ask: why were others voluntarily buying the other 70-75% of it?

Low interest rates in the post-dot-com years was another factor. The Fed wanted to stifle the effects of the dot-com bust. Interest rates were kept low. Recently hit by the stock market, some people started to see housing as a good investment (which it rarely is). Around 2003, apartment rental companies were giving big discounts because there was a move to home ownership. A bubble like this can be started by the government, but people get carried along. In essence, the government is distorting the price-mechanism in the market, and leading people into incorrect calculations. For example, for the home-building companies, seeing the rush of orders, it becomes difficult to untangle how much is a true shift and how much is caused by temporary government impetus.

With no presumption of equal weighting, I see the intellectual roots as coming from two sources: socialism/government intervention and "modern finance theory". These two things lead people astray. Added to that, one has the charlatan Cinderellas (both on Main Street and on Wall Street) who are happy to play along, hoping to leave the ball just before the clock strikes midnight (to borrow a Buffett analogy). The CRA is just one aspect of the government-intervention portion.

I have always known (since the time I first grasped the role of the FED) that the Federal Reserve played a big part in this.

According to Dr. Brook, it was a combination of the CRA, the FED, Fannie and Freddie, and the Bush initiative that said that "everyone who wants to own a home ought to be able to have one" and the ensuing lax lending standards pushed by Fannie and Freddie. His argument made pretty decent sense.

EDIT: Also...the long-standing policy of "too big to fail". That explains the reason why some large corporations would snap up risky investments. The analogy I read was that many of these large institutions acted like ordinary individuals act when they go to open a bank account. For the most part, they don't care who they do business with. Some interest-rate shoppers aside, a bank is a bank, and since all banks are Federally insured, you don't need to worry too much about how financially sound they are or what their lending practices are.

Edited by prosperity
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As I said in this post, I have not yet seen anyone demonstrate that CRA was the primary cause of the current crises, at least in the direct way assumed by the argument above. Therefore any argument that traces CRA as a cause has to be more subtle than that.

Any thoughts on the notion that M&A activity had to pass CRA screens before being allowed? It is common place practice now to anticipate any sort of regulatory hurdles and many tmes simply roll on them in the interest of expediency.

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The CRA is a bad law. The government encouraged people to take loans when banks thought those people were bad risks. The government was surely doing those borrowers no favors as a group, even though some of them might have benefited. However, as bad as it was, the CRA is a small piece of the puzzle... more like a symptom than a cause.

To answer your specific question, Kendall: I'm sure CRA forced banks to give bad loans. That's not in contention. However, if was primarily forced loans that all players continued to know were bad, it would hurt the lenders and borrowers, but go no further. The bank would be forced to "eat" the cost of those loans, by writing down the value to match its expectation of losses. In that scenario, the deed is done, with little implication to the bank's subsequent P&L . However, the bank may not do that. Instead of writing the loan down, it may kid itself that it will perform better because <fill in reason here>. Or, it may convince others about such loans, and have them buy them.

This is the point at which the effect of Fannie/Freddie matter: because at some point they became involved in buying the sub-prime paper. Over all, with such a big player in the market, it makes it easier for the banks to sell those poor loans. So, analytically, it is the incentive from Fannie/Freddie that is providing the ability to evade. However, if we blame Fannie/Freddie, we must also understand that they bought the AAA-rated tranches of the sub-prime, while other people were buying the other tranches. So, there is a further web of incentives and causation.

I think hind-sight will show that CRA had a smaller role to play than did Fannie/Freddie. I think we will find that Fannie/Freddie had a smaller role to play than did monetary and fiscal policy.

Finally, I think we'll discover that even if one aggregates all the government actions -- CRA, Fannie/Freddie, inflation, deficits -- those add up to a big a part of the problem, but do not explain a big portion. The broader issue is not just bad government, but bad philosophy. Of course, that is so abstract that while it is obvious, it is also useless in narrowing our focus. Rather, I mean bad philosophy other than its influence on government and on voters who were deciding how government should act.

Specifically, bad philosophy came in via the universities to influence professors of finance. Universities the world over have given this generation of finance graduates a higher dose of rationalism that previous generations. There are too many finance graduates who can start with certain assumptions about the risks of various events, and build a great portfolio to maximize the risk/reward ratio. However, it has made them less eager and able to question the relationship of those starting assumptions to reality.

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*** Mod's note: Post moved, from the general Financial situation discussion, to this thread. - sN ***

This article with a provocative title Did poor minorities cause the crisis? denies that the CRA/Fannie&Freddie explanation of the current crises' roots is valid. The author claims, for example:

A national study of the performance of banks covered by the Community Reinvestment Act (CRA), enacted by Congress in 1977, shows that these government-backed banks were much less likely than other lenders to make the kinds of risky, high-cost home purchase loans that helped fuel the foreclosure crisis. The average interest rate for CRA loans was much lower than other lenders. CRA banks were more than twice as likely as other lenders to keep the loans they write instead of selling them off to the highest bidder.

By and large, the problem with subprime lending was that independent, unregulated brokers pushed inappropriate loans to poor borrowers and to many American middle-class and wealthy consumers who could not qualify for their second or third vacation home and who took a "liar's loan" from brokers, not covered by CRA. These loans were then sliced and diced into mortgage-backed securities by Wall Street investment houses that then sold them to the financial institutions of the world.

And so on...

I am not knowledgeable enough to evaluate the article's arguments. What do you think of them? Thanks.

Edited by softwareNerd
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This article with a provocative title Did poor minorities cause the crisis? denies that the CRA/Fannie&Freddie explanation of the current crises' roots is valid.

Government regulations led to this mess, and that article is very short on facts. Did there arise a whole new class of exchanges on the open market? Yes, mortgage backed securities did arise because of the housing bubble, but that never would have happened had not the Community Reinvestment Act been given teeth by Clinton making banks and other mortgage institutions liable if they did not engage in the sub-prime market.

I wouldn't say that poor people or minorities caused the problem, but rather that the government catering to poor people and minorities led to the problem. I mean, if you were poor and a minority, and could have gotten a house under the CRA, then why not take advantage of it? Provided you could pay off the loan, there was no problem.

Trying to place the blame on entrepreneurs taking advantage of the bubble, which is what this article does, places no blame whatsoever on the government regulations that led to the bubble in the first place. The secondary market in MBSs would not have existed to the extent that it did without the government causing a housing bubble by injecting artificial demand into the market place by pointing a gun at banks.

The article also blames some brokers for tactics that led to more and more poor people buying a house (that they couldn't afford), but you, the individual, are responsible for what you buy on credit. If you go beyond your limits, or opted for a variable mortgage rate, and couldn't pay the bills or the mortgage, then that house is not yours and a foreclosure needs to be in the works.

Keep in mind that the standards of the Left is that more minorities and more poor people bought a house, and they don't care about the rest.

The market was coerced into this mess by the CRA and other regulations, and trying to blame the free market for making a profit from it is evil.

It is interesting that Kudlow was kicked of the set of that show, as if anyone who is for capitalism and keeping government manipulation of the markets out, will not be given his time to explain the crises. Those who are against placing the blame on the CRA and other government force want socialism or fascism. And now is their time to grab as much power as they can to get new regulations in place before people are educated as to the real cause.

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  • 5 months later...

A little story from Fox News about the FDIC and the CRA

The secret behind East Bridgewater Savings Bank's accomplishments is the careful approach of 62-year-old chief executive Joseph Petrucelli. ... ... But rather than reward Petrucelli's tactics, the FDIC recently criticized his bank for not lending enough, slapping it with a "needs to improve" rating under the Community Reinvestment Act, the Journal reported.

HT: Food or Poison blog

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Here is the most crude version of the argument that says the CRA was the cause: because banks were forced to lend to poor people, those people are now defaulting.

Here is the problem with this argument: Bear Stearns, Lehman, and AIG did not make mortgages directly. They bought the the paper, and related derivatives. They did so voluntarily. Here is how one would expect this to operate: the bank giving the poor loan is stuck with the cost. People would be willing to buy the mortgage-paper from them, but only at (lower) prices that account for poorer quality.

As I said in this post, I have not yet seen anyone demonstrate that CRA was the primary cause of the current crises, at least in the direct way assumed by the argument above. Therefore any argument that traces CRA as a cause has to be more subtle than that.

Yes, but they were only able to do so due to the increase of liquidity that the CRA created.

Edited by Rearden_Steel
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It's quite clear that it was the trigger, sine qua non, proximate cause and specific root or, route, of this mess

http://forum.ObjectivismOnline.com/index.php?showtopic=15684

Which is why I used the terms smoking gun and CSI. Also in a reply furhter down the thread, i link to the NY Time 13 September '99 that shows the beginning of it all.

As to the convoluted manner in which such things play out. well that's how it played out.

Even Bill Clinton agrees with us on this and you know what it takes to get him to badrap the Democrats.

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Where can I find statistics related to the number of CRA loans given, esp in relation to 'regular' mortgages, and how many have actually defaulted. Although I cast blame on the CRA, I've been more inclined to the position of SoftwareNerd, in that CRA is one of the least things to blame. FNMA holds, owns or guarantees, about half of the mortgage market, and I don't think there is that much of the market--including the other half not owned by FNMA--wrapped up in CRA loans. If I see the numbers I may change my mind, but until then I will continue to evaluate its influence of the housing market as low. I think FNMA was the main concrete problem because without FNMA, the housing inflation, pre-bust bubble, would have never existed. FNMA is what provided (ensured) the liquidity of the housing market by buying mortgages, allowing banks to move forward and sell more mortgages, all the while the market continued to inflate.

What's the main cause, and is to blame, is the essence of the two particulars of CRA and FNMA: Government intervention in the marketplace for the reason of increasing home-ownership because "it's good"--I think I may scour the internet for quotes by our leaders about the intrinsic value, or American dreaminess, of home owning. This is responsible for the creation CRA, as well as FNMA and the Fed's policies.

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Here's an example of how CRA bullying works to destroy banks.

A Massachusetts bank that has defied the odds and remained free of bad loans amid the economic crisis is now being criticized by the Federal Deposit Insurance Corp. for the cautious business practices that caused its rare success.

The agency also faulted the bank, which does not have a Web site, for not promoting its loan products enough, the Journal reported.

Considering his bank is doing well in tanking industry and even the FDIC’s deposit insurance fund is in trouble after paying for an upswing in bank failures, Petrucelli [the bank's 62-year-old chief executive] told the Boston Business Journal that the negative rating caught him by surprise.

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What's the main cause, and is to blame, is the essence of the two particulars of CRA and FNMA: Government intervention in the marketplace for the reason of increasing home-ownership because "it's good"--I think I may scour the internet for quotes by our leaders about the intrinsic value, or American dreaminess, of home owning. This is responsible for the creation CRA, as well as FNMA and the Fed's policies.

This is a relatively good explanation of Fannie & Freddie and how they created the secondary market for mortgage backed securities.

http://gbr.pepperdine.edu/084/ff.html

Without that secondary market, you never would have had the vast amounts of capital flow into mortgage products. This source of funds also had the effect of further inflating the real estate bubble. Near the end, anyone could buy a house. All you had to do was sign the paperwork. Also, anyone who tries to claim that encouraging home ownership has not been a government priority for at least the last two decades must have been asleep during that time.

This article from the NY Times in 1999 talks about how Fannie Mae was easing its credit standards in an effort to further push home ownership among people with poor credit:

http://query.nytimes.com/gst/fullpage.html...;pagewanted=all

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  • 1 month later...
Here is an interview of Thomas Sowell that clearly places the housing market debacle clearly on the regulators. There is also a video, but I guess it is being overly accessed and is not readily available.

Strange coincidence that you would post this today Tom because I actually closed on the refinance of two mortgage loans this afternoon. As I was signing the mounds of paperwork required by government regulations, I was also talking with the owner of the mortgage company about the causes of the crisis. In her opinion, government programs (and agencies) designed to encourage home ownership were the primary cause. These programs and agencies were funded under both Democrat and Republican administrations and the end result was that people were encouraged to borrow amounts they could not afford to repay.

Government regulation and perverse incentives have already wrecked the housing, auto and banking industries. Now Obama is setting his sights on healthcare. Given the government's track record, it's hard to believe that a sane person could support this.

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