Bad government policies, including too-prolonged expansion of the money supply and haphazard financial-sector regulation, are major components of the economic mess we now face. But their interactions are complex.
Unfortunately, a simplistic myth is increasingly voiced — that everything would be hunky-dory if the federal government had not forced otherwise unwilling lenders to make risky loans to poor people.
U.S. Rep. Michele Bachmann has been an enthusiastic propagator of the myth. In an op-ed last month, the Republican from Minnesota’s 6th District asserted: “Using the authority of the Community Reinvestment Act, the big push for subprime mortgages began in earnest during the Clinton years. Banks that didn’t play ball were subject to serious fines and lawsuits, and regulatory obstacles were placed in their way.” She went on to say that risky loans resulting from such government pressure composed the bulk of the bad mortgage-backed securities that were the precipitating cause of financial market chaos.
There are several problems with this argument.
First, the CRA includes no provisions for fines, and no bank ever has been fined for a violation. A bad CRA rating can give regulators cause to disapprove a merger or sale to another bank, but that is a rare occurrence.
More generally, the law is clear that compliance does not require any bank to make any loan that does not meet usual standards of safety and soundness.
Indeed, the original law is blandly unspecific. It requires only that banks make good-faith efforts to “meet the credit needs of their communities” in ways that are “consistent with safe and sound operations.” As first enacted in 1977, this often meant bureaucratic file-building.
Agency rules governing how the law is implemented were revised in 1995 to reduce bureaucratic requirements and clarify just what constituted compliance. These specified, for example, that lending to farms or small businesses was evidence of serving community credit needs but instituted no mandate to make any specific loans.
This revision did take place during the Clinton administration but involved all the major federal bank regulators including the FDIC, the Comptroller of the Currency and the Federal Reserve.
At that time, five of the seven Fed governors were Reagan or George H.W. Bush appointees, and the governor most directly involved in CRA matters was Lawrence Lindsey, the only true-blue supply-sider ever to serve on the board. (Lindsey went on to be President George W. Bush’s key economic adviser until he committed the faux pas of saying a war in Iraq might cost as much as $250 billion.) Thus, the CRA revisions did not spring from a clique of liberal zealots.
A second problem with blaming CRA for subprime lending is that the law applies only to depository institutions insured by the FDIC. The vast number of subprime loans, including virtually all “Alt-A,” “stated-income,” “liar loans” and those with “negative amortization,” were made by lenders exempt from CRA and other federal bank regulations.
In 2006, at the height of the boom, lenders subject to CRA made only 15 percent of all subprime loans, and their share of all such loans made to low-income households was about the same.
If you look at the 25 largest issuers of subprime loans, only one was a lender subject to CRA. The rest were non-depository mortgage lenders like New Century Financial, Ameriquest and Countrywide. Since these lenders did not have banking charters and did not accept deposits, they were not subject to most federal banking regulation, including CRA.
Third, thousands of banks passed CRA examinations without ever making a subprime mortgage. Thus, it stretches credulity to argue that the government was using this act to force banks to make unsafe loans.
Western Bank, a family-owned, state-chartered bank here in St. Paul, is a prime example. Steve Erdall, its CEO for the past two decades, said on his recent retirement: “I’m really proud that we’re a high-performing bank, that we get the highest grades under the Community Reinvestment Act and that we proved that you could be profitable in the inner city of St. Paul. We’ve been lucky, but you didn’t have to be smart to stay away from subprime mortgages. That was mortgage-broker and investment-banker greed.”
That states it pretty well.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.