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Wednesday, September 17, 2008

Where Were Foreclosures Most Concentrated: Countering CRA as the Cause of the Mortgage Meltdown

In a previous post, I countered the argument that the community reinvestment act

The Community Reinvestment Act (or CRA, Pub.L. 95-128, title VIII, 91 Stat. 1147, 12 U.S.C. § 2901 et seq.) is a United States federal law that requires banks and thrifts to offer credit throughout their entire market area and prohibits them from targeting only wealthier neighborhoods with their services, a practice known as "redlining." The purpose of the CRA is to provide credit, including home ownership opportunities to underserved populations and commercial loans to small businesses.

The CRA was passed into law by the U.S. Congress in 1977 as a result of national grassroots pressure for affordable housing, and despite considerable opposition from the mainstream banking community. Only one banker, Ron Grzywinski from ShoreBank in Chicago, testified in favor of the act. [1]

was a major contributing factor to the mortgage crisis. I am really sick and tired of rank partisan opportunism using the mortgage crisis as some sort of a platform to reinforce their world view. Deregulation is the liberal's main partisan target, and the CRA is the conservative's main target. The theory goes that Congress demanded that banks lend in poorer community and so banks loosened their standards in order to lend there.

Now, first, I am no fan of the CRA, and I do believe that it had the effect that its attackers say it had, however, the effect is significantly more limited than any of the conservative partisan make it out to be. As such, while it may have had a corrossive effect on lending standards, this effect was a small blip compared to other factors.

I bring this up because I have noticed that some conservatives are once again making a play to blame the CRA for the crisis. Here is Hot Air quoting from Investor's Business Daily.

Sounds a little like the Democratic denial of problems in Social Security, doesn’t it? Nothing to see here, no crisis on the horizon. Everybody just move along, now. The Democrats had forced lenders to assume more risk at lower interest rates in the 1990s, as IBD points out today, and they didn’t want to countenance an end to their populist policies:

But it was the Clinton administration, obsessed with multiculturalism, that dictated where mortgage lenders could lend, and originally helped create the market for the high-risk subprime loans now infecting like a retrovirus the balance sheets of many of Wall Street’s most revered institutions.

Tough new regulations forced lenders into high-risk areas where they had no choice but to lower lending standards to make the loans that sound business practices had previously guarded against making. It was either that or face stiff government penalties.

Here is Charles Krauthammer yesterday on Special Report.

Look, given the fact that Obama is blaming it on Republicans and Bush policy, I'm heartened that McCain is joining in the mindless populism, blaming it on Wall Street greed. What does he think happens on Wall Street?

The causes of this are not obscure, and there are several of them. One of them is that the Federal Reserve under Alan Greenspan kept the punch bowl open for a long time with low interest rates after 9/11, which led to a wild borrowing spree of Wall Street and Main Street.

Secondly, for two decades you've had Republicans and Democrats in the presidency and also in Congress who pushed to expand lending for housing to people who hadn't had it before, particularly African-Americans, who had been denied it because of discrimination and racism, and encouraged subprime loans, which in the end collapsed in a fury and in a wave.

And, thirdly, what we had was a kind of an advance in computers in which people that derived these esoteric instruments of debt, which was understood not as a way to cheat and hide but as a way to spread the risk of mortgages.

But, ultimately, because it was obscured, it had the opposite effect of spreading the liability in a way that people aren't even sure how much they own.

Now, ironically enough, Charles is dead on with points one and two. Each of those were major contributing factors, however I couldn't disagree more that CRA was one of the three main reasons for the crisis.

To really prove that CRA was an insignificant factor, what one really needs to do is identify those areas most helped by the real estate boom and also those areas with the most foreclosures. If all these Conservatives are correct, then the real estate boom would have centered most of all in most of the poorest areas of the country and the current crisis in foreclosures would also be the same. In other words, the years 2003-2007 should have then seen an explosion in areas like Bedford Stuyvesant in New York, Englewood in Chicago, and Compton in California, and on the flip side those areas should be leading the pack for foreclosures now.

Instead, the biggest concentrations of foreclosures can be found in well to do areas like Boca Raton, Riverside County near San Diego, and of course Las Vegas. Does anyone really believe that there was an explosion of lending in Vegas because banks were attempting to meet some sort of quota of lending to poor folks? In fact, the real estate boom had a fairly negligible effect on the poorest areas of the country. In fact, the same areas Boca, Phoenix, Miami, and Vegas that boomed the most during the height of the real estate market are also now the ones suffering the most now that it is over. We aren't have a mortgage meltdown because there is an explosion of foreclosures in Englewood, though foreclosures likely exploded there, but in Phoenix and Las Vegas. To attributed the mortgage meltdown to the CRA is to assign altruism to the mortgage meltdown. We don't have a crisis because banks were trying too hard to lend to the downtrodden. We have a mortgage crisis because banks were trying too hard to lend in booming areas.

Don't get me wrong. The CRA likely did explode foreclosures in poor areas and this article clearly provides evidence of such. In fact, a more appropriate thesis might be that the CRA wound up being detrimental to the very areas it was meant to service. That doesn't mean that it was a major contributing factor to the mortgage crisis. As such, this idea that the mortgage crisis was created because banks responded to government regulation to lend more to poor folks is simply not supported by any facts. Yeah, it is a nice sounding idea, and I hate regulation as much as just about anyone. Still, facts can be inconvenient, and a thesis has to be backed up by facts. While there maybe a certain logic to this theory, it just simply is not rooted in reality, and I hope my conservative brethren will cease peddling it.

For a full summary of how we got here take a look at this piece.


Anonymous said...

New York Times 9/11/03:
" New Agency Proposed to Oversee Freddie Mac and Fannie Mae"

While the CRA may have been only one of the many factors contributing to the current crisis- the impulse behind it was certainly a major factor in warning signs of impending problems being denied.

In 2003, Bush's efforts to establish oversight mechanisms over Freddie and Fannie were opposed by Democrats, with arguments centered around the issue of affordable housing.

''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''

There's more than enough blame to extend in all directions- but the blinding ideology of social engineering is certainly one of them.

mike volpe said...

Partisanship is linking Fannie/Freddie to CRA. Nonsense. The troubles at Fannie and Freddie have nothing to do with CRA. That is another conservative fantasy. Both of them began to get more aggressive responding to Sub prim and Alt capturing more and more of the marketplace. This had absolutely nothing to do with social engineering.

Like I said, I don't think that this law is any good, but giving it any prominent blame in the mortgage crisis is nonsense.

Anonymous said...

Freddie Mac and Fannie Mae should have never bolstered the market for the subprime loans. In purchasing these shady loans from banks they made it easier for banks to make loans that shouldn't have been made.

It seems that once the heat was on the FM's, they followed more sound business practices. So the banks didn't have a place to sell their shady loans to, and the mortgage market started crumbling. Any thoughts?

mike volpe said...

I don't know how many shady loans they bought, however there would have been a massive market for these shady loans with or without Fannie and Freddie buying them.

Everyone started looking at these loans more closely once the property values stopped going up in a massive way.

Again, all of this happened because people were greedy not because they were responding to some need to help the downtrodden.

Anonymous said...

OK, I have been doing a lot of reading trying to figure this out and I want to add my 2 cents. I hope Mike will be kind enough to allow my comment and respond. To say that for the CRA to be responsible for the Mtg crisis, you would have the foreclosures occuring in CRA-based loans (e.g. subprime) is a non-sequiter. While the CRA was meant to guard against discrimination against low-income, high risk, and/or minority applicants, it did not discriminate against low risk applicants receiving the same benefits. To clarify; if a bank needed to offer more favorable terms to low income applicants to gain approval, those same benefits were also available to people who would have qualified without the favorable terms. To my knowledge, there were not separate loan packages available based upon income. In other words, if a CRA borrower could qualify with no money down and a relatively high debt to income ratio, so could a non-CRA borrower. So, all other factors being equal (and I understand they aren't) the ability to aquire overly favorable loan terns would exist across the economic spectrum and the foreclosures influenced by the CRA would not be tied only to CRA loans.

I should note that I have been active in the housing market for 25 years and I have now seen 2 housing bubbles burst. They were each preceded by attractive financing options that allowed people who wouldn't normally qualify FOR A CERTAIN LEVEL of home to qualify for it. These deals were not restricted to low priced homes or low income families. They were available to everybody and everybody suffered.

Please tell me where I am wrong.


mike volpe said...

I wrote this in another piece.

Both Fannie and Freddie created special programs to serve in those areas, Home Possible for Freddie and My Community for Fannie.

As such, they created sub set programs to serve the underprivileged. As such, either these sub set loans were the bulk of the problem, which clearly they weren't, since the foreclosures occurred in other areas. It was also possible that these loans drew in their other programs and made those easier as well. Except that the other programs didn't become easier as a result of these two programs. They became easier because both Fannie and Freddie loosened their restrictions to respond to the market share they lost.

Anonymous said...

Market share they lost to what?

If you inject new buyers at the bottom of a market, they displace the people who would have bought those "entry level" homes. This would place new pressures on the market that could resolve in various ways. If the pressure was slight or non-existent, it would effectively mean that the CRA was unsuccesful. The 1995 report showed that the CRA was succesful with a substantial increase in purchasing by the target buyers. This had to put pressure on the market by naturally increasing the total pool of buyers. How does this result in Lost Market share? I apologize if you have been through this already. I am trying to play catch up.

mike volpe said...

I don't know however what happened in 1995 had little to do with the actual mortgage crisis. That's what folks that attempt to blame CRA on this crisis can't seem to understand. If CRA was responsible, why didn't the crisis start in 1996 or 1997. If this was really due to CRA, why did it take nearly eight years for all of this to materialize. The reality is that whatever CRA did to change the dynamic of the real estate market that in and of itself was inconsequential to the mortgage crisis.

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