Wednesday, October 14, 2009

The CRA debate

In the continuing debate over What Caused the Mortgage Crisis (was it planners?), many have blamed the 1977 Community Reinvestment Act.  Don't expect the debate to die down anytime soon.  Here is a new article from Edward Pinto (a former chief credit officer for Fannie Mae)  in City Journal entitled "Yes, the CRA is Toxic; So why is Congress Thinking About Expanding It?"  Excerpts:

The question of how well CRA loans have performed is of vital importance because of the trillions of dollars in such lending. . . .

Though the feds, again, haven’t collected figures for CRA loans’ performance as a whole, we do have statistics from a few lenders that are troubling indeed. . . .

Taxpayers deserve to know why not one regulator had the common sense to track the performance of CRA loans. . . . Incredibly, the House Financial Services Committee is considering legislation that would broaden the scope of the CRA.

Accoring to Pinto, HR 1479, which I'm not all that familiar with myself (feel free to post a comment if you are), will supposedly expand the CRA from banks to subsidiaries, credit unions, and other financial institutions.  I'm not an expert on the CRA nor do I have The Answer to the question of what caused the mortgage crisis, but if Pinto is right in the excerpts I've quoted above, it's unfortunate if no one has been able to collect the nationwide data to make these analyses.

For a counterpoint to Pinto's "toxic" assessment, see Raymond Brescia's (Albany) article Part of the Disease or Part of the Cure: The Financial Crisis and the Community Reinvestment Act, forthcoming in the South Carolina Law Review.  From the abstract:

The argument that the CRA is to blame for the financial crisis is hard to reconcile under any reading of the statute’s terms and after any assessment of the CRA’s true reach. As this article explains, the CRA was not too strong, but rather too weak. Designed to fight the last war, the CRA became the financial equivalent of the Maginot Line: easily circumvented, lightly defended, and quickly overrun.

An appreciation for the true causes of the financial crisis, together with the fact that the federal government has expended billions to bail out the financial industry, offer strong justifications for expanding the reach of the CRA to cover all financial institutions, not just those that take deposits.

Let the debate continue (hopefully with more data).

- Matt Festa

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I'm a retired retail banker (33 years) who's had to live with the CRA since its inception. It is my opinion that the CRA has little to do with the financial meltdown. What happened was a relaxation of risk standards in the financial markets with ultimately extended to our primary mortgage lenders: FHLMC & FNMA. For decades bankers have had as financial resources high-rate asset-based loan money. This was money put up by investors who were willing to take a higher risk in return for a higher return. Usually these lenders only advanced 60% or so of the property’s value which as a fallback source of repayment left plenty of room should the borrower be unable to meet the monthly payment. Conventional mortgage loans (FHLMC & FNMA) required a borrower to qualify using a conservative set of ratios such as a historical and verified gross monthly income equal to 3+ times the proposed mortgage payment.

What happened after 2000 was that the "conventional" lenders began expanding into the higher risk asset-based loans which qualified borrowers based on their "stated", unverified income preferring instead to hang their hats on the value of the property vs. the ability to make the payments. The "wisdom" was that if they couldn't make the payments, we could always sell the property." Other factors like lending 100% or more of the appraised value vs. a historical and rational 80% contributed further to the meltdown. Well, of course this logic only holds in flat or rising real estate values. Should a downturn happen and the borrower can't make the payments, then the lender is faced with a loss since his collateral won't cover the amount owed. But with one of the longest economic expansions in history going on, financial wiz's put together investment pools (mutual funds, derivatives, etc.) to push to cash heavy retirement funds and other investors looking for higher returns. The money raised by these pools went into financing these higher risk mortgages supposedly “safe” due to the real estate held as collateral. How could one loose in this ever expanding economy?

So, I think one can see how this financial feeding frenzy ultimately had to end; the bubble had to burst as real estate prices (values) far exceeded the growth in personal incomes and every Tom, Dick & Harry became a real estate investor regardless of how unstable their job/income was. It took only a slight downturn in the economy for this highly leveraged situation to implode. And as with any over-leveraged situation, there was no margin of safety and it all went down the tubes.

Posted by: Manawai | Oct 15, 2009 7:19:34 PM