Bush, Mae and the Financial Crisis

[Tiggs]

Yeah, it was the subprimes that were the actual 'problem', but, had it not been for the CRA, the subprime market simply would have never existed.

So why is it that subprime markets have managed to appear everywhere else throughout Western civilization?

[+joc]

So why is it that subprime markets have managed to appear everywhere else throughout Western civilization?

I imagine it is a monkey see, monkey do scenario...I don't really know. What I do know however, is why the subprime markets appeared in this country.

The following article by the late economist Brenda B. White goes a long way toward explaining the history of subprimes. At one time Brenda B. White worked for Merrill Lynch as the Vice President of Financial Analysis:

Two decades ago sub-prime borrowers would typically have been denied credit, as lenders were restricted by usury laws that prevented them from charging rates high enough to compensate them for the risk. However, the adoption of the Depository Institutions Deregulatory and Monetary Control Act in 1980 eliminated rate caps and made subprime lending more feasible for lenders.

In addition, the Tax Reform Act of 1986 eliminated interest deductions on consumer and auto loans while allowing interest deductions on mortgage debt, thus making the latter a more attractive source of financing. These legislative reforms encouraged the development of technologies enabling lenders to deliver risk-adjusted pricing rather than shut the door on higher-risk mortgage borrowers altogether.

1994 to 1997

It wasn't until the mid-1990s that subprime lending began to gain traction: Rising interest rates in the mid-1990s led to declining origination volumes and intense financial competition in the prime market. Furthermore, the endorsement of the beginning of subprime securitizations by Wall Street firms and the willingness of investors to buy those securities represented an endorsement of this product segment, and provided impetus for expansion.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Keep in mind that the CRA came into existence in 1977. As I said in the beginning, it was the changes to the CRA..the evolution of the CRA that brought about the subprime market.

Passed by Congress in 1977, the Community Reinvestment Act(CRA) states that “regulated financial institutions have continuing and affirmative obligations to help meet the credit needs of the local communities in which they are chartered.” The act establishes a regulatory regime for monitoring the level of lending, investments, and services in low- and moderate-income neighborhoods that are traditionally underserved by lending institutions. Examiners from four federal agencies evaluate and “grade” banking activities in these neighborhoods.

If a regulatory agency finds that a bank is not serving these communities, it can delay or deny the institution’s request to merge with another lender, open a branch, or expand any of its other services.

Edited October 11, 2012 by joc

[Tiggs]

Keep in mind that the CRA came into existence in 1977. As I said in the beginning, it was the changes to the CRA..the evolution of the CRA that brought about the subprime market.

So...because the CRA was created back in '77, 15 years or so prior to the time that the subprime market began in earnest - you believe that that's what created the subprime market?

As opposed to, I don't know, say, that deregulation act that you've quoted combined with the economic circumstances you've also quoted from the beginning of her article, entitled "A short history of subprimes"?

In that entire article, Brenda B. White mentions the CRA exactly no times. Zero. Zip. Zilch.

Which quite accurately sums up the relationship between the CRA and the subprime market.

[+joc]

So...because the CRA was created back in '77, 15 years or so prior to the time that the subprime market began in earnest - you believe that that's what created the subprime market?

As opposed to, I don't know, say, that deregulation act that you've quoted combined with the economic circumstances you've also quoted from the beginning of her article, entitled "A short history of subprimes"?

In that entire article, Brenda B. White mentions the CRA exactly no times. Zero. Zip. Zilch.

Which quite accurately sums up the relationship between the CRA and the subprime market.

Apparently you are not getting the connection. You have all the dots...you are just refusing to connect them. It wasn't the CRA, per say, that created the subprime market. In fact, the promoters of the CRA originally complained about the enforcement aspects of it...rather the lack of enforcement.

Let me put it this way:

Let's suppose that I am Dr Frankenjoc. I create a living breathing creature. It doesn't really do much. It just walks around and grunts a little bit. But then, later down the road, other people start messing with my creation...they give it teeth, and claws, and instill in it a desire to be an Enforcer. Then, later on down the road, the creature becomes a raging monster and kills everyone in the town. It didn't even look anything like the creature I created. But someone started pointing fingers at me saying, See, that Dr. Frankenjoc...he is the one! He is the one who created the monster...kill him!

Well, no, Dr. Frankenjoc did not create that monster. My creature wasn't even capable of much. But when they added The Act of Teeth And Claws and later The Act of Enforcer...that is what caused my creature to destroy the entire town. And you are right...my creature is not responsible for the calamity down the road. But I also am right by saying that...if I had never created my creature, there never would have been a calamity. Does that make any sense to you?

Edited October 11, 2012 by joc

[Yamato]

We're lost in the weeds here so let's get back on the road.

The government enabled and encouraged the housing bubble with zero percent interest rates, endless bureaucratic babble from both parties, and government guarantees.

None of this would have happened in the free market. Banks wouldn't have touched these lenders with a 10-foot pole if it wasn't for government guarantees. And if a dumb bank did make dumb loans, it should pay the dumb price in full. That's the free market, it's not being allowed to work. Nobody seems to care. If you let greedy people have the means to be greedy, they will be greedy every time. They will sell as many houses as they can and make as much money as possible, and when the house of cards come crashing down, they won't be around to feel the pain. They'll have rung the register and will let the bag holders suffer their efforts. It isn't government's job to control housing prices. And it's still at the switch trying to do exactly that. Nothing's been learned, there are no lessons here. It's business as usual and everyone is shrugging their shoulders wondering what's to worry about. I'm not going to get burned again. Once was enough. I'm going to retire in peace and comfort someday I'm not going to let these government clowns and financial yahoos destroy my future, thanks.

[Tiggs]

Apparently you are not getting the connection. You have all the dots...you are just refusing to connect them.

Sometimes - two dots are just two dots.

Let me put it this way:

Let's suppose that I am Dr Frankenjoc. I create a living breathing creature. It doesn't really do much. It just walks around and grunts a little bit. But then, later down the road, other people start messing with my creation...they give it teeth, and claws, and instill in it a desire to be an Enforcer. Then, later on down the road, the creature becomes a raging monster and kills everyone in the town. It didn't even look anything like the creature I created. But someone started pointing fingers at me saying, See, that Dr. Frankenjoc...he is the one! He is the one who created the monster...kill him!

Well, no, Dr. Frankenjoc did not create that monster. My creature wasn't even capable of much. But when they added The Act of Teeth And Claws and later The Act of Enforcer...that is what caused my creature to destroy the entire town. And you are right...my creature is not responsible for the calamity down the road. But I also am right by saying that...if I had never created my creature, there never would have been a calamity. Does that make any sense to you?

Sure. But as an analogy, it bares no resemblance to what we're discussing.

The changes to mortgage legislation which made subprime mortgages more attractive to banks - were changes made to mortgage legislation in general. Not changes to the CRA legislation.

General mortgage legislation. CRA legislation. Two entirely different things.

It's like you created a creature that just walked around and grunted a bit, while someone else created a monster that destroyed Tokyo and then blamed you for it, because you created something that was alive, too.

[Yamato]

Banks don't need "encouragement" from anyone, least of all the government. They should be responsible for themselves. I know self-responsibility is a lot to ask in this day and age. And encouragement is another word for market distortion, to change the behavior of what otherwise would have been. The connection between the CRA and the subprime market is the government encouraging creditors to extend credit where they otherwise wouldn't extend it. Risk is naturally regulated by the market. If the consequences of assuming risk (something businesses already do in spades) include bankruptcy and failure, risk aversion or at least prudent risk management will be the rule of the day. If a risky transaction is made and an unwanted outcome occurs, then the consequences of that transaction should come down with full gravity on whoever screwed up. But the government guarantees distorted that justice too. The CRA forced banks to change their behavior and lend to non-creditworthy borrowers; thus the CRA forced the sub prime market to grow larger than it otherwise would have been. It encouraged the very definition of sub-prime; the connection is definitive. The intent of the law was sound as the intent of nearly all laws are, yet the results were disastrous and if we don't allow ourselves to learn from the errors of the past we're doomed to repeat them. And it's no surprise to me that we are still repeating them today and no, the ostrich isn't able to stop it.

[+joc]

Sometimes - two dots are just two dots.

Sure. But as an analogy, it bares no resemblance to what we're discussing.

The changes to mortgage legislation which made subprime mortgages more attractive to banks - were changes made to mortgage legislation in general. Not changes to the CRA legislation.

General mortgage legislation. CRA legislation. Two entirely different things.

It's like you created a creature that just walked around and grunted a bit, while someone else created a monster that destroyed Tokyo and then blamed you for it, because you created something that was alive, too.

Could you please define 'general mortgage' legislation...specifically, the 'general mortgage' legislation that created the subprime market?

[Tiggs]

Could you please define 'general mortgage' legislation...specifically, the 'general mortgage' legislation that created the subprime market?

General Mortgage legislation is legislation that applies to financial institutions regarding mortgages, as opposed to CRA legislation, which is the original 1977 act and later specific amendments to that act.

For simplicity - I'll happily use the two you referred to earlier from Brenda B. White - The Depository Institutions Deregulatory and Monetary Control Act of 1980 and the Tax Reform Act of 1986 - neither of which were amendments to the CRA.

[+joc]

General Mortgage legislation is legislation that applies to financial institutions regarding mortgages, as opposed to CRA legislation, which is the original 1977 act and later specific amendments to that act.

For simplicity - I'll happily use the two you referred to earlier from Brenda B. White - The Depository Institutions Deregulatory and Monetary Control Act of 1980 and the Tax Reform Act of 1986 - neither of which were amendments to the CRA.

I will concede that the analogy could be better. It is more like...instead of tweaking my creature, other creatures were created...I will give you that. You are correct that not all legislation was CRA induced. Nonetheless...I still think that the CRA acted as the initial catalyst for other legislation down the road. To better answer the question I asked you...of which you provided two examples...and for anyone interested in more 'light' reading...I introduce this LINK, A Short History of Financial

Deregulation in the United States

This has been a very interesting discussion. While we may disagree on certain aspects...overall, it has been a vehicle for learning, and I thank you Tiggs for your time and input.

[Yamato]

The CRA is exemplary of the attitude government has to banks lending money to people they otherwise wouldn't: Easy, cheap, and the most ridiculous of all: guaranteed. Is the CRA solely responsible? Of course not. Partisans always argue over the quantity of regulations in a marketplace and they're all missing the point. The last kind of regulation we want on a marketplace is the kind of regulation that undoes the real solution to bad lending practices. The last kind of regulation we need is a government enabled problem that prevents the market's solution. What are credit ratings even worth now? How many times have we seen politicians standing in front of voters preaching about how more Americans own a home than ever before? About how housing prices are the highest they've been in years/months/decades? About how whatever statistic they want to torture out of the data turns into another talking point about why they deserve your vote? Politicians shouldn't be price fixers. They don't have perfect knowledge. Prices are the market's job. This game on people is played all the time in politics and the people are the ones who suffer for it. How subsidized with federal funds is New Orleans for example? How many poor people are encouraged to live below sea level with some walls around it with federal subsidies only to be used as pawns in a bragging match for how wonderful New Orleans is doing, when no insurance company would affordably touch these people with a ten foot pole if it wasn't for government distortion? Why is the government then the force for good when these people get washed out from the next hurricane? Stop distorting the marketplace, government. That's the elephant in the room here and I'm not surprised when people ignore it because that's the politically popular thing to do.

[whitelight]

I don't remember exactly when but I'd guess 1995, Gingrich and Clinton reached an agreement to partially privatize Fanny and Freddy. While it was moving through Congress, former members of the Carter and Reagan administrations warned that privatizing the profits and making public the losses would end in disaster.