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Monday, November 29, 2021

CRA me a river

There is a myth. And like the myth that Columbus had the intention or effect of showing that the earth was round, it is discredited, yet repeated. This myth holds that the Community Reinvestment Act (CRA), Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac andunnecessary government intervention are to blame for the financial meltdown; that government forced otherwise righteous and omniscient financial institutions to make subprime loans, and then securitize, tranche, leverage and triple-A rate those loans for sale to each other.

As I said, this is a myth. But rather than rely on the sophistry of an ideologically driven think-tank to show that, I’m going to rely facts and data.

The CRA applies only to banks, not to private mortgage originators, and incentivizes them to lend to minority and low-income areas. This was largely to end the practice ofred-lining;” before the act, banks would literally draw red lines around black neighborhoods and issue no loans to people living there. They were rejected not because ofhistorically poor credit, but because of their race. The spurious argument goes that the CRA forced banks, and thus their non-bank competitors, e.g. Ameriquest, to make untold numbers of risky loans. Only it didn’t.

Federal Governor Randall Kroszner reports that just 6 percent of subprime loans to low-income borrowers came from CRA lenders. And law professor Michael Barr shows that 75 to 80 percent of all subprime loans in the U.S. were made by institutionswhich are not subject to routine examination or supervision. That is, unregulated by the CRA or any federal agency. As for foreclosures, Kroszner found thatfilings have increased at a faster pace in middle- or higher-income areas, areas unrelated to the CRA. And in California alone, CRA loans arehalf as likely to go into foreclosureas loans from unregulated mortgage brokers. So not only are CRA banks barely dealing in subprime, their supposedly risky clients are actually better at paying bills than the rich folk.

But what of the GSEs? Surely we can blame the admittedly corrupt Fannie and Freddie for pushing bad loans by their sheer market power right? Wrong.

Fannie and Freddie were created to buy mortgages off banks so they would have more cash to lend. This is important: they do not write loans, and they have strict limits on the kinds of loans they’re allowed to buy; indeed, the definition of a sub-prime loan is a loan that the GSEs are not chartered to purchase. But as these loans became more common, the GSEs lost ground to private, unregulated originators; compared to 1999, in 2006 the private sector’s market share of securitized mortgage debt was up 261 percent. To maintain market share, GSEs bought securities backed by subprime, but they still couldn’t keep up.

According to economists at UC Irvine and CSU Fullerton, “a credit regime shift took place in late 2003, as the GSE’s were displaced in the market by private issuers of new mortgage products. Total GSE market share fell about 30 percent from 2003 to 2006, and their share of subprime debt fell 50 percent to less than a quarter of the market. So while they dipped, they didn’t dive; and they only dipped after the rest of the mortgage industry dove head first into the shallow end.

Far from demanding 20 percent down and proof of income, unregulated mortgage companies preferentially made shady loans to generate fees; in 2006, 61 percent of subprime loans went to people who could have qualified for prime. And government didn’tcrowd out private lenders from the prime market into subprime; firms like Ameriquest still made prime loans, which accounted for 80 percent of all mortgages made from 2004 to 2006. But subprime was more profitable and unregulated, so guess what got issued?

That said, subprime itself isn’t even the main problem for finance; the problem is the unregulated securities, credit default swaps and other exotic derivatives based on subprime. Selling these securities off meant there was no accountability for the originator; some sucker down the line got caught with his pants down. And, being unregulated, this was something financial firmsinnovated all on their own.

So why does this all matter? It matters because the myth that the CRA and GSEs caused the crisis is part of a larger myth: the myth of the infallible invisible hand, designed to create disaffection with government and ideologically legitimize wealth concentration and economic exploitation in the name ofindividual rights. It matters because as we begin to pick up the pieces, these myths dangerously misinform the public and policy makers alike. It matters because we don’t want a next time.

It matters because if these myths are allowed to persist, there will be.

 

K.C. CODY has a few other myths to bust. Suggest some of your own at kccody@ucdavis.edu.

 

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