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Congress Caused This Depression. Not Wall Street. Not the Banks
Raymond Richman, 4/20/2010

A bi-partisan Congress and successive Democratic and Republican administrations caused this depression. What else should one call an economic situation in which nearly 10 percent of the work force is unemployed and an additional 8.5 percent have given up looking for jobs. The administration would like you to believe that it was caused by the big investment houses on Wall Street and by the banks. The banks caved in under government threats and blackmail by ACORN and other self-appointed community groups and made the rotten loans whose defaults were responsible for this depression. Wall Street, seeing there were profits to be made, volunteered to raise the capital to convert the trillions of dollars of foolish mortgages into foolish investment vehicles. It turned out to be very profitable in the short-run but catastrophic in the long-run. But the bubble had been set in motion by Congress, not Wall Street and not the banks. 

It all began innocently enough with the passage of the Community Reinvestment Act of 1977 which required the banks to end their alleged discrimination against the poor, mostly black, residents in poor, so-called, red-lined neighborhoods. It was leftist propaganda that accused the banks of deliberately discriminating against blacks and the line was bought hook, line, and sinker by Sen. Proxmire, the bill’s sponsor, President Carter, and a know-nothing Congress. Banks, including black-owned banks, as is to be expected, made fewer mortgages in economically deteriorating neighborhoods. But the act ignored reality and required banks to make loans in such areas and if they failed to do so, they would suffer penalties.

The act, which was strengthened under Pres. George HW Bush and Pres. Bill Clinton in the nineties, is placed under the administration of several federal supervisory agencies, namely the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Commission, the Office of Thrift Supervision, and the Comptroller of the Currency who are required to consider CRA performance when evaluating applications for Charters for national banks or federal savings and loan associations; deposit insurance for a newly chartered state bank, savings bank, savings and loan association or similar institution, establishment of a domestic branch or other facility with the ability to accept deposits, relocation of a home office or a branch office, merger or consolidation with, or the acquisition of the assets, or the assumption of the liabilities of a regulated financial institution, acquisition of shares in, or assets of, a regulated financial institution. Clearly, getting a favorable CRA rating became important for every bank practically. 

In addition, every regulated financial institution was required to make its CRA file consisting of the institution’s most recent CRA performance evaluation available for inspection by the public. including ACORN or any other group. Pres. GHW Bush supplied the coup de grace when he approved ranking banks on the basis of the effectiveness local lending. The Federal Financial Institutions Examination Council (FFIEC) coordinates inter-agency information about the CRA. In 1994, ACORN sued Citibank under the Community Reinvestment Act alleging racism. Information about the CRA ratings of individual banking institutions from the four responsible agencies (Federal Reserve, FDIC, OCC and OTS), is publicly available from the website of the FFIEC. These ratings were first made available by the Clinton administration to enable public participation and public comment on CRA performance, and calling for public hearings. ACORN and others succeeded in blackmailing the banks by threatening to ensure low grades if the banks failed to accommodate their wishes. They also sued if threats were not enough.

ACORN sued Citibank in 1994 in a class action alleging racial discrimination in Chicago in 1994. One of their lawyers was none other than Barack Obama. Citibank settled. A few did fight back. In 2004, after being accused of predatory lending by ACORN, Wells Fargo came out swinging. But three years later, they settled a class action lawsuit in California for $6.8 million. Most banks paid attention and soon understood that it was easier to partner with ACORN than to fight them. ACORN performs services for the banks and had contracts with the federal government and some states. Its income for such services is in the tens of millions of dollars.

This writer is not only concerned about the foolishness of the policy that created the CRA but also with its implications about the role of government in our economy. Here is the government forcing risky lending decisions upon private banks. Like the federal government taking over the management of General Motors, it puts the banks under the direct control of government. While the former is socialism, the latter is fascism under which daily business policies are made by government.

In his prepared statement to the Financial Crisis Inquiry Commission, Alan Greenspan, former Chairman of the Federal Reserve System, defended the Federal Reserve System by saying no one anticipated the bursting of the real estate bubble. Apparently, he never twisted radio dials or watched random programs on TV. On radio and television, promoters claimed anyone could make millions in real estate and they would show their listeners and viewers how. One hedge fund manager made a fortune for himself and his investors by correctly anticipating in 2006 that the bubble could not last very long. But what was disturbing was his justification of the Fed’s tolerance of lending with little or no money down and other risky practices. Following is an example: 

Adjustable-rate mortgages that might be inappropriate for one borrower might be the most suitable option for another; low-down-payment loans to borrowers with limited savings but adequate income to support the monthly payments might be perfectly appropriate, while the same loans to borrowers who cannot document their income may not be. In short these and other kinds of loan products, when made to borrowers meeting appropriate underwriting standards, should not necessarily be regarded as improper, and on the contrary facilitated the national policy of making homeownership more broadly available. [my italics]. 

Clearly, neither the Fed nor any government agency monitored underwriting standards. Under the CRA, the national policy became to encourage banks to make risky loans, the consequences of which are clear to see. It is surprising that neither Greenspan nor Bernanke saw the dangerous risk we were taking. 

Besides, the national policy of making home ownership more broadly available was in conflict with the Fed’s responsibility for maintaining the solvency of the banking system. Neither Greenspan nor his successor Bernanke voiced any threat to the solvency of the banking system until it had been destabilized. Unfortunately, recent economic history shows that the mortgage defaults in the U.S. have threatened world economic stability. And the CRA is still the law.   

A number of economists have attempted an evaluation of the effects of subprime and undersecured mortgages that resulted from the CRA and to their surprise they found that the number of defaults were not significantly larger than those experienced in better neighborhoods. One of the troubles with that conclusion is that there is little reason to expect a different result as long as real estate values are increasing and the economy is running close to full employment. One can predict that under inflation, with rapidly rising prices throughout the economy, there will also be few defaults. We believe that that is likely to be the way we shall solve the housing crisis. 

Greenspan told the Congress that the selling of the soaring number of subprime mortgages in securities to investors was the trigger for the financial crisis. He blamed affordable housing mandates set by federal officials on the government-sponsored housing enterprises Fannie Mae and Freddie Mac, and their subsequent large-scale purchases of subprime mortgages, for the housing bubble that later burst, sending financial markets reeling. We agree with him but would generalize it to include all mortgages that are made at excessive risk.

On March 30, 2007, Chairman Bernanke celebrated the thirtieth anniversary of the CRA with a speech to the Community Affairs Research Conference in Washington, D.C. He was supportive of the changes made over time to the original act. He said “the CRA affirmed the obligation of federally insured depository institutions to help meet the credit needs of communities in which they are chartered, consistent with safe and sound operations.” No laughter, please. Politics has a way of creating unintended consequences.

He stated that bankers were gaining experience in underwriting and managing the risk of lending in lower-income communities. “After years of experimentation, the managers of financial institutions found that these loan portfolios, if properly underwritten and managed, could be profitable. In fact, a Federal Reserve study found that, generally, CRA-related lending activity was at least somewhat profitable and usually did not involve disproportionately higher levels of default.” As for ACORN and other community groups, he stated “that community groups and nonprofit organizations began to take a more businesslike, market-oriented approach to local economic development, leading them to establish more-formalized and more-productive partnerships with banks.”  Keep in mind that he spoke these words before the financial crisis and the current depression. They sound so ostrich-like.

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Comment by C. Blaster, 4/21/2010:

Excellent Article.  We have posted it on our home page.

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