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.
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.
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. "
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.
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...
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.
The derivative instruments in the complexity you are describing were not really present at the root of the problem in the 1995-1999 timeframe.
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.
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.
Note that there are no quotas, minimums or mandates. This is a very soft rating system.
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?
One could read the sequence of events as being: political mandate to increase homeownership + sliding lending standards and redefinitions of prime and subprime -->
By way of comparison,
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...
"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!'"
delmoi, you say "racist" the way Joe McCarthy said "Communist." With exactly the same level of justification.
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