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Thursday, April 16, 2009

The Community Reinvestment Act and the Sub Prime Explosion

This particular piece that I wrote, a financial crisis white paper, was linked by several places including this site. Here is how the proprietor introduced my piece.

I highly recommend that you read it. It is not complete however, leaving out the initial causes which forced banks to making risky loans in the first place: flawed government policies during the Carter and Clinton years... the Community Reinvestment Act of 1977 (amended in 1993)

In a similar vein, here is how the conservative blog, Powerline, analyzes President Obama's recent speech at Georgetown.

Obama omits any mention of the Community Reinvestment Act, the Federal Reserve or Fannie Mae/Freddie Mac in creating the housing bubble. Rather, Obama points his finger at Wall Street. Obama finds Wall Street culpable for the growth of subprime loans. According to Obama, "the reason these loans were so readily available was that Wall Street saw big profits to be made."

The Community Reinvestment Act was an act of Congress that set minimum quotas for banks to follow as far as granting loans in low income areas. The CRA is often championed by conservative ideologues as the zenith of the mortgage crisis. Sean Hannity is the number one offender of this. That's because it's very important for conservatives to have the CRA be blamed for the crisis. That's because the CRA is exhibit A as far as government intrusion and manipulation. If the CRA is blamed for the crisis, then by extension, so to will government interference into the market place. If that's the case, then conservatives can again blame liberal big government policies for this crisis.

Now, my analyis is not incomplete as the author implies. That's because, in my opinion, the CRA is of minor consequence in causing the crisis. I say this not for any ideological reasons. There is nothing I would ideologically like more than to blame the CRA. It would affirm all my small government conservative principles. I don't blame it because from where I saw the crisis, it had nothing to do with it.

Anyone who has read any of my work on the crisis knows that I mostly blame the action of the Federal Reserve. Greenspan's lowering of the Fed Funds Rate to below 1% created loose money, in my opinion, and this lead to the crisis.

It's important to explain how I arrive at this conclusion so that I can again debunk this idea that CRA had anything of substance to do with the crisis. Sometime between the end of 2003 and the beginning of 2004, account reps from brand new sub prime banks started showing up at my mortgage company. Over the next year or so, there was an explosion in new sub prime banks. This culminated with the creation of Argent which finally lead the industry into a whole new level of irresponsible lending. Over that time, the sub prime lenders we dealt with exploded literally every week. My own mortgage company, along with most, had a centralized list of all the banks we deal with. Over that time, we could count on five new sub prime banks signing up with us just about every single week. This corresponded with the explosion in sub prime in general.

Now, of course none of the pieces fell into place at the time. Yet, as I look back, I now realize that all of these sub prime banks were popping indirectly from the loose money created by the Fed. That's because the loose money allowed banks and other financial services firms access to a lot more money. They used much of this money to make bigger plays in sub prime. That's because they eventually ran out of loans for prime borrowers (people with good credit) and found a new market in sub prime. New sub prime banks were popping up because there was a new appetite for sub prime loans. The reason that I blame the Fed is that the timing makes sense. Somewhere just under two years after the Fed Funds Rate was first lowered to below 1%, I first started seeing new sub prime banks. Six months later, sub prime was flourishing like it never had before.

Here's the important point. Those buying these sub prime loans were NOT Fannie/Freddie and they weren't doing it to satisfy their quotas for CRA. They were large insurance companies, hedge funds, private equities, banks and other financial service companies. Fannie/Freddie eventually got in on the act but by then sub prime was long flourishing.

In fact, the two loans, Home Possible and My Community, that Fannie/Freddie created to satisfy CRA were not altogether popular loans. The ridiculous stated, no money down loans weren't in any way shape or form created, funded, or fueled to satisfy CRA. CRA had almost nothing to do with their explosion or growth. The reason I don't talk about CRA in the context of the mortgage crisis is because it had almost nothing to do with it.


Anonymous said...

Have you ever heard of any instances of prime borrowers being offered subprime loans? I remember hearing someplace that HSBC and Household Financial only made subprime loans.

mike volpe said...

I've heard that charge. In my opinion, that rarely happened because prime borrowers are usually far too sophisticated to accept a sub prime loan. Many banks only dealt in sub prime.

Argent only dealt in sub prime loans. That doesn't mean that they got a lot of prime borrowers.