The point here is not that low-income borrowers received mortgage loans that they could not afford. That is probably true to some extent but cannot account for the large number of sub-prime and Alt-A loans that currently pollute the banking system. It was the spreading of these looser standards to the prime loan market that vastly increased the availability of credit for mortgages, the speculation in housing, and ultimately the bubble in housing prices.He is not claiming that brown people who stopped paying caused the problem.
By 2007, Fannie and Freddie were required to show that 55 percent of their mortgage purchases were LMI loans and, within that goal, 38 percent of all purchases were to come from underserved areas (usually inner cities) and 25 percent were to be loans to low-income and very-low-income borrowers. Meeting these goals almost certainly required Fannie and Freddie to purchase loans with low down payments and other deficiencies that would mark them as sub-prime or Alt-A.He's saying that the very definition of "sub-prime" moved during the GSE expansion.
In the early 1980s, he was a top official in the Reagan Treasury Department. And Fannie Mae, at least by some measures, was insolvent, thanks to the economic storms that were then roaring through the savings-and-loan industry.
"Discussing the company's successes, Mudd said one of Fannie Mae's achievements in 2006 was expanding its involvement in the market for subprime and other nontraditional mortgages. He called it a step "toward optimizing our business." A month later, Fannie Mae outlined plans to further expand its activities in the subprime market. The company recognized the already weak performance of subprime loans but predicted that they would get better in 2007, according to another Fannie Mae document. . . This month, Fannie Mae reported that loans from 2006 and 2007 accounted for almost 60 percent of its second-quarter credit losses."Once the standards were relaxed for low-income borrowers, it would seem impossible to deny these benefits to the prime market. Indeed, bank regulators, who were in charge of enforcing CRA standards, could hardly disapprove of similar loans made to better-qualified borrowers. "Those lowered standards enabled house-flipping. The lowered standards were not predatory--no one made people take out mortgages. The greed in the consumer, the upper middle class consumer specifically, is what drove the actual flipping. People had to want to buy that second home to flip. Low-income homeowners were not flipping, the middle class was. It drove prices up, which drove lending up, etc etc and here were are. You create all those risky loans, it will invariably lead to the creation of a markets to spread around that risk because you have to manage it somehow.
since the late 1990s, the world has experienced a chronic shortage of financial assets to store value. The reasons behind this shortage are varied. They include the rise in savings needs by aging populations in Japan and Europe, the fast growth and global integration of high-saving economies, the precautionary response of emerging markets to earlier financial crises, and the intertemporal smoothing of commodity producing economies. The immediate consequence of the high demand for store-of-value instruments was a sustained decline in real interest rates.setser concludes:
As central bank demand pushed yields on Treasuries and Agencies down (and as the fed raised rates), a host of financial institutions took on more risk. Other financial institutions supplied the product that they wanted. And when it blew up, the financial sector – not the world’s central banks – was left with big losses... low yields on traditional, safe assets triggered a surge in demand for assets that appeared safe but offered the kinds of returns private investors were used to...also btw, dunno if they're going to be shocked to find gambling going on but here's hoping!
Incidentally, One implication of Caballero’s argument is that the US should have been running bigger budget deficits to meet the rise in demand for safe assets. That would have kept yields up and reduced incentives to create “synthetic” triple AAA. Rather than following Dr. Chinn’s advice and trying to bring about rebalancing with a tight fiscal policy, the US should have met the world’s growing demand for truly safe reserve assets by running large fiscal and current account deficits.
Who knows - that could be where we are heading...
Had China allowed its currency to rise in 2004 rather than tightening fiscal policy and limiting lending to avoid inflation, I rather suspect that Chinese demand for safe US and European financial assets would have become demand for US and European goods. That would have produced a more balanced – and ultimately less risky – global economy.
And, well, if the US and UK governments hadn’t looked the other was as leverage in the financial sector rose — as financial institutions made bigger bets to keep profits up as spreads fell — that too would have produced a more balanced and ultimately less risky global global economy.
What he is saying is that the CRA, by trying to extend loans to a small percentage of home buyers, lowered the standards for everyone. It was that lowered standard that enabled Casey Serin and his greedy ilk to the point where by 2005 40% of home sales were for second homes.Maybe in 2004. But if you look at what was happening in 2005, 2006 you see that standards weren’t lowered, they were ignored. Stated income loans, liar loans, NINJA loans, no doc loans. None of these were encouraged by the government, other then that the government totally ignored them. The reason that these standards were ignored was because of the demand for the mortgage backed securities which could be 'laundered' by being put into tranches and getting a big fat AAA rating on a bunch of garbage.
The derivative instruments in the complexity you are describing were not really present at the root of the problem in the 1995-1999 timeframe.And... there was no housing bubble at the time either! What a coincidence!
No, the purpose of this article is to lay the blame at the feet of Clinton and the Democrats. As if Bush and the Republicans were powerless for the last 8 years, and as if Gramm and the rest of the deregulators had nothing to do with it.Except that the Clinton and the Dems had a hand in deregulation as well.
In 1995, the regulators created new rules that sought to establish objective criteria for determining whether a bank was meeting CRA standards. Examiners no longer had the discretion they once had. For banks, simply proving that they were looking for qualified buyers wasn't enough. Banks now had to show that they had actually made a requisite number of loans to low- and moderate-income (LMI) borrowers. The new regulations also required the use of "innovative or flexible" lending practices to address credit needs of LMI borrowers and neighborhoods. Thus, a law that was originally intended to encourage banks to use safe and sound practices in lending now required them to be "innovative" and "flexible." In other words, it called for the relaxation of lending standards, and it was the bank regulators who were expected to enforce these relaxed standards.But Ritholz at TBP says there weren't:
Note that there are no quotas, minimums or mandates. This is a very soft rating system.Neither cites andy support for their statement. One of them must be wrong. I suspect that a definitive answer to these questions, "Did CRA or some related legislation have the effect of imposing quotas on the number of loans the banks made? Did they similarly require the lowering of lending standards?" would change either of their minds and get us substantially closer to the truth.
As for arguments that derivatives & crappy ratings were the key driver, if the GSEs and their government-backed credit hadn't been willing to purchase giant heaps of subprime securities, subprime originations and consequent securitizations wouldn't have happened. They were the market makers, were they not?This begs the question "Where the GSEs willing to purchase giant heaps of subprime securities?" And the answer is no, they were not, until 2005/2006. And there was no government pressure to do that, the companies decided to get into that market because it was profitable for the companies that were involved. Let me say that again profit motive, not government pressure, caused Freddie and Fannie to invest in subprime mortgages at the height of the bubble. And even then, subprime was only a tiny portion of their balance sheet. But what happened is that regular prime loans started to go bad because of declining home values and a bad economy. that's why the companies had problems. Subprime was just a symptom.
One could read the sequence of events as being: political mandate to increase homeownership + sliding lending standards and redefinitions of prime and subprime -->Why not throw in the moon landing and the Lewinsky affair as well? I mean, those things happened, then other things happened, so first must be the cause of the second! Just because you can come up with some convoluted hypothesis doesn't actually imply causality.
By way of comparison,The fed is basically saying that because the bank isn't making loans to the LMI borrowers in proportion to their size and level of demand in the market, the bank fails. This is an effective quota, i.e. you must make loans to a market in proportion to that segment of the market's size. This is an odd metric to use, considering the criteria for lending includes which segment of the market the borrower is in (i.e. income).
over 30 percent of all the 1997 HMDA reportable loans originated by lenders in the Little
Rock MSA were made to LMI borrowers3, indicating a demand for this type of lending
by this segment of the population. Based on these comparisons and the absence of
any impediments to the bank's ability to lend, the distribution of consumer loans reflects
a poor penetration to borrowers of different income levels, particularly LMI borrowers.
In fact the CRA has an honored place among the factors contributing to the meltdown: it signaled to the financial industry as a whole that federal regulators were...It was a "signal"? That just seems like such a strange thing to say. The CRA was passed in 1970s and the housing bubble didn't even really get going until 2005. Presumably mortgage lenders didn't need to interpret some semaphore from decades past in order to figure out what regulators "wanted", they could talk to them directly and in fact they negotiated all the time using lobbyists.
"OK, the Feds say we gotta make loans like these. How can we get rid of 'em? What's this 'securitization' I've been hearing about? Hey, and couldn't we make other junk loans and get rid of 'em the same way? The regulators can't very well complain, can they? They just finished saying 'Go wild, guys!'"Actually I recently read a book that talked about how Lew Ranieri created securitized mortgage products in the late 1970s. It went nothing like that. The actual reason to do the securitization was so that they could be sold like bonds with a fixed end date, whereas mortgages could be refinanced at any time. If you bundled and securitized the mortgages, you could use the average or estimated end time like the end time of a bond, which made it easier to figure out how much they were worth. This is the person who invented the term 'securitization'
delmoi, you say "racist" the way Joe McCarthy said "Communist." With exactly the same level of justification.The whole point of the CRA was to help minorities get into homes. Making the claim that the CRA caused the mortgage bubble is equivalent to saying that lending to poor minorities caused the mortgage bubble.
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Adam Smith, Wealth of Nations
posted by amuseDetachment at 9:42 PM on February 11, 2009 [2 favorites]