Clinton, FMs not to blame for mortgage meltdown

I'm throwing down the gauntlet again.  Who will challenge me?

Poor Homeowners, Good Loans

By Michael S. Barr and Gene Sperling

October 18, 2008  | New York Times

 

 

For those who championed a hands-off approach to the supervision of finance, the economic meltdown should have prompted reflection on the value of common-sense regulation. Unfortunately, a growing chorus in conservative circles is trying to shift blame for the current crisis to the poor and the advocates for the poor.

 

Here's their story line: our current problems were caused not by people in high finance and government over the past eight years, but powerful antipoverty groups and the Clinton administration, which through their advocacy for the Community Reinvestment Act and homeownership goals for Fannie Mae and Freddie Mac bullied a Republican Congress and the titans of Wall Street into bringing global finance to its knees.

 

There's only one problem with this story: it isn't true.

 

It is not tenable to suggest that the Community Reinvestment Act, which was enacted more than 30 years ago, suddenly caused an explosion in bad subprime loans from 2002 to 2007. During the 1990s, enforcement under the reinvestment act was strong, prime lending to low-income communities increased and it was done safely. In 2000, a Federal Reserve report found that lending under the act was generally profitable and not overly risky.

 

By contrast, in the 2002 to 2007 period, the act's enforcement was weak and its advocates had little influence with Congress. In 2003, President Bush's chief thrift regulator — holding a chainsaw in his hands as a prop — boasted of his plans to cut banking regulations, including the scope of the reinvestment act and his enforcement staff, which he carried out over the next two years.

 

Instead, the bad subprime loans were predominantly made by financial firms not covered by the act. According to recent Fed data, 75 percent of higher-priced loans during the peak years of the subprime boom were made by independent mortgage firms and bank affiliates that were not covered by the act.

 

If the Community Reinvestment Act caused the subprime crisis, it is hard to make sense of why non-covered lenders drove the growth. These subprime lenders were competing with more responsible lending under the act by banks and thrifts. Their loans undid the work of community banks that had been making sound mortgage loans to creditworthy low- and moderate-income borrowers for years.

 

The second claim from advocates of deregulation is that the roots of the current crisis lie in efforts to encourage Fannie Mae and Freddie Mac to do more to help low- and moderate-income homeowners. The assertion is that Democrats encouraged financial recklessness by insisting that Fannie and Freddie fulfill their congressionally mandated public purposes by expanding access to home mortgage loans to non-creditworthy borrowers. But again, the argument is not supported by the facts.

 

The Clinton administration explicitly discouraged Fannie and Freddie from buying predatory subprime loans. A report on predatory lending in 2000 from a task force formed by the Treasury Department and the Department of Housing and Urban Development called for Congress to enact legislation to "prohibit the purchase by each of these entities of predatory loans."

 

Furthermore, Treasury Secretary Lawrence Summers and Gary Gensler, an undersecretary of the Treasury, were severely criticized by the Republican Congress in 1999 and 2000 when they called for reforms to address the systemic risk from Fannie and Freddie and to reconsider their government line of credit. When the Clinton administration left office, the two mortgage firms were still bit players in the subprime market.

 

The subprime boom was led by investment banks and mortgage brokers, not by government-sponsored enterprises. Fannie and Freddie became unhinged in the middle of this decade when they tried to play catch-up. Their shareholders and managers pushed them to recover the securitization market share they had lost to unregulated investment banks getting absurd AAA ratings for packaging subprime dross. From 2005 to 2008, Fannie Mae purchased or guaranteed $270 billion in loans to risky borrowers — triple the amount in all its earlier years combined. That was a serious mistake in risk management, but it was not driven by the desire to fulfill affordable housing goals set in the 1990s or by the Community Reinvestment Act.

 

There are many lessons to learn from the financial meltdown. Chief among them is to beware the reckless spending, conflicts of interest and opaque practices of those seeking high profits. But it is a serious mistake to attribute any of our troubles to consumer protection laws and the actions of those in the nonprofit community with a history of promoting responsible lending to families of moderate incomes.

 

Michael S. Barr, a professor of law at the University of Michigan, and Gene Sperling, the national economic adviser to President Bill Clinton from 1997 to 2001, are senior fellows at the Center for American Progress.