In response to an IBD editorial titled “The Real Culprits In This Meltdown” sent to me by a family member, I wrote the following on 9/21/2008:

I am no expert, but I am rather obsessed with business news, the stock market, politics, and I have a deep interest in finding things out for myself. What follows is the result of attempting to distill from hours of primary reading some kind of summary response to the IBD editorial. If you want to get straight to the heart of what I feel then read the next paragraph and the last three paragraphs. Most of what follows is a copy-and-paste selection of expert analysis of the Community Reinvestment Act (CRA), its realtion to the subprime-induced credit crisis, and a history of banking regulation related to the CRA. For added amusement I suggest watching this very funny 9-minute video of satirists John Bird and John Fortune explain the credit crisis.

First, the author’s use of the word “multiculturalism” is used completely out of its normal context–the idea that no one culture should dominate others. Rather, in this editorial the author uses the word as shorthand to negatively connote the “socially engineered” ideals of multiculturalism and, worse, equate “multiculturalism” with the needs of “minorities” and “low income” people. This is a typically misguided racist and classist attempt to defeat the ideals of multiculturalism. Second, therefore, this editorial of unattested authorship says that encouraging “minority homeownership” by Clinton’s “social engineers” who were “obsessed with multiculturalism . . . led to lenders taking on hundreds of billions in subprime bilge.” The implication is clear: “multiculturalism” = “bad,” “harmful,” and is in fact one of the root casuses of the mess we’re in, and therefore “Obama” (because of “who he is” wink, wink, nod, nod) = “bad,” “harmful,” and will give us more bad and harmful “social experiments” and a “new round of meddling.”

See this WSJ article for a more in-depth review of the subprime-related crisis:

To examine the surge in subprime lending, the Journal analyzed more than 250 million records on mortgage applications and originations filed by lenders under the federal Home Mortgage Disclosure Act. Subprime mortgages were initially aimed at lower-income consumers with spotty credit. But the data contradict the conventional wisdom that subprime borrowers are overwhelmingly low-income residents of inner cities. Although the concentration of high-rate loans is higher in poorer communities, the numbers show that high-rate lending also rose sharply in middle-class and wealthier communities.

Banks and other mortgage lenders have long charged higher rates to borrowers considered high-risk, either because of their credit histories or their small down payments. As home prices accelerated across the country over the past decade, more affluent families turned to high-rate loans to buy expensive homes they could not have qualified for under conventional lending standards.

High-rate loans are those that carry interest rates of three percentage points or more over U.S. Treasurys of comparable durations.

The Journal’s findings reveal that the subprime aftermath is hurting a far broader array of Americans than many realize, cutting across differences in income, race and geography. From investors hoping to strike it rich by speculating on condominiums to the working poor chasing the homeownership dream, subprime loans burrowed into the heart of the American financial system — and now are bringing deepening woe.

Higher-income home buyers began using such loans [interest-only loans, payment-option loans, negative amortization loans, piggyback mortgages, and Alt-A loans] for larger purchases. Among borrowers characterized in the data as white with annual income of at least $300,000, the number of high-rate loans jumped 74% last year, the numbers show. The average high-rate loan grew 10% to $158,000 last year, compared with a 1% rise in the average size of all home loans.

For detailed information on the development of these problems see the work of Dan Immergluck at the Georgia Institute of Technology, who testified before Congress on these matters on March 21, 2007:

As some context for the statistics that you are hearing today, I would like to relay a slightly longer historical view on the issue. In the early to middle 1990s, after decades of decline of older urban neighborhoods, it appeared that, in many modest-income neighborhoods, things were really beginning to really turn around. There was a strong sense that groups like NeighborWorks organizations, community development corporations, and community development financial institutions were making real progress in reviving the housing stock and economies of neighborhoods and communities around the country. To their credit, some banks – often in partnership with local community organizations – were beginning to become much more active in lending to these communities. The revitalization of housing and small business markets was happening in many places. Indeed, census data show that, from 1990 to 2000 [Clinton years], there was an overall decline in geographically concentrated poverty in U.S. metropolitan areas. In many cities, the population losses of the 1970s and 1980s slowed or even reversed, and many observers saw real hope that the urban trauma of earlier decades had come to an end.

However, many of us who followed housing patterns began to notice a development in home finance in the middle 1990s that caused some concern. While some banks and thrifts were doing more to serve urban communities – especially within their Community Reinvestment Act assessment areas — a set of different lenders, many of which were new firms or formerly niche lenders that were growing into much larger firms, was also beginning to target these underserved markets. These communities were now beginning to be supplied with a new form of high-priced credit, often involving disadvantageous terms that were rarely employed in the conventional, prime market. Many borrowers were being charged very large up-front fees or sold ancillary financial products for which they did not appear to have any use. Moreover, it appeared that, in many cases, borrowers were being given loans that they had little prospect of being able to repay right from the get-go. Some loans contained terms that would make default more likely and refinancing to more affordable products more difficult. In other cases, borrowers that would qualify for traditional loans at conventional, low rates, were being given loans with excessive fees or interest rates. Frequently, traditional ability-to-pay underwriting practices appeared to be being discarded by some of these new lenders.

Well, ten-plus years later, it is clear that the subprime market and some parts of the prime market are in many respects fundamentally dysfunctional – both from the perspectives of affected borrowers and the communities impacted by large numbers of subprime and aggressive, exotic mortgages.

The industry publication, Inside Mortgage Finance, shows that subprime lending grew from approximately $35 billion in 1994 to $665 billion in 2005. We now have a flood of credit, much of which is structured to the detriment of the borrower and to the benefit of the credit arrangers. This flood of credit is distorting housing markets and causing negative spillovers from directly impacted borrowers onto neighbors and communities.

Implications for Federal Policy
First, it seems a sad commentary on state of the federal regulatory regime that federal agencies have – at least until very recently [read: “Bush administration”] – been more willing to act to control exotic mortgages in the prime market while doing little to protect the even more vulnerable borrowers in the subprime market.

Second, the market has shown that it does not transfer risk appropriately across different agents in the lending process. Brokers and originators are able to pass poorly underwritten loans off to packagers of special purpose investment vehicles who are, in turn, able to tolerate losses as long as their investors are receiving adequate average returns from their entire portfolio of mortgage-backed-securities. And when housing markets overall are appreciating fairly rapidly, high levels of risk can be tolerated –at least in the short run. Moreover, the de-localization of credit markets has meant that geographically diversified lenders can tolerate very high foreclosure rates in particular communities while maintaining nationwide rates that they are able to cover through high margins and aggressive growth.

***Regulation must work to shift a much more substantial share of the costs of irresponsible lending to the supply side of the market – to lenders, brokers, and, especially, the Wall Street investors that feed the beast of irresponsible credit.*** On the origination side, mortgage brokers should bear fiduciary responsibility to borrowers. If stockbrokers have an obligation to act in accordance with the interests of their clients, should not mortgage brokers – who serve a much broader cross section of the American public – have the same obligation?

And now let’s get down into the nitty-gritty history of the CRA and government regulation or lack thereof. See Immergluck’s article “Out Of The Goodness Of Their Hearts? Regulatory And Regional Impacts On Bank Investment In Housing And Community Development In The United States” in the Journal of Urban Affairs:

Throughout the 1980s, community reinvestment advocates argued that CRA regulations were not being meaningfully enforced and that examiners focused too much on the processes banks engaged in rather than on actual lending and investment outcomes. The Federal Reserve released data in late 1981 revealing that it had rated only 3% of banks as less than satisfactory in 1980. In Congressional hearings in the late 1980s, it was revealed that the number of examiner hours devoted to consumer compliance responsibilities, including CRA, dropped by approximately 75% in the early 1980s.

So, under the CRA–created in 1977–during the Reagan years regulators decreased their attention to compliance by 75%. Hmmm . . .

Community groups increasingly responded to lax federal regulation by recognizing that they had to “carry the burden of CRA and fair housing enforcement in the absence of responsible intervention by the financial regulatory agencies.” As a result, they began using activism and their analyses of Home Mortgage Disclosure Act (HMDA) data to bring financial institutions to the negotiating table. Community organizations and banks entered into an increasing number of CRA agreements during the late 1980s. The number of CRA agreements increased from three per year in 1982 and 1983, to 11 and 12 in 1984 and 1985, and then to 32 and 31 in 1986 and 1987, respectively.

So then, under Regean and Bush #1 regulators were not doing the job they were paid to do, and thus “community organizers” (eh-hem) had to “carry the burden” and work directly with banks to make sure low-income people and minorities could get a fair shake at getting a loan.

And now the half-truth in the original IBD editorial:

Bill Clinton made increasing CRA’s impact a significant part of his urban policy campaign platform in the 1992 presidential election. In 1993, the four federal banking regulatory agencies together proposed a uniform set of major revisions to regulations implementing the CRA, although it was clear that some agencies supported the initial version of these revisions more than others. The Clinton Administration’s point person on, and chief advocate for, “CRA Reform” was Comptroller of the Currency Eugene Ludwig. In this proposal, regulators argued that the new regulations would be an attempt to focus more on actual lending results and less on processes like demonstrating community contacts and advertising efforts, which had been the focus of CRA regulations up until that time. Consistent with the Administration’s more general “reinventing government” efforts, regulators also argued that the revised regulations would leave bankers with less paperwork requirements. Thus, CRA reform was promoted as an attempt to make both reinvestment advocates and bankers happy.

In April 1995, after 18 months of repeated public comments and debate, and publicly aired disagreements among the regulatory agencies over various provisions in the proposal [read: “regulatory agencies were dragged kicking and screaming by the Clinton administration to do their jobs after many years of neglect under Regean and Bush”], the four regulators released a uniform set of revised CRA regulations. The rules replaced the 12 assessment factors in the previous regulations with an outcome-based evaluation system. This system was intended to assess how well institutions served their communities on lending, investments, and financial services, rather than on how well they conducted needs assessments and documented community outreach.

While a shift from process to outcomes was a primary objective of the final regulatory changes, there was also some attention given to “easing the regulatory burden” of banks, especially for smaller institutions. As a part of this, a two-tier evaluation system was established, with banks classified as “small” (less than $250 million in assets) having more limited evaluation procedures than “large” institutions.

CRA reform boosted the importance of bank investments, in part, by making investment activity a more explicit expectation for banks with more than $250 million in assets.

Immergluck then reports his detailed statistical analysis of different regulatory bodies and banks by size related to “qualified investments” (i.e. CRA-related, commnity-based investments) and finds of the “large” banks ($1 billion to $100 billion in assets) and the few “mega” banks (more than $100 billion) that “once [they] reach a very large size, they do not increase their investments as much” even though “very large banks may have substantially greater capacity to make investments from which smaller banks may shy away.” Immergluck conculdes, “This [increased investment] might occur if regulators’ expectations regarding the amount of qualified investments hit some threshold, greater than which any further investments would be unlikely result in a higher Investment Test score.” “All institutions receive an overall rating of one of four possible levels: ‘Outstanding,’ ‘Satisfactory,’ ‘Needs to Improve,’ or ‘Substantial Noncompliance’.” Regarding the mega banks, Immergluck writes, “In order to economize on examination costs, the exams for these banks typically involve a sampling of data in several subsets of their national CRA “assessment area.” Moreover, these banks rarely receive anything but Outstanding CRA ratings.”

Based on the analysis above, banks and thrifts invest in community and economic development activities (measured here by CRA-qualified investments) at widely different rates.

The first factor that affects bank investment activity is bank size.

The finding that regulator matters is a critical one. First, large differences in the rigor of enforcement by different regulators could result in banks “shopping around” for a new, easier regulator.

The finding that regulatory agency is a significant and nontrivial determinant of qualified investment activity is also powerful evidence that the CRA plays a substantial role in promoting investment in community and economic development activity.

Recently, policymakers [read: “Bush Administration”] have weakened the Investment and Service Tests in CRA regulations by formulating a new “community development test” for banks between $250 million and $1 billion in assets. This move essentially means that these banks no longer have to perform adequately in both services and investments, but can pick and choose their nonlending activities to bolster their CRA rating in the way that works to their greatest regulatory advantage. For many banks in this size range, this is likely to mean giving short shrift to investment activity.

CRA can and does have an important role in promoting bank involvement and investment in community development activities. While this study focuses on a certain range of bank sizes, and does not directly address the very large megabanks, it provides a strong warning that reducing regulatory attention to investment activity is likely to have a sizeable, negative impact on flows of resources to community and economic development from the financial sector. Moreover, since many public sector community and economic development programs require substantial involvement by private sector investors, reducing bank and thrift investments are likely to make public sector support for community and economic development scarcer, at least in the short run.

The sad and ironic part of all of this is that the CRA and the increased focus under Clinton for economic development brought much neeed attention to underdeveloped communities, but that increased attention also brought harmful predatory lending practices into those areas. It is clear that many mortgage brokers preyed on uneducated people, many of whom were unable to truly afford a mortgage, because CRA investment meant that neighbors were receiving loans (those who qualified) and some people were “left out.” The subprime mortgage brokers piggybacked on the increased investment from banks due to CRA by fostering “me, too” sentiment. Then because the mortgage brokers were paid by volume they had to find new markets to pump “no money down” and “low APR intro rates” with adjusting rates, etc. The end result was the rapid increase in house prices in many markets and some to the bubble stage where they “popped.” Once house prices started coming back down the game of getting easy loans for house flippers, speculators, and relatively innocent people merely trying to climb the home equity ladder the frenzy was stopped in its tracks and the investment community slowed originations and finally looked at what the heck they actually had on their balance sheet. This is the problem with the market. Bubbles develop all of the time, and they’re always predicated on the idea that there is a greater fool to whom I can sell my house, stock, gold, fill in the blank. Now that the whole thing has fallen apart the lowest income people are the ones who face the most trouble in getting refinancing, etc. and thus their communities are now spiraling back down into despair and outright abandonment and degredation. This is why the the half-truth skin of the partisan politics in the IBD editorial is so insidious. Even if it is true that this whole mess germinated from CRA activity, to blame Clinton, multiculturalism, Democrats, goverment regulation, and Obama is clearly to commit the genetic falacy. And even worse, the implication is that trying to help disadvantaged people and those discriminated against with goverment assistance is likely to prove counterproductive, to say the least, and destructive to “the rest of us” to be more honest.

In conclusion, if we’re typically Republican voters let’s not simply blame Clinton for this mess. Likewise, if we’re typically Democratic voters let’s not simply blame Bush. Despite my editorializing I do not blame Bush for this mess, though I do think the de-regulation philosophy of 20 of the last 28 years of Republicans in the White House did not help. I blame first and foremost the fallenness of human nature and our propensity to greed and avarice. In this sense we are all guilty of contributing to this mess. Even Eun-Hye and I participated in the mentality that put us where we are today by entertaining the idea a few years ago of buying a house (though we didn’t need one) because we thought we could afford it, because we know of pastors who bought wisely early in their careers and wound up with a good investment, and because we wanted to “get in” before prices got too outrageous. Well, we never bought a house.

I am not a pure partisan voter. I voted for Dole in 1996. I voted for Bush in 2000. I voted for Kerry in 2004. I will vote for Obama in 2008. I hope and pray that this country will get over simplistically blaming one party or the other for the ills of society. We need to work much harder to understand the relationships between political and economic theories and practice and how one candidate or another may or may not align with our views of what makes for beneficial governance of our country. Of course to do this we first must arrive at our own understanding of what makes for beneficial governance and be able to articulate that understanding to others in a non-threatening way. I am afraid the IBD editorial is just one more example of someone who did not take the time to become acquinted with the history of the CRA and instead chose to parrot partisan political talking points.