Every now and then I like to imagine a day on which everyone will have finally understood the contribution of the Community Reinvestment Act to the mortgage crisis.
On that day people will understand it is totally irrelevant that most subprime lending was done by independent mortgage companies not directly subject to the CRA. They will not make the incredibly untrue claim the CRA was a 1970s era law that could not have caused a crisis decades later. They won't say that the CRA did not require toxic loans.
Today is not that day.
Over at syndication service AlterNet, senior writer Joshua Holland has become the latest business writer to put forth the crackpot idea the CRA had nothing to do with the mortgage bubble.
The reality is that no bank has ever been “forced to comply with government mandates about mortgage lending” — it's a bald-faced lie.
There are no “government mandates,” and there never were. In order to qualify for government-backed deposit insurance — a benefit that banks aren’t forced to accept but enjoy having — the Community Reinvestment Act — and similar measures designed to prevent discrimination in lending (to qualified individuals) — only encourage banks to lend in all of the areas where they do business. And Section 802 (b) of the Act stresses that all loans must be “consistent with safe and sound operations”—it’s the opposite of requiring that lenders write risky mortgages.
There are no penalties for noncompliance with CRA guidelines. The only “stick” hanging over banks that fail to meet those standards is that their refusal might be taken into account by regulators when they want to open new branches or merge with other financial institutions.
What’s more, there are no defined standards for CRA compliance, and within the banking community, the loose guidelines are considered to be somewhat of a joke.
There's not one sentence in those three paragraphs that is true.
To believe anything that Hollander claims you have to be a statutory fundamentalist, someone who believes all that matters is what the law says. To put it slightly differently, you have to believe the actual operation of the law and the activities of regulators it empowers are irrelevant.
There are plenty of these people. Former FDIC chair Sheila Bair is one of them. She once asked, “Where in the CRA does it say make loans to people who can’t afford to repay? Nowhere!"
This is like arguing that no person could ever have been wrongly imprisoned because the law says only the guilty should go to jail.
"Where in the criminal code does it say the innocent can be imprisoned? Nowhere!"
The truth is regulators took the view that banks should drop every traditional lending standard to comply with the CRA. The regulators wanted down payments to come down or be eliminated altogether. They told banks not to use credit histories anymore, to relax income requirements, to develop automated underwriting programs that took human judgment out of mortgage lending.
A 1999 study by the Treasury Department concluded the CRA was influencing the lending practices of institutions that weren't covered by the law.
"Furthermore, by helping banks and thrifts discover that lending to LMI [low- and moderate-income] borrowers and areas can be profitable, the CRA may have had a positive “demonstration effect” on lenders not covered by the Act, and thus indirectly increased lending by these institutions as well," the study said.
There was a very strong penalty for non-compliance with the regualtors' view on how banks should comply with the CRA: Bank regulators could block bank mergers if one side was found to have flunked the government's CRA test. Hollander acts as if this isn't a big deal, but it certainly was a big deal to banks.
The very first time the Federal Reserveever blocked a bank merger using the powers under the CRA was the 1993 acquisition of New Datrmouth Bank by the Shawmut National Corporation. The Fed refused to approve the merger on the grounds that Shawmut hadn't done enough to make CRA loans.
How did Shawmut react? It immediately began touting its "flexible income criteria" for loans and establishing mortgages with down payments of as little as 2.5 percent.
The Shawmut rejection was a shot across the bow of the banking industry. Here's what the New York Times reported at the time:
"The Fed is sending a strong signal to the banking industry that they're going to be looking at banks' lending practices," said Joseph Duwan, a banking analyst with Keefe, Bruyette & Woods. "Clearly Shawmut is being made a little bit of scapegoat."
In a move showing banking regulators' increased emphasis on ending loan discrimination, the Federal Reserve Board has, for the first time, blocked a large bank merger because of concern over possible bias against minority groups in mortgage lending.
Hollander, like so many who have come before him, want all of this to just vanish down the memory hole. It's a convenient story for people who desperately want to trust that benign regulators will prevent another financial crisis. It's a far scarier world when you realize that regulators were in on the mess from the start.
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