Lil White Lies: No Way CRA

My "blog nemesis" Bryan White seems to revel in criticism of his local newspaper columnist, Robyn Blumner, whose credentials include having been a director for the ACLU.…Well there ya go!

At his blog there’s a *Topic of Note* section devoted to “Bashing Blumner” which includes his numerous write ups. One recently piqued my interest.

As stated by Bryan in his write up, the essence of this particular column by Blumner was that she… “perhaps once again inspired by a book from a liberal author, attempts to explain why Republicans are wrong to pin the financial crisis on the Community Reinvestment Act [CRA].” The liberal author Blumner drew from was financial expert and author of book Bailout Nation Barry Ritholtz, which  explains why the CRA was not to blame. The basis of Bryan’s contention of Blumner “buying” Ritholtz’s faulty reasoning was a critique by John Carney of Business Insider. This is the John Carney who wrote this article at the website American Conservative where he stated “We’re the backbench of a minority.”

The essence of Bryan’s argument was that through the CRA , Fannie Mae and Freddie Mac, the government enabled the subprime crisis to happen by “forcing” banks to relax their lending standards. “The government made subprime mortgages profitable with its actions… The risky loans didn't have to be CRA loans. Banks simply had to use a certain amount of money on such loans to remain in compliance with government standards.”

Bryan goes on to say “…The point above pretty much negates the point Blumner cites from Ritholtz about the prediction of banks with CRA mortgages failing disproportionately. John Carney at Business Insider goes into greater detail and specifically debunks Ritholtz's objection, using the Countrywide mortgage company as an example.”

But did John Carney actually “specifically debunk Ritholtz’s objection”?

He supposedly “debunked” it with three points as to how the CRA created more lax lending standards which “spread” to other lenders…I will try to address each point.  Here you can also read a little more about Carney's "bizarre crusade" against the CRA.

(1) The Creation Of Artificial Demand For Low-Income Mortgages. In order for this to be true at the time, there would necessarily have to have been more regulatory moves by Bush. The OTS (Office of Thrift and Supervision), however, was a captured agency for the lenders. The OTS tried to make the environment for them as “CRA-free” as possible. So there was no impetus for such “artificial demand.” Additionally, most of these mortgages were not low-income; the majority were non-origination, re-finance mortgages that went across all demographics.  

John Carney also asserts that banks that were regulated by the CRA often found it difficult to meet their obligations under the CRA directly, and one way of addressing this problem was buying the loans in the secondary market. According to him, “A huge driver of the demand for subprime loans was the demand for CRA bonds.”

However, according to Neil Bhutta and Glenn B. Canner, two Federal Reserve Economists:

“…In 2006, only about 9 percent of independent mortgage company loan sales were to banking institutions. …And among these transactions, only 15 percent involved higher-priced loans to lower-income borrowers or neighborhoods. In other words, less than 2 percent of the mortgage originations sold by independent mortgage companies in 2006 were higher-priced, CRA-credit-eligible, and purchased by CRA-covered banking institutions.”

(2) The Threat Of Regulation Is Often As Good As Regulation. So… “Non-depository institutions were worried about being brought under the influence of the CRA, who wanted them to make subprime loans, so they made a concession to the CRA of… creating the large majority of subprime loans?”  The threat of regulation was not a concern during the Bush administration.

(3) The CRA Distorted the Mortgage Market. With banks offering mortgages with high loan to value, delayed payment schedules and other enticing features, the mortgage companies would have quickly found themselves unable to compete if they didn’t offer similar loans. This means that the banks should have led the way and started the subprime offerings earlier than the mortgage companies. According to Mike Konszal, financial engineer, “I’ve never seen a data set that pass[ed] this hurdle.”

More from “quants” Bhutta and Canner:

“Using loan origination data obtained pursuant to the Home Mortgage Disclosure Act (HMDA), we find that in 2005 and 2006, independent nonbank institutions—institutions not covered by the CRA—accounted for about half of all subprime originations. (See Table 1.) Also, about 60 percent of higher-priced loan originations went to middle- or higher-income borrowers or neighborhoods, populations not targeted by the CRA. (See Table 2.) In addition, independent nonbank institutions originated nearly half of the higher-priced loans extended to lower-income borrowers or borrowers in lower-income areas (share derived from Table 2).

In total, of all the higher-priced loans, only 6 percent were extended by CRA-regulated lenders (and their affiliates) to either lower-income borrowers or neighborhoods in the lenders' CRA assessment areas, which are the local geographies that are the primary focus for CRA evaluation purposes. ..”

In 2005 and 2006, the period the “spike” or “panic” began, banks connected to the CRA made fewer loans than the independent non-bank institutions. In other words, the CRA banks did not lead the way; it began with the independent lenders.

Here’s Bryan’s (and Carney’s) Conservative argument summary re-stated from a study completed by Traiger and Hinckley LLP in January, 2009:

“The root of today’s financial crisis can be found in the government’s effort to use the banking and financial system to expand home ownership. There are many good reasons to increase home ownership in our society, but the way to do it was not by distorting the lending decisions of banks and other mortgage market participants. That, however, is the direction the government chose when it imposed the CRA on insured banks in 1977 and an “affordable housing” mission on Fannie Mae and Freddie Mac in 1992. Instead of assisting low income families to become homeowners with direct subsidies, the government--through CRA--required banks to lower their lending standards. Down payments, steady jobs, good credit histories, and income levels commensurate with mortgage obligations were abandoned in favor of “flexible” lending requirements. Bank regulators, required to enforce CRA, approved mortgage loans that would not previously have been acceptable, and demanded that banks do more.”

Their study’s conclusion: “Significantly, while the origination rate for LMI (low to middle income) mortgage applicants remained stable in 2007, the origination rate for middle- and upper-income (MUI) mortgage applicants fell 6.6 percent. In each of the 15 most populous MSAs, the origination rate for MUI applicants decreased by more than the rate for LMI applicants. This suggests that it was the underwriting standards for upper-income applicants that required tightening, not the standards for LMI applicants….

Critics of the CRA claim that the law compels banks to downgrade their credit standards in order to make mortgage loans to unqualified LMI borrowers. We hypothesized that if this was true, lending data from 2007, a time of tightened underwriting standards and regulatory emphasis on safety and soundness, would show significantly diminished lending to LMI borrowers by CRA-subject banks.

Instead, our analysis of 2007 data indicates that the percentage of LMI applications that were originated by CRA-subject banks remained stable even in the climate of heightened scrutiny and wariness that prevailed. This finding contradicts the notion that compliance with the CRA is dependent on imprudent lending….”

In other words, following Carney’s logic, if it was indeed lax lending standards, wouldn’t the tightening up of those standards in 2007 therefore cause LMI mortgage originations to drop, and MUI mortgages to increase or stay steady? After all, MUI borrowers could more easily meet the lax lending standards (since it’s been also established they were getting many of the subprime loans). Instead, LMI mortgage originations stayed steady, and MUI mortgage originations dropped.

“An analysis of subprime mortgages shows that within the first year of origination, approximately 10 percent of the mortgages originated between 2001 and 2005 were delinquent or in default, and approximately 20 percent of the mortgages originated in 2006 and 2007 were delinquent or in default. This rapid jump in default rates was among the first signs of the beginning crisis.

If deteriorating underwriting standards explain this phenomenon, we would be able to observe a substantial loosening of the underwriting criteria between 2001–2005 and 2006–2007, periods between which the default rates doubled. The data, however, show no such change in standards.

Actually, the criteria that are associated with larger default rates, such as debt-to-income or loan-to-value ratios, were, on average, worsening a bit every year from 2001 to 2007, but the changes between the 2001–2005 and 2006–2007 periods were not sufficiently high to explain the near 100 percent increase in default rates for loans originated in these years.”

It should be emphasized that the subprime mortgage crisis was not unique in its origins.

“The mortgage crisis in the United States is large and devastating, and it has led to global financial turmoil. In this sense, it is certainly unique. However, neither the origin of this crisis or the way it has played out was unique at all. In fact, it seems to have followed the classic lending boom-and-bust scenario that has been observed historically in many countries. In this scenario, a lending boom of a sizable magnitude leads to a lending-market collapse if it is associated with a deterioration in lending standards, an increase in the riskiness of loans, and a decrease in the price markup of said risk. Argentina in 1980, Chile in 1982, Sweden, Norway, and Finland in 1992, Mexico in 1994, and Thailand, Indonesia, and Korea in 1997 all experienced a pattern similar to the U.S. subprime boom-and-bust cycle. The United Stated has had similar episodes, though on a smaller scale, as well: a crisis with farm loans in the 1980s and one with commercial real estate loans in the 1990s.”

As for Angelo Mozillo’s dream of “democratizing the glories of home ownership”:

“The availability of subprime mortgages in the United States did not facilitate increased homeownership. Between 2000 and 2006, approximately one million borrowers took subprime mortgages to finance the purchase of their first home. These subprime loans did contribute to an increased level of homeownership in the country—at the time of mortgage origination. Unfortunately, many homebuyers with subprime loans defaulted within a couple of years of origination. The number of such defaults outweighs the number of first-time homebuyers with subprime mortgages.

Given that there were more defaults among all (not just first-time) homebuyers with subprime loans than there were first-time homebuyers with subprime loans, it is impossible to conclude that subprime mortgages promoted homeownership.”

Finally, there’s this claim about the CRA “forcing” the banks …like, they held a gun to their head and said “You better relax your mortgage standards so you can make MO MONEY!”? Subprime mortgage rates are on average about 4 points higher than those of a standard mortgage. It was simply more profitable.  The lending was all predicated on indefinitely inflating housing values.  This was a classic lending boom and bust scenario driven by “irrational exuberance."  Let's remember that even GSE's Fannie Mae and Freddie Mac had stockholders to satisfy. But to blame the CRA is like a teenager who is driving Dad’s car and wrecks it….and blames his Dad for letting him take it for a drive.



Post-Script:  Apparently, Barry Ritholtz was so certain of his position on the irrelevancy of the CRA  to the subprime debacle that he challenged John Carney to a debate….to the tune of $100,000….