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Tuesday, April 08, 2008

"Did Liberals Cause the Sub-Prime Crisis?"

One response to the housing crisis has been to blame a 1977 law that prevents lenders from red-lining or other practices that limit the availability of credit in low-income neighborhoods for the problems. However, the evidence is inconsistent with this idea:

Did Liberals Cause the Sub-Prime Crisis?, by Robert Gordon, TAP: The idea started on the outer precincts of the right. Thomas DiLorenzo, an economist who calls Ron Paul "the Jefferson of our time," wrote in September that the housing crisis is "the direct result of thirty years of government policy that has forced banks to make bad loans to un-creditworthy borrowers." The policy DiLorenzo decries is the 1977 Community Reinvestment Act, which requires banks to lend throughout the communities they serve.

The Blame-CRA theme bounced around the right-wing Freerepublic.com. In January it figured in a Washington Times column. In February, a Cato Institute affiliate named Stan Liebowitz picked up the critique in a New York Post op-ed headlined "The Real Scandal: How the Feds Invented the Mortgage Mess." On The National Review's blog, The Corner, John Derbyshire channeled Liebowitz: "The folk losing their homes? are victims not of 'predatory lenders,' but of government-sponsored -- in fact government-mandated -- political correctness."

Last week, a more careful expression of the idea hit The Washington Post, in an article on former Sen. Phil Gramm's influence over John McCain. ... [T]he Brookings Institution's Robert Litan ... suggested that the 1990s enhancement of CRA, which was achieved over Gramm's fierce opposition, may have contributed to the current crisis. "If the CRA had not been so aggressively pushed," Litan said, "it is conceivable things would not be quite as bad. People have to be honest about that." ...

The revisionists say the problem wasn't too little regulation; but too much, via CRA. The law was enacted in response to both intentional redlining and structural barriers to credit for low-income communities. CRA applies only to banks and thrifts that are federally insured; it's conceived as a quid pro quo for that privilege. This means the law doesn't apply to independent mortgage companies (or payday lenders, check-cashers, etc.)

The law imposes on the covered depositories an affirmative duty to lend throughout the areas from which they take deposits, including poor neighborhoods. The law has teeth... Studies ... have shown that CRA increased lending and homeownership in poor communities without undermining banks' profitability.

But CRA has always had critics... Rhetoric aside, the argument turns on a simple question: In the current mortgage meltdown, did lenders approve bad loans to comply with CRA, or to make money?

The evidence strongly suggests the latter. First, consider timing. CRA was enacted in 1977. The sub-prime lending at the heart of the current crisis exploded a full quarter century later. ... In late 2004, the Bush administration announced plans to sharply weaken CRA regulations... Yet sub-prime lending continued, and even intensified -- at the very time ... the law had weakened.

Second, it is hard to blame CRA for the mortgage meltdown when CRA doesn't even apply to most of the loans that are behind it. ... Perhaps one in four sub-prime loans were made by the institutions fully governed by CRA.

Most important, the lenders subject to CRA have engaged in less, not more, of the most dangerous lending. Janet Yellen, president of the San Francisco Federal Reserve, offers the killer statistic: Independent mortgage companies, which are not covered by CRA, made high-priced loans at more than twice the rate of the banks and thrifts. With this in mind, Yellen specifically rejects the "tendency to conflate the current problems in the sub-prime market with CRA-motivated lending." ...

Yellen is hardly alone... One of the only regulators who long ago saw the current crisis coming was the late Ned Gramlich... But Gramlich praised CRA...

It's telling that, amid all the recent recriminations, even lenders have not fingered CRA. That's because CRA didn't bring about the reckless lending at the heart of the crisis. Just as sub-prime lending was exploding, CRA was losing force... And the worst offenders, the independent mortgage companies, were never subject to CRA -- or any federal regulator. Law didn't make them lend. The profit motive did. ...

    Posted by on Tuesday, April 8, 2008 at 01:33 AM in Economics, Financial System, Housing, Policy, Regulation | Permalink  TrackBack (0)  Comments (40)

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