The recent financial crisis happened partly because of loosened lending standards, which resulted in risky loans to people with bad credit and no money for a down payment. Why were these risky loans made? One reason was government pressure. The Obama administration is now ratcheting up that pressure on banks to make more of the risky loans that led to the financial crisis. Legal commentator Ted Frank explains how we got into this mess:
“Once upon a time, banks loaned on the basis of creditworthiness. This resulted in racially disproportionate lending patterns: African-Americans and Hispanics, with higher unemployment, and lower income, savings, and educational attainment, tended to have worse credit than whites. Though there was no evidence banks were discriminating on the basis of race rather than objective financial criteria, there was government pressure to loosen lending standards and have more outreach to minorities. . . .Thus, as banks sought regulatory approval for mergers in the 1990s and early part of this century, they loosened lending standards to demonstrate their willingness to lend to minorities. Of course, it would be illegal to offer those loosened lending standards to just minorities, so lending standards were loosened across the board. And we all know what happened next. . . the mortgage bubble collapse.”
Now, reports Business Week, “the Obama administration Department of Justice has created a twenty-person task force” to bring more discrimination cases against banks that don’t make enough loans in poor or disadvantaged areas. The government is also adopting more onerous interpretations of the Community Reinvestment Act and fair-lending laws to force banks to make more risky loans:
“The 1977 Community Reinvestment Act (CRA) requires banks to make loans in all the areas they serve, not just the wealthy ones. . . . the percentage of banks earning negative ratings from regulators on CRA exams has risen from 1.45 percent in 2007 to more than 6 percent in the first quarter of this year. . . . At the Justice Dept., a new 20-person unit dedicated to fair lending issues received a record number of discrimination referrals from regulators in 2010 and has dozens of open cases. . . .Potential penalties can reach into the millions of dollars. . . . lenders are being cited for failing to operate in minority and low-income census tracts near their branches, even when they have never done business there.”
One bank was forced to open a new branch in a poor town it had never done business in before to settle charges against it.
The Wall Street Journal, Investors Business Daily, investment bankers and many economists, have argued that the Community Reinvestment Act was a key contributor to the financial crisis by virtue of regulations promulgated under the Act during the Clinton administration that greatly expanded its reach and provided powerful incentives for risky lending. Yet the Obama administration has consistently supported expanding its enforcement.
Clinton-era affordable housing mandates were also a key reason for the risky lending. The Washington Examiner cited a recent study by Peter Wallison, who had prophetically warned about risky financial practices for years, finding that two-thirds of all bad mortgages were either “bought by government agencies or required to be bought by private companies under government pressure.”
As the economist Thomas Sowell noted, liberal lawmakers imposed these mandates heedless of the consequences:
“It was liberal Democrats, again led by Dodd and Frank, who for years pushed for Fannie Mae and Freddie Mac to go even further in promoting subprime mortgage loans, which are at the heart of today’s financial crisis. Alan Greenspan warned them four years ago. So did the Chairman of the Council of Economic Advisers to the President. So did Bush’s Secretary of the Treasury, five years ago. . . . the facts show that it was the government that pressured financial institutions in general to lend to subprime borrowers, with such things as the Community Reinvestment Act and, later, threats of legal action by then Attorney General Janet Reno if the feds did not like the statistics on who was getting loans and who wasn’t.”
Sowell’s observations about the harmfulness of affordable-housing mandates are echoed in a study by Ed Pinto, a former executive of the government-sponsored mortgage giant Fannie Mae, which later had to be bailed out at a cost of hundreds of billions of dollars thanks to such mandates.
Banks and mortgage companies have long been under pressure from lawmakers and regulators to give loans to people with bad credit, in order to provide “affordable housing” and promote “diversity.” That played a key role in triggering the mortgage crisis, judging from a story in the New York Times. For example, “a high-ranking Democrat telephoned executives and screamed at them to purchase more loans from low-income borrowers, according to a Congressional source.” The executives of government-backed mortgage giants Fannie Mae and Freddie Mac “eventually yielded to those pressures, effectively wagering that if things got too bad, the government would bail them out.”
Analysts who once downplayed the harm of government mandates now think they were a major factor in causing the financial crisis. In a May 3 note to clients, Michael Cembalest, the Chief Investment Officer of JP Morgan Private Bank, revised his 2009 account of what caused the financial crisis. Under the general heading of “Retractions – the primary catalyst for the US housing crisis” he wrote:
“US Agencies played a larger role in the housing crisis than we first reported. In January 2009, I wrote that the housing crisis was mostly a consequence of the private sector… However, over the last 2 years, analysts have dissected the housing crisis in greater detail. What emerges from new research is something quite different: government agencies now look to have guaranteed, originated or underwritten 60% of all “non-traditional” mortgages, which totaled $4.6 trillion in June 2008. What’s more, this research asserts that housing policies instituted in the early 1990s were explicitly designed to require US Agencies to make much riskier loans, with the ultimate goal of pushing private sector banks to adopt the same standards.”