We all know what caused the subprime crisis: a distinct lack of regulation that allowed fly-by-night mortgage originators make really expensive loans (often to people who could not afford them) and sell these loans immediately to the securitizers, who would package them up and send them to buyers around the world who had no idea what they were getting. This game worked well as long as house prices kept increasing. But there is a group of people out there who are claiming that the crisis is a result of too much regulation, not too little, and in particular that kind of “politically correct” regulation that forced banks to lend to minorities when they were really a poor credit risk.
Now, thankfully, Robert Gordon has debunked this myth in its entirety. At the heart of the issue is the 1977 Community Reinvestment Act (CRA), which simply required banks to lend in the communities they serve. This came in response to evidence that minorities were being systematically frozen out of the lending market, for no other reason than that they were poor and a minority. Racism was rampant. Remember, 1977 was only a decade after the assassination of Martin Luther King. So, the story goes, it was the CRA that got us into this economic mess, and the fault is clearly government regulation, social engineering, and all that goes with it. This theory started bouncing around the far-right Free Republic website, until it was picked up by a Cato Institute affiliate named Stan Liebowitz, and then hawked on the National Review blog.
Nice talking point, but completely bogus. Why?
Well, first, the timing is off. CRA dates from 1977, and yet the subprime mortgage market took off in the middle of this century. In fact, in 2004, the Bush administration actually watered down the CRA requirements, before the bulk of subprime lending.Second, the CRA is restricted banks and thrifts that are federally insured. These were not the entities responsible for the subprime mess. At least half of all subprime loans were issued by mortgage originators outside the jurisdiction of the CRA. Another 25-30 percent came from bank subsidiaries and affiliates, where CRA is much weaker. Only 20-25 percent of subprime loans came from an institution fully under the CRA.
And third, the most dangerous lending was made precisely by those entities not subject to the CRA. Gordon quotes Janet Yellen, president of the San Francisco Federal Reserve, who notes that independent mortgage companies made subprime loans at twice the rate of banks and thrifts. In fact, Yellen notes that CRA has been a force of moderation at the same time as increasing responsible lending to low- and moderate-income households. The late Ned Gramlich, former Fed governor, made similar points. While Greenspan’s free market ideology blinded him, Gramlich was raising the alarm and calling for more regulation of mortgage entities. But Gramlich had only good things to say about the CRA: “banks have made many low- and moderate-income mortgages to fulfill their CRA obligations, they have found default rates pleasantly low, and they generally charge low mortgages rates. Thirty years later, CRA has become very good business.”
So there you have it. The CRA is a nice convenient scapegoat for those who want to keep living, Goundhog Day style, in 1981– getting to attack government regulation and social policy that benefits minorities at the same time. Except that the argument is simply wrong. This is 2008. The villain here is the free market.