The Community Reinvestment Act - Eye of the Storm

Housing Crisis, Financial System Debacle, and The Community Reinvestment Act

Who is at fault? The “house of cards” is complicated and cannot possibly be tied definitively to one entity which is why all involved have been so successful with blame deflection. Much of the information available is written with significant agenda bias and cannot be taken at face value.

Basically, the now famous Community Reinvestment Act of 1977 started the ball rolling, but not until the Act was revisited and strengthened in 1995. Regardless of the spin politicians and biased individuals want to place on this, the facts are that banks were being pressured through this Act to make risky loans to people who were not qualified based upon down-payment, income and/or credit rating.

This pressure would not, alone, have resulted in significant problems because, initially, banks resisted and limited their exposure.

So, what were the factors that changed the dynamic resulting in unchecked escalation of risky loans?

1. The Federal Housing Enterprises Finanacial Safety and Soundness Act of 1992 mandated that HUD set CRA lending goals for Fannie Mae and Freddie Mac. In order to meet HUD's 50% CRA holdings requirement by 2010, Fannie Mae actively pursued low-mod income mortgages by "reaching out to credit-impaired borrowers..." (Michelle Davis, Fannie Mae VP). Banks saw large profit potential in lowering standards for making all loans because there was a now a hungry market in Fannie Mae and Freddy Mac where risky loans could be unloaded due to lowered repurchase guidelines for Fannie and Freddie. The whole operation was further fueled by sale of bundled Community Reinvestment Act loans as securities and by the sales of insurance derivatives of risky securities (think AIG).

2. While CRA loan increases and CRA loan securitization shenanigans increased demand and prices in the low-end housing market, the Taxpayer Relief Act of 1997 which raised home sale capital gains tax deduction from $125,000 to $500,000, increased demand for higher priced homes. Although banks did not recieve "CRA credit" for typical loans in this category, the new lower standards for borrowing were increasingly applied without prejudice because the mortgage-backed securities secondary market was taking off.

3. The 1999 passage of the Financial Services Modernization Act or Gramm-Leach-Bliley Act fueled the fire by increasing the motivation for banks to increase CRA loans. Banks were permitted to expand profits through addition of investment and insurance services to their commercial banking operations as long as their CRA loan activity remained high enough to satisfy politicians and community activist groups.

4. Finally, the Fed was cooperating by offering extremely low interest rates.

The market responded as would be expected with so much tinkering.

• Increased loan accessibility resulted in escalating housing demand and prices.
• Politicians and community activists crowed about how many people could now “own” homes regardless of financial situation.
• Freddie and Fanny were “making” lots of money and heroically increasing CRA holdings even faster than mandated by government This made their “bosses“ in Congress happy and assured big bonuses for company management.
• Banker/investor types were happy because they were earning millions on the transactions.

Unfortunately, what goes up without basis must come down and by 2007 the once lucrative subprime (loans to unqualified borrowers) market was imploding. Buyers were defaulting on loans they couldn’t afford in the first place which resulted in collapse both housing values and securities values. The collapse took down both uninvolved homeowners and heavily involved financial institutions.

So… who is at fault?

• Government for pressuring banks with CRA in the first place provided the catalyst.
• Government for enabling HUD to force increases in Fannie Mae and Freddie Mac CRA loan percentages regardless of risk
• Congress for ignoring warnings about Fannie Mae and Freddie Mac in the 2005, 2006, and 2007 annual oversight reports (Report copies went to Christopher Dodd, Richard Shelby, Barney Frank, Michael Oxley, and Paul Sarbanes)
• Greedy, clever Wall-Streeters (yes, they will always outsmart our employees in Congress) who found a way to take advantage of the system.
• Bankers who responded as all true capitalists would by jumping in to take advantage of a lucrative moneymaking scheme.
• The Fed who acted as enabler by providing cheap money for banks to use.

We have no power over the Federal Reserve

We have no control over the bankers and investors involved

Since CRA was initiated in 1977 and strengthening was accomplished through the executive branch in the 1990s, few of the "initiators" are still in Congress.

We can fire the Representatives in Congress who voted for the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 which fueled an increase in subprime mortgage and CRA mortage purchases by Fannie Mae and Freddie Mac.

Voting Records in Congress