Thursday, October 23, 2008

Muddying Up The Waters

By William Fisher

A 31-year-old law designed to put an end to “redlining” and other restrictive practices that effectively shut poor and minority families out of home-ownership and neighborhood development is being attacked by conservative commentators as a major cause of today’s sub-prime mortgage mess.

The charge is being incessantly repeated by some of the so-called mainstream media as well as by right-wing bloggers.

For many years, local and regional banks were happy to take deposits from people who lived in deprived neighborhoods. A large proportion of these depositors were members of racial minority groups.

But the banks did not extend credit to these depositors. Small businesses did not receive finance. Mortgage loans were not made. Supermarkets and other shops were not built, forcing residents to travel miles for their household needs. Local jobs dwindled. Crime rose. Riots broke out in some cities in the U.S. Whole neighborhoods fell apart.

Then, in 1977, when Jimmy Carter was President of the U.S., Congress passed the Community Reinvestment Act (CRA). The Act required federally regulated and insured financial institutions to show that they were lending and investing in their communities.

Initially, some local and regional banks opposed the measure. To these, it represented unnecessary government interference in the private sector and mired them in what they saw as a sea of additional paperwork.

But over the years, these banks have largely become adjusted to the requirements of the CRA. Today, most regard it as normal “cost of doing business.”

The key words here are “federally regulated and insured financial institutions.” Which means commercial banks and thrift organizations.

Not included were investment banks, mortgage brokers, and the now-bankrupt non-bank lenders such as New Century Financial Corp. and Ameriquest that underwrote most of the subprime loans that we now know were so toxic.

The reason is that these private non-bank lenders were regulated by 50 different state banking supervisors instead of the federal government – which effectively meant they were not regulated at all.

And those who champion the CRA point out that the default rate on CRA mortgages is far below the national average and many times lower than the sub-prime mortgages written by unsupervised lenders.

Ellen Seidman, Director of the U.S. Office of Thrift Supervision under President Bush 41 until 2001 and now an official at The New America Foundation, told us, “In the 30 years since its enactment, CRA has generated major changes in the manner in which banks and thrifts view and serve low- and moderate-income communities and consumers.”

Federal housing data shows it was the unregulated private sector -- not the government or government-backed companies – that was responsible for the explosion of subprime lending at the core of the crisis. According to the Federal Reserve Board, more than 84 percent of the subprime mortgages in 2006 were issued by private unregulated lending institutions and that private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year.

Nor does the timing correspond. Subprime lending offered high-cost loans to the weakest borrowers during the housing boom that lasted from 2001 to 2007. Subprime lending was at its height from 2004 to 2006.

Conservative critics of the CRA also claim that the Clinton administration pushed Fannie Mae and Freddy Mac to purchase risky sub-prime mortgage loans made to people with known poor credit histories.

These entities have operated since 1968 as government sponsored enterprises (GSEs). This means that, although the two companies are privately owned and operated by shareholders, they were assumed to be protected financially by the support of the Federal Government – and now, both have been taken over by the Government.

Fannie Mae was created in 1938 as part of President Franklin Delano Roosevelt's New Deal. The collapse of the national housing market in the wake of the Great Depression discouraged private lenders from investing in home loans. Fannie Mae was established in order to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing.

But Fannie and Freddie aren’t lenders, to minorities or anyone else. They purchase loans from private lenders who actually underwrite the loans. In an effort to promote affordable home ownership for minorities and rural whites, the Department of Housing and Urban Development (HUD) set targets for Fannie and Freddie in 1992 to purchase low-income loans for sale into the secondary market that eventually reached 52 percent of loans given to low-to moderate-income families.

But these loans, and those to low- and moderate-income families, represent a
small proportion of overall lending. Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding 48 percent of the subprime loans to holding about 24 percent. Among the reasons is that Fannie and Freddie were supervised by far more robust standards than most of the unregulated players in the private sector. Most of these unregulated players have now gone bankrupt or are in serious legal trouble.

During the same three-year period, these same unregulated private investment banks dominated the mortgage loans that were packaged and sold into the secondary mortgage market. According to McClatchy News Service, in 2005 and 2006, the private sector securitized almost two thirds of all U.S. mortgages, supplanting Fannie and Freddie.

Ellen Seidman, who successfully presided over the thrift crisis in the 1980s and 1990s -- the failure of 2412 savings and loan associations -- testified to Congress that “Billions, perhaps trillions, of dollars of credit and investment has come into these communities spurred, incented, or directed by the Act and collateral laws such as the Home Mortgage Disclosure Act (HMDA), various anti-discrimination statutes, and obligations placed on Fannie Mae and Freddie Mac. And while there was a time when those subject to CRA complained bitterly about it, in general that time has passed.”

But despite a substantial body of evidence to the contrary, conservative critics of the CRA continue to blame it for the nation’s economic woes.

Conservative columnist Charles Krauthammer wrote recently that while the goal of the CRA was admirable, "it led to tremendous pressure on Fannie Mae and Freddie Mac — who in turn pressured banks and other lenders — to extend mortgages to people who were borrowing over their heads. That's called subprime lending. It lies at the root of our current calamity."

And on FOX News, commentator Neil Cavuto remarked, “I don't remember a clarion call that said Fannie and Freddie are a disaster. Loaning to minorities and risky folks is a disaster.