Organized Crime
36. Why the Government is Responsible for the Sub-Prime Mortgage Meltdown
The hordes of mortgage defaults and foreclosures that occurred in the “sub-prime” housing market during the “Great Recession” was the direct result of the Fed’s “easy money” policy along with thirty years of government policy that forced mortgage lenders to make bad loans to un-creditworthy borrowers. When the Greenspan Fed pursued the policy of keeping interest rates as close as possible to zero in the wake of the sharp stock market decline at the turn of the century, the banking system inevitably responded by extending more and more mortgage loans to marginally-qualified borrowers.
When interest rates were higher and were not artificially lowered by the Fed, banks lent money for houses according to the creditworthiness of the borrowers. But when interest rates are artificially lowered by the Fed a whole new class of potential borrowers is added, namely, people with poor or below-average credit ratings who become just barely qualified for mortgage loans as a result of the lower interest rates, which translate into lower monthly loan payments. Many thousands of these marginal borrowers defaulted once the recession hit and their incomes dwindled. Others who had taken out adjustable rate mortgages found that, since they were always on the precipice of not being able to make their monthly payments, the small increase in interest rates that occurred caused them to default.
In addition to the Fed’s monetary policies stimulating the unsustainable sub-prime mortgage market, the government’s 1977 Community Reinvestment Act (CRA) also played a prominent role. This Carter administration law compelled banks to make mortgage loans to low-income borrowers and to what supporters of the law call “communities of color” that they believe will have trouble acquiring mortgage loans based on traditional economic criteria, i.e., they are economically unqualified to borrow money to buy a house.
The original proponents of the CRA were the hardcore, extreme leftists who supported the Carter administration, especially such “neighborhood organizations” as “ACORN” (Association of Community Organizations for Reform Now). Barack Obama worked as a lawyer and “community organizer” for ACORN after leaving Harvard Law School.
So-called “community groups” like ACORN benefit themselves from the CRA through a process that sounds a lot like legalized extortion. The CRA is enforced by four federal government agencies: the Fed, the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corporation. The law is set up so that any proposed bank merger, branch expansion, or branch creation can be postponed or cancelled by any of these four bureaucracies if a CRA “protest” is issued by a “community group” like ACORN. This can cost banks great sums of money and the “community groups” use this concern by the banks as leverage to enrich themselves. They demand that the banks give them millions (and sometimes billions) of dollars along with promises to make additional millions (or billions) in bad loans to unqualified, sub-prime borrowers in return for a withdrawal of the protest.
A man named Bruce Marks (pronounced like “Marx”) became quite notorious as a Boston “community organizer” from pressuring banks in that city to earmark literally billions of dollars to his “Neighborhood Assistance Corporation of America.” He once boasted to the New York Times that he had “won” commitments from banks as a result of CRA protests totaling $3.8 billion. That was just one “community group” in one city.
As a result of the CRA banks in every city in America were forced to hold a portfolio of bad loans. In order to compensate themselves for this additional systemic risk imposed on them by the Fed, many banks increased lending fees associated with mortgage loans, forcing qualified borrowers to subsidize some of their losses from the CRA-inspired bad loans. They also did what banks have always done—charge higher interest rates for the inherently riskier, sub-prime loans.
The community groups screamed that such practices were discriminatory and “predatory” and lobbied for anti-predatory lending laws that would prohibit such fees. They succeeded in many states, forcing banks to “eat” the losses from the sub-prime loans.
A sort of “smoking gun” in this entire CRA charade is an influential Boston Fed publication entitled “Closing the Gap: A Guide to Equal Opportunity Lending.” There is a gap, you see, between the lending abilities of: (a) people who have enough income to afford a mortgage loan of a certain amount; and (b) those who do not have enough income to qualify for the same loan. Of course, by this criterion there is also an automobile gap, a grocery gap, a two-week vacation gap, etc. The Boston Fed study threatens to use the coercive powers of the state to close the “housing gap” by stepping up pressures on mortgage lenders so that they would make orders of magnitude more bad loans to unqualified borrowers.
In addition to making more bad loans, the Fed urged banks to make more use of racial hiring quotas in their hiring decisions, presumably under the theory that minority loan officers would be more inclined to sign off on more of these bad loans to fellow racial minorities.
The Boston Fed claimed that its document was only offering “lending guidelines,” but it is very clear that failure to obey the Fed’s “guidelines” could lead to serious financial penalties for any mortgage lender. The report stated in bold letters that
Failure to comply with the Equal Credit Opportunity Act or Regulation B can subject a financial institution to civil liability for actual and punitive damages in individual or class actions. Liability for punitive damages can be as much as $10,000 in individual actions and the lesser of $500,000 or 1 percent of the creditor’s net worth in class actions.
All mortgage lenders—banks, independent mortgage companies, etc.—were told that they needed to pay close attention to “such laws and regulations as the Equal Credit Opportunity Act (Regulation B), the Fair Housing Act, the Home Mortgage Disclosure Act (Regulation C), and the Community Reinvestment Act.” A “conscientious [bank] Board will recognize the potential liability associated with noncompliance.”
The Fed instructed mortgage lenders to ignore traditional measures of creditworthiness when it came to “minority and low-income consumers.” Traditional underwriting standards were said to contain “arbitrary or unreasonable measures of creditworthiness” such as proof of income. Instead, lenders were instructed to adopt “special standards” of lending that were supposedly “appropriate to the economic culture of urban, lower-income, and non-traditional consumers.” For example, traditional underwriting standards take into consideration such things as age, location, and condition of a house, but these should be abandoned according to the Fed when it comes to minority and low-income borrowers.
Traditional ratios of mortgage payments to monthly income should also be ignored, instructed the Fed. But not to worry: The Fed also promised mortgage lenders that the risk associated with making billions of dollars of bad loans to unqualified borrowers would be erased because Fannie Mae and Freddie Mac would purchase the loans from them and then bundle and “securitize” them for sale on “the secondary market” for mortgages.
Of course, the Fed also instructed mortgage lenders that “lack of credit history” should also be ignored when it comes to minority and low-income borrowers. “Successful participation in credit counseling” is an adequate substitute for an actual credit history, said the Fed.
For “normal” borrowers, shopping around for a dishonest property appraiser who cooks the books to accommodate his clients involves criminal penalties. But not for the Fed’s mascots—minority and low-income borrowers. If a “sub-prime” borrower has a property appraisal problem that might hold up his loan, then the Fed will gladly hope to find “another experienced appraiser” who would presumably cook the books for the subprime borrower.
Having generated the prospect for a banking crisis by forcing billions of dollars of bad loans on mortgage lenders in the name of increasing home ownership, the government sought to prevent such a crisis through the “magic” of “securitization.” Beginning in the mid-1990s Fannie Mae and Freddie Mac were instructed by Congress to step up the purchasing of CRA loans from mortgage lenders, bundling them, and selling them as “securities” on so-called secondary markets.
Fed Chairman Ben Bernanke boasted of the alleged wisdom and moral superiority of this policy in a March 30, 2007 speech entitled “The Community Reinvestment Act: Its Evolution and New Challenges.” The speech was part of the government’s celebration of the thirtieth anniversary of the Act. According to Bernanke,
Securitization of affordable housing loans expanded, as did the secondary market for these loans, in part reflecting a 1992 law that required the government-sponsored enterprises, Fannie Mae and Freddie Mac, to devote a large percentage of their activities to meeting affordable housing goals.
In addition to the 1992 law that Bernanke refers to here, the 1994 Riegle-Neal Interstate Banking and Branching Efficiency Act loosened up the regulatory barriers to bank mergers, which greatly enhanced the clout and bank accounts of the leftist “community groups” like ACORN. As Bernanke went on to explain: “[A]dvocacy groups increasingly used the public comment process to protest bank applications on CRA grounds.” There was, in other words, an explosion of the type of legalized extortion activity that the CRA was always intended to generate. Not surprisingly, “banks began to devote more resources to their CRA programs,” said Bernanke.
That’s not all. In 1995 the U.S. Treasury Department decided that the government itself should get directly involved in the bad-loan-to-unqualified-borrowers business by using billions of taxpayer dollars to capitalize so-called “Community Development Financial Institutions” that would lend directly to “sub-prime” borrowers. It was also at this point—1995—that the government, with the Fed as its enforcement arm, began pressuring banks to abandon the traditional loan qualification criteria for low-income and minority borrowers, such as savings and credit history, income verification, and the size of the loan relative to monthly income.
By 2003 one financial institution, Countrywide Bank, had made so many CRA loans—in excess of $600 billion worth—that the Fannie Mae Foundation gave Countrywide a special award and publicly held the company out as a role model for all other banks. Countrywide filed for bankruptcy shortly thereafter, drowning in an ocean of bad CRA loans.
