How Much Blame To Throw At the CRA?

Some experts and some non-experts have pointed a finger at the Community Reinvestment Act as part of the reason behind the housing bubble bursting and setting off an economic crisis.  I afforded it due consideration, but when all is said and done holds minimal blame in the grand scheme.

The failures in government regulation undoubtedly played a part in the economic crisis.  However, compared to other government action, the CRA accounts for a tiny share of the pie in more ways then one.  It was a mistake to change CRA compliance requirements to be measured on a quantitative basis and away from a qualitative value judgement.  This forced lending institutions to require meet an annual lending quota or risk jeopardizing government benefits.  The CRA most definitely encouraged lending to those who could not afford.

But looking at the percentage what the government qualified as CRA loans pales in comparison to the total share of outstanding subprime loans.  Between 1993 and 1998, only $467 billion dollars qualified as CRA loans – a tiny slice of the trillions and trillions of dollars in outstanding home loan mortgages.  Present day estimates indicate that CRA home mortgages only account for about 20% of all home mortgage loans.  Even taking into account the higher default rates of subprime loans, a 9% default rate on CRA loans doesn’t even begin to approach the aggregate value in total defaulted home mortgages.

Numbers aside, it’s questionable whether or not a repeal of the CRA would have stopped the subprime lending spree.  In fact, two other government actions greatly encouraged subprime mortgage practices far more then the CRA.

Combined, Freddie Mac and Fannie Mae has either bought up or issued nearly half of all outstanding home mortgages by buying up loans from other lending institutions.  Freddie Mac and Fannie Mae were able to begin buying up large amounts of outstanding home loans because they could now sell mortgage backed securities.  Prior to the passage of the Gramm-Leach-Billey Act(which repealed the Glass-Steagall Act), banks were prohibited from offering investment services.  But now Freddie Mac, Fannie Mae, and all banks could begin leveraging their outstanding home mortgage loans to raise additional capitol.

It was a new way to raise capitol revenue and a new way to increase profits.  It’s natural for all businesses to exploit their profit margins while managing risks.  However, the risks of mortgage backed securities were lessened by the nonbinding understanding in the financial sector that the government implicitly guaranteed the securities issued by Freddie Mac and Fannie Mae.  The federal government has long provided these two instutitions with tax breaks, subsidies, low interest loans, and a reduction in capitol backing regulations.

Believing the mortgage backed securities issued by Freddie Mac and Fannie Mae would always be liquid, believed, to some degree, that the risk of subprime lending were offset by the implicit government backing.  With the ability to leverage loans as capitol and the perceived invunrability of Freddie Mac/Fannie Mae, fueled an increase in subprime lending.  It was a fantastic short term way to spur growth in the housing market, but miscalculated the risk involved based on assumptions.  It was not the need to meet CRA requirements that caused banks to make high-risk loans, it was the incentive to raise capitol.  The CRA could have been nonexistent and lending institutions would have still pursued those avenues which appeared profitable.

Government missteps played a role in where we are today.  Banks should have never been allowed to enter the investment market through government deregulation.  And the government never should have allowed Freddie Mac and Fannie Mae become the lynch pin in the home mortgage market.

Instead of pointing our finger at a single, politically self-serving source lets all grow 90 more fingers, so we can point the blame in all directions where it rightly deserves to be.  This wasn’t the CRA’s doing.  This was a confluence of events ranging from government to free market to populace none of which are to be used to gain the political upperhand.