When the government goes around telling the lenders how to evaluate risk in lending, you can be sure that a bailout is just around the corner; it just depends on how long it takes for the inevitable crash to occur.
With the Wall Street meltdown in full swing, and the federal government looking to bail out the various participants in risky investment activities; in effect, insuring the investment banking industry against its own foolish behavior, there has been little real action to put the blame where it squarely belongs.
There has been the usual amount of griping and moaning from the financial community, and of course the political Left has made its usual speeches about the failed economic policies of the Bush Administration. Meanwhile, the political Right has promoted the government bailout, on the theory that it is necessary for the preservation of the economy. None of this addresses the issue of responsibility, and it also fails to account for the culpability of government in the whole mess. One cannot entirely eliminate blame on the banking industry, which has over-promoted the use of credit in the last several decades. See my previous article on that subject here.
Meanwhile, some people do get it. Drew Zahn , writing for WorldNetDaily and citing Stan J. Liebowitz, professor of economics at the University of Texas at Dallas states that:
“the federal government over the last 20 years pushed the mortgage industry so hard to get minority homeownership up, that it undermined the country's financial foundation to achieve its goal. In an attempt to increase homeownership, particularly by minorities and the less affluent,an attack on underwriting standards was undertaken by virtually every branch of the overnment since the early 1990s," Liebowitz writes. "The decline in mortgage underwriting standards was universally praised as 'innovation' in mortgage lending by regulators, cademic specialists, (government-sponsored enterprises) and housing activists."He continues, "Although a seemingly noble goal, the tool chosen to achieve this goal was ne that endangered the entire mortgage enterprise."
Also cited by Zahn is John Lott, a senior research scientist at the University of Maryland, who noted in an article for Fox News that the success in raising home ownership rates came at a great price.
ccording to Lott, a manual produced by the Federal Reserve Bank of Boston in the early '90s more than encouraged home mortgage lenders to provide urban and lower-income minority applicants home loans despite their failure to meed "outdated" criteria as credit history, ability to make a down payment or verified stable employment and sufficient verifiable income. Supporters of sound lending practices based on these criteria were roundly criticized. For example, in 2003 Congressman Barney Frank broadsided Greg Mankiw, chairman of President Bush's Council of Economic Advisers, "because he is worried about the tiny little matter of safety and soundness rather than ‘concern about housing.'"
Michael Barone of National Review, Craig R. Smith, and Jonah Goldberg are some of the others who have voiced the same sentiments, all blaming government pressure on the lending industry for the problem. They are right, in part, but only in part, because their approaches fail to address the entire issue. The part they do not address is important because it provides the necessary information on how this whole debacle spread beyond the mortgage lending banks. This final piece of information is found in the history of what is known as the Glass-Steagall act of 1933 which was one of the pieces of post 1929 legislation designed to control speculation in the investment markets, prevent conflicts of interest, perhaps, most importantly for our purposes, segregate the various portions of the investment and banking industry by prohibiting retail bank holding companies from owning other financial companies such as insurers or investment banks. This provision, among other things, was expected to prevent a significant breakdown of the entire economic system if one portion of it experienced problems.
The Glass-Steagall legislation was a product of Franklin Roosevelt's first 100 days of office. It set up the Federal Deposit Insurance Corporation allocated money to the Federal Reserve, and separated the banking industry according to the type of business conducted. The provisions that prohibited banks from owning other financial companies were repealed on November 12, 1999 by the Gramm-Leach-Bliley Act signed by President Bill Clinton, at about about the same time as federal banking regulators moved against safe lending practices in the name of “community reinvestment” and expanded home ownership.
The combination of relaxed banking ownership rules and unsafe lending practices were a recipe for disaster. The “sub-prime” loans were heavily marketed with government approval and loan brokers jumped on them as an opportunity to make additional money. They weren't lending anything, so their risk was minimal. The banks probably knew that the rising real estate market couldn't last forever, and that at some point the bad loans were going to crash. This knowledge, combined with the blurred lines between commercial and investment banking is likely what led the mortgage lenders to convert their real estate loans into “securities” which they then sold in the investment markets, effectively creating a virus which infected the entire financial industry. Now, the whole economy is feeling the effects of the disease.
Implicit in the deregulation of the banking industry must have been a federal bailout if problems developed, and one can be certain that problems would. The crash of real estate investment trusts sponsored by bank holding companies in the 1970s and 1980s should have been fresh on everyone's minds, as well as the savings and loan collapse in roughly the same period. The one lesson which no one seemed to have learned at any time was that government should not be in the business of promoting risk taking, or insuring against it. That should be the venue of business ownership and management. If the risk turns out to be bad one, then the responsibility rightly falls on their heads. If they succeed, then they gain the rewards. Promoting bad risks as a matter of attaining social policy goals was a bad idea all around and the financial companies should have wanted no part of it.
As many critics of the government's policies s have pointed out, the Community Reinvestment Act, which led to the marketing of sub-prime home loans had no real teeth in it, other than the government's ability to label banks which refused to cooperate as not promoting minority homeownership. Bank management had the option of backing out, and accepting those consequences. Instead, they went along to get along, and presumably, could count on government intervention when the inevitable crisis occurred. After all, they were, collectively speaking, too big to fail.
The crux of this matter for the near future, is that the government bailout is going to cost a lot, and the process will pump more of our unbacked currency into the marketplace. Inflation should be just around the corner. And we thought that a Republican President would prevent such problems from happening. McCain – Palin may have come along about 8 years too late.
slaib@intellectualconservative.com
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Read more articles by Steven D. Laib
Mr. Laib understands the problem. Unfortunately he is one of the very few who have articulated it. Instead we get the political hacks trying to get political advantage from the situation they created.
Worse, that Washington cabal along with their minions will fix the problem by creating a bigger problem. I suspect they believe that shoe will drop when they're out of office and either deceased or living in retirement with the loot they amassed for all their years of unfaithful service.
An unpleasant side note to this saga is that with every twist and turn, problem and solution, the Imperial Federal Government gets more powerful, more intrusive and more controlling of everyone's life. Somewhere along the way the US Constitution has been ignored or forgotten.
In sum: this doesn't bode well for the nation.
Comment by NHGrouch | September 20, 2008
There is a growing list of right-wingers who have decided to blame the current subprime mortgage crisis on the Democrats who passed the Community Reinvestment Act of 1975. Predictably enough, it doesn't take much effort or research to figure out that this claim has very, very little resemblance to the truth.
The basis behind the claim that the CRA caused the subprime crisis is relatively simple. The Community Reinvestment Act requires banks to make loans in the low- and moderate-income areas that they serve. Everyone knows that low- and moderate-income families are going to be bad risks, so this means that the banks are being forced to make subprime loans. Therefore, the CRA is the cause of the current problem.
The thing is, very little of this is true.
Let's start with the Community Reinvestment Act and the reasons that it was passed. For decades prior to the law's passage, banks engaged in a process known as redlining, where they declined to write loans in certain geographic areas - typically low-income areas with large minority populations. They did not decline to write bad loans in these areas; they refused to write any loans at all. For example, in 1975 the largest bank in the Bronx wrote a grand total of 32 loans in the entire borough. No loans means no new businesses, no new housing, no opportunity.
The CRA simply requires that any federally-insured bank that accepts deposits from people living in a certain area also write loans in that area. That's all. It does not require a fixed number or percentage of loans to be made, and it does not require that the banks relax their lending criteria in CRA areas. In fact, the law specifies that federal agencies evaluating the covered banks:
"assess the institution's record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods, CONSISTENT WITH THE SAFE AND SOUND OPERATION OF SUCH INSTITUTION" [emphasis added]
Simply put, the claim that the CRA forces banks to make subprime loans is absolute nonsense. The law contains a clause that protects banks from having to take on unsafe levels of risk. It was also passed in 1977, more than a quarter-century before the current crisis began to unfold. But what about the rest of the claim. Isn't there some truth to the claim that anyone lending money in a poor area is going to have to be willing to lend to subprime borrowers?
Apparently not. According to the President of the Federal Reserve Bank of San Francisco, over 80% of CRA loans made in 2006 by banks covered by the act are prime loans. Simply put, being poor does not mean that you are irresponsible, or that you have bad credit. It just means that you don't have a high income or a lot of money. There is no shortage of responsible poor people out there, who have good enough credit and enough savings to qualify for a traditional, prime home loan.
It's not the banks covered by CRA that are making most of the bad loans. They account for about a quarter of all subprime loans. Bank subsidiaries that are not necessarily subject to CRA account for about another quarter. The rest - representing slightly more than half of all subprime loans - were made by the mortgage companies.
To sum up, the Community Reinvestment Act was signed more than 25 years before the current subprime crisis erupted. Banks, which are the only financial institutions covered by the CRA, have made a little less than a quarter of the riskier loans. These riskier loans only account for 20% of the total number of CRA-eligible loans that they have been made. The majority of the subprime loans were made by mortgage companies that do not have to comply with the CRA, and 40% of the mortgage loans initiated in the mortgage company sector in 2006 were subprime. The claim that the CRA caused the subprime crisis is nothing short of asinine.
This latest "spin" is nothing less than an attempt to, once again, blame minorities for something the GOPers did. And since Barack "Hussein" Obama is a minority, you at Rove & Co. hope it will be that much more readily believed. Good luck in Novemeber…you going to need it.
Comment by Rory Talbot | September 21, 2008
Mr. Talbot your attempt at torturing logic was very successful. I can feel it begging for mercy all the way around the globe.
For anyone to say the CRA is not a major contributor to this mess is bizarre. If you truly believe what you wrote then you are as naive as the candidate that you support.
No one action or law brought about this financial crises. It evolved over time. However, to attempt to say that the CRA was not a part of the problem is just intellectually dishonest.
Banks, investment banks, and mortgage houses can always have pressure place upon by the government. You discount the individual States and the regulations that they place and the regulations of the Fed and beyond that even Freddie and Fannie and how they could influence lenders.
This is a very complex issue facing America and your weak attempts to make it a partisan issue shows your ignorance of finance, economics, and politics. Karl Rove? That comment alone shows you are a political hack devoid of any intellect beyond your fanatical loyalty to the great empty suit known as Barack Obama.
Comment by jfking | September 22, 2008
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It seems clear that both sides are to blame for the grand scale of this crisis.
Gramm-Leach-Bliley was put into place by a Republican majority, initiated by Republican congressmen. Yes, Clinton signed it, but it was un-vetoable anyway because of its backing by Congress. This enabled banks to become super-banks that did everything - invest, issue credit, make mortgage loans, etc. So, if something went very wrong, it went wrong in a BIG WAY. And it made the whole business so complicated that it no doubt affected oversight.
The CRA was implimented by Democrats. It had a good intention, of course, of making things fair for everyone way back when it was first put into place. BUT, it was screwed up by poor implementation. It should have been clear that allowing fringe groups to rate banks would cause banks to have to "buy their favor" and do irresponsible things along the way if it wanted to do something new like merge (which seems like in the past 10 years is all they ever want to do).
And, of course, bank loan officers who wanted more and more mortgage loans and consumers who were giddy that they could flip a house and make big bucks are to blame also. They were GREEDY. As a person who purchased in the past year, I have little sympathy for those who willingly went into ARM's beyond their means and raised home prices in the past decade way beyond what a lot of honest families could afford. Prey of predatory lenders are another story, but it seems like it will take a lot of work to disentangle the two groups.
In conclusion, if we didn't have CRA, we wouldn't have had the subprime loan problems. If we didn't have the G-L-B Act, we could have a subprime loan problem or any other financial debacle and it wouldn't be such a big catastrophe because it might have been caught earlier and wouldn't be affecting so many financial sectors at once.
(By the way, can we please keep Rove and Co. and empty suit Obamas out of the comments. That just dumbs down the conversation. After all, we are self-proclaimed intellectuals, are we not?).
Comment by dumbbroad | September 22, 2008
Maybe a review of the facts would help. This issue was noticed and the Democrat controlled congress was asked to take action. They did not because taking action would have made loans "not fair" because those with little chance of paying them back would not get loans. This whole issue was driven by Democrat attempts to buy votes by ignoring good loan practices. Worked really well, they got control but then a slight dip in the economy proved that social engineering does not work.
Comment by Mickey G | September 23, 2008
http://article.nationalreview.com/?q=MDM3NGE0ZjAyYjk4ODIzMDQyODNkYzg5NDU1MTNkOGQ=
Gramm-Leach-Bliley has helped more than it has hurt. Thanks to what this legislation now allows, mega-banks, not taxpayers, were able to bail out some of the lesser banks. Unfortunately, it looks like we'll still be on the hook for others.
Comment by Anderson | September 23, 2008