Taking One For The Democrats

October 1st, 2008 at 09:17pm Mitch Mulhall 171

In these days leading up to the election, the Con Man’s staunch partisanship is sadly quixotic. On Wednesday, he spent an undue amount of time beating the “Conservatives take no blame” drum, as if this is a trait unique to Republicans and Conservatives. Nothing could be further from the truth. Yet, despite the fact that the primary cause of current economic instability is fiscally liberal policies implemented by Democratic Presidents, I don’t see the Con Man stepping up to accept responsibility. Do you?

In 1977, President James Earl Carter Jr. signed the Community Reinvestment Act (CRA), a law that mandates banking practices designed to foster lending to low- and moderate-income people. This impresses me as a highly principled idea that strikes at a central element in Maslow’s hierarchy of needs: without shelter, a person cannot attain self-actualization. If you think improving the human condition is a noble pursuit, and who doesn’t, providing affordable housing to the poor is a great place to start. To his credit, former President Carter has put his money where his mouth is on this. You need look no farther than his post-presidential philanthropy through Habitat for Humanity.

But did CRA really create affordable housing for poor folks?

Not really. You can bring a low-income person to a bank, but you can’t make him a qualified borrower.

CRA’s provisions did precious little to make housing available to the poor. Instead, CRA created rules banks had to follow to remain Federally Insured. Among other things, CRA mandated that every depository institution be evaluated every 48 to 60 months to determine whether it was “meeting the credit needs of its entire community, including low- and moderate-income neighborhoods.”

How effective were these provisions?

That depends on what your standard is. If your standard is massive bureaucracy and tedious reporting obligations, CRA was highly effective. If your standard is fairness of credit extension as measured by mortgages on properties in low- and moderate-income neighborhoods, CRA was barely passable. However, if your standard is to provide affordable housing for the poor, CRA failed flatly. Even after the signing of CRA, loan qualification was what it should be. A person couldn’t borrow more than he or she could afford based on time-tested debt-to-income ratios designed to protect the borrower from loan default.

That all changed on January 31, 1995 when President Bill Clinton signed laws that put meat on the bones of the CRA. These regulations intensified the CRA by changing the test for FDIC membership. Instead of relying on what banks reported, the Government would use home-loan data broken down by neighborhood, income group, and race as proof of CRA compliance. The good news was banks no longer had to compile evidence and submit reports. The bad news was FDIC membership relied on data collected by the Federal Government. The only way to protect FDIC membership was to write mortgages and lots of them—traditional debt-to-income ratios be damned. Banks created mortgage products designed to attract low-income borrowers like Ninja loans, Adjustable Rate Mortgages (ARMs), Interest Only loans, Nothing Down, Pay Later, anything they could do to make sure that the Government data supported their full CRA compliance.

The first publicly secured sub-prime loans were issued in 1997. These were followed shortly by Congressional authorization of $1 Trillion dollars in new sub-prime loans and a mandate that deposit-taking banks offer these loans to anyone. After the 1999 Gramm-Leach-Bliley Act, the advent of sub-prime loans lead to the issuance of mortgage-backed securities (MBSs) on these sub-prime loans. With the distinction between investment banks and depository institutions lifted, investment banks like Lehman Brothers, Bear Stearns, and Merrill Lynch bought these sub-prime MBSs as a dividend tax shelter. Fannie Mae alone bought $2 Billion of these MBSs. (That makes Fannie Mae, a Government entity, a holder of thousands of foreclosed properties, but that’s a subject for another post.)

What happened next is, in my opinion, clearly something President Clinton anticipated, for surely a Rhodes Scholar understands the basics of supply and demand. All these new buyers drove housing prices up quickly. As a consequence, many of these low-income buyers found themselves in homes purchased at a premium, often making the monthly mortgage payment not only higher than it should be, but arguably more than a low-income borrower could realistically afford.

But there were also conditions President Clinton could not have foreseen. First, I don’t think President Clinton could have imagined the kinds of mortgage products banks would come up with. In truth, he probably thought mortgage products would remain exactly what they always had been. Second, the Federal Reserve began raising interest rates. Low-income borrowers with ARMs were the first to suffer. Third, gas prices went through the ceiling, squeezing every penny in the family paycheck, especially low-income paychecks. More and more people had no money to pay the mortgage and didn’t. Foreclosures commenced.

In time, banks quit writing sub-prime loans and the sub-prime credit market collapsed. Foreclosures created huge housing inventories in real estate markets with no buyers, only sellers. Home values dropped like a rock. Fannie Mae mortgage-backed securities became worthless. Investment Banks that bought this paper collapsed. Jobs disappeared overnight.

Is the 1995 expansion of the CRA to blame for this “bubble burst”?

In my judgment, it is. Prior to 1995, home value increases paralleled inflation rates. After CRA expansion, home values shot through the roof, leaving inflation in the dust. This created a bubble, if you will, similar to the perceived value of the “.com” companies in the late 80s. The “.com” bubble had grim effect on the stock market back in ’87. On Black Monday, October 19, 1987, the Dow Jones Industrial Average (DJI) lost 22.6% of its value in a single day. How does that compare to last Monday’s precipitous 777 point drop? Last Monday, the DJI lost 7.5%. Understand this: the effect of this economic crisis has not been fully or even partially realized in the stock market this week—not even close. What happens next in the markets is wholly a function of what Congress does, or doesn’t do, next.

Why didn’t anyone do anything about this?

Some tried.

In 2003, the Bush Administration tried to establish a new Agency to oversee the lending practices Fannie Mae and Freddy Mac, but Congressional Democrats blocked this effort. At the time, Massachusetts Congressman Barney Frank questioned the need for such an Agency saying, “The more people exaggerate these problems, the more pressure there is on these companies [Fannie Mae and Freddy Mac], the less we will see in terms of affordable housing.” Frank could not have been more correct. If the duty of such oversight were to ensure that mortgage lending adhered to proven lending principles, like reasonable debt to income ratios, access to dodgy mortgage products would have, at least in theory, dried up. But oversight with this as its aim would make lending what it was under the pre-Clinton provisions of the CRA, so Congressional Democrats dug-in and squashed the Administration’s efforts.

In 2005, Senators Elizabeth Dole, John McCain, and John Sununu co-sponsored the Housing Enterprise Regulatory Act, which proposed measures to regulate the lending practices of Fannie Mae and Freddy Mac. It was introduced on January 26, 2005, but the Democrats never scheduled it for debate and it died in Committee. It was re-introduced in 2007 but met a similar fate.

To be fair, the Republicans ran Congress from 1995 to 2006. Could they have done more to mitigate the effects of the 1995 changes to CRA? Maybe, but that’s Monday morning quarterbacking. Besides, I’m not sure anyone could have foreseen the full magnitude of what has transpired. What is clear is that no matter how noble their intent, the fiscally liberal policies that brought us this crisis came from the only two Democratic Presidents elected in the last forty years.

Since the Con Man won’t accept any responsibility for this economic mess, let me, as a registered Democrat since 1978 and as a Carter supporter in 1980, stand in and take the rap. If you’re looking to blame somebody, blame me, Mitch Mulhall, and never let it be said that “Democrats take no blame.”

Oh, and in the face of this grim financial reality, please accept my sincere apology if blaming me fails to make you feel better.

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