Monday, October 13, 2008

Is the Community Reinvestment Act responsible for the 2008 financial meltdown?

The following post is in response to a video link emailed to me:

First, how can the 30 year old CRA be responsible for the mortgage crisis, given the following fact?
More than 3/4 of subprime loans were not governed by CRA regulations.

Now, you assert that ACORN and low-income minorities are at fault in this financial crisis. Therefore, the loan officers and lending institutions are not to blame. The following must merely be tangentially related to the economic mess we are in:

When the Tech Bubble burst, some 8 years ago, the Federal Reserve cut interest rates to 1%. This was an effort to stimulate an economic recovery from the recession. The stock market is abysmal, mortgage rates are attractive, and real estate becomes popular. The Housing Bubble begins to expand.
Moral hazard is an economic and insurance term that describes how people behave recklessly when they're insured or protected in some way. If you sell flood insurance, people will build on flood plains. If you make airbags and anti-lock brakes standard in all cars, people will drive faster and tailgate more closely. If you introduce fat-free cookies (fat-free, but still loaded with calories), people will eat more cookies than before, and get just as fat.
In the last four years or so, mortgage standards became lax because each link in the mortgage chain collected profits while believing it was passing on risk to the next link in the chain. Brokers weren't lending their own money, so they were pushing risks onto the lenders. Lenders sold mortgages soon after underwriting them, pushing the risk onto investors. Investment banks bought the mortgages and chopped up mortgage-backed securities into slices, with some slices being less risky and other slices being more risky. Investors bought securities and hedged against the risk of default and prepayment, pushing those risks further along. All of these businesses accepted profits and tried to leave the next guy vulnerable to risk. Participants thought they were insulated from the negative consequences of bad decisions. That's an example of moral hazard.
The people who take applications, the companies that lend the money, the appraisers who check property values, the investment banks that sell mortgages to investors and the investors themselves -- all had millions of reasons to keep mortgages flowing to borrowers who couldn't afford them. Each reason had a dollar sign attached to it. As long as each participant kept saying yes to risky borrowers, everyone made money.

Loan Officers
Brokers and loan officers make their livings by persuading people to get mortgages. There's no profit in telling an applicant that he has no business buying a house. Except in cases of flagrant fraud, brokers and loan officers don't suffer consequences if their customers later fall behind on their house payments.
Appraisers are told by mortgage brokers and loan officers: "I'll give you all the work you can handle, but just don't kill any deals," says Jonathan Miller, president and chief executive of Miller Samuel Real Estate Appraisers, in Manhattan. "If you kill just one deal, you won't get any business."

"The lending sector has really driven out a vast number of qualified experts to be replaced by an army of form-fillers -- basically, appraisers that simply 'make the number.' That's their job," Miller says.
Behind the brokers and loan officers are the companies that do the actual lending. During the nonprime boom years of 2003 to the middle of 2006, lenders had an incentive to approve mortgages to uncreditworthy borrowers because lenders don't hang onto loans for long. They sell most home loans to investors. Lenders thought they were in the clear after selling loans: If the borrower fell behind on the payments, the investor -- not the lender -- would face the consequences
Secondary Mortgage Market
investment banks and a few big lenders collect fees by packaging and selling bundles of mortgages. As long as borrowers keep getting approved for mortgages, these companies earn fees. It's not in their interest to halt the gravy train.

Bundled loans are sold to investors as mortgage-backed securities. Most nonprime mortgage-backed securities are thought to end up in the possession of hedge funds, pension plans and Chinese millionaires who think they know what they're getting into. These investors clamored for high-yield bonds, and one of the best ways to create high-yield bonds is to underwrite high-interest, risky mortgages. Lenders were responding to demand from eager investors as much as they were responding to demand from nonprime borrowers.

It turned out that investors can force lenders to buy back loans that go bad soon after the loan is sold. Buybacks were relatively rare until 2006 because house prices were rising quickly. Troubled borrowers could sell their houses quickly and for a profit, removing bad loans from investors' books.

But in many places, house prices stagnated or fell in 2006 and fewer people applied for mortgages. Subprime and Alt-A lenders became more reckless in their lending decisions in an intensely competitive market. Lots of new borrowers fell behind on their house payments within just two or three months. Rather than lose money on the inevitable foreclosures resulting from these "early payment defaults," investors forced lenders to buy back hundreds of millions of dollars in bad loans.

More than 20 subprime lenders have gone out of business or declared bankruptcy since December because they didn't have enough cash to buy back bad loans.

The Republicans have been having a lot of fun at the expense of ACORN recently:
ACORN pays poor people for each voter they register. Some poor people register fake voter names to get paid more money. To result in true voter fraud would require a person to show up at the polls with a fake ID showing that they are a fake person living at a fake address. ACORN loses money, and it gets blamed for "massive voter fraud" by the Republicans.

Do you know anything about ACORN?

ACORN did not want poor people losing their homes.
ACORN fought to help prevent poor people from ending up in foreclosure.
Friday, August 1, 2003
The Office of the Comptroller of the Currency wants national banks to be exempt from state and local laws that aim to curb predatory lending.

A few cities and some states -- most notably, Georgia, New York and North Carolina -- have ordinances and laws that restrict certain lending practices. Among the forbidden practices: very high interest rates, long periods in which prepayment penalties apply, and lending on the basis of a home's foreclosed value rather than the borrower's ability to repay.
In a news release announcing the proposed regulation, Comptroller John Hawke says, "We have no evidence that national banks are engaged in predatory lending practices."

Hawke's see-no-evil statement draws rueful laughs from the likes of Lee and of ACORN, the Association of Communities Organizations for Reform Now. Lee's organization has filed complaints to the OCC about subsidiaries of Citigroup, and ACORN is campaigning against the lending practices of some affiliates of Wells Fargo.

The OCC's proposed pre-emption policy "is a backward approach," says David Swanson, ACORN's communications coordinator. "States are very carefully enacting good legislation protecting their homeowners, and that's because, you might argue, the federal government is not doing its job."

Rumors are rampant that 'low income minorities' caused this meltdown
  • What is another word for 'low income minority'? Black.
  • Why is this not racist? It is.
Recently, the Republican Party has been KKK-lite (half the flavor, all the calories).

Why are the Republicans spreading these false rumors?

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