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Affordable housing didn't cause the financial crisis

Posted by: scarpenter on October 30, 2008 - 11:00am

Journalist and noted curmudgeon H.L. Menken once observed, "For every complex problem, there is an answer that is clear, simple, and wrong."

Such is the case with claims we're seeing recently that investment in affordable homeownership triggered the current global fiscal crisis.

Critics take particular aim at the Community Reinvestment Act of 1977 and the government-sponsored mortgage giants the Federal National Mortgage Association, commonly known as Fannie Mae, and the Federal Home Loan Mortgage Company, or Freddie Mac. They argue that banks and secondary markets were "forced" by government regulation to lend to low- and moderate-income families.

Actually, the President's Working Group on Financial Markets, in a recent report, states that it wasn't regulations that caused this crisis, but the fact that regulations were ignored. That report identifies "the principal underlying causes of the turmoil in financial markets" as a breakdown in underwriting standards, a significant erosion of market discipline, flaws in credit rating agencies' assessments, weaknesses in risk management, and failure of regulatory policies to mitigate those weaknesses.

Regarding the CRA, it's hard to see how a 1977 law suddenly triggers a 2008 crisis. CRA requires federally-insured and regulated commercial banks and thrifts — not investment banks or non-bank mortgage lenders — to make investments in their communities. That was considered a fair exchange in return for American taxpayers guaranteeing their soundness, and it was a response to the practice of "redlining," meaning banks' refusal to lend to people who lived in low-income neighborhoods.

Earlier this year, Janet Yellen, President and CEO of the Federal Reserve Bank of San Francisco, defended CRA: "Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans, and studies have shown that the CRA has increased the volume of responsible lending to low- and moderate-income households. We should not view the current foreclosure trends as justification to abandon the goal of expanding access to credit among low-income households."

Subprime, a term used to cover a wide variety of lending, started as a way to give investors a little more return for a little more risk in helping someone get into a home — that new schoolteacher with a lot of student loans or the family who started a business and who just needed to borrow a little more for another car. But more people wanted a piece of this greater investment return, and some got greedy. Lending and many of the financial practices around it turned predatory.

Data from the Federal Reserve reported in a recent McClatchy News Service story show that, in 2006, more than 84 percent of subprime mortgage loans were made by private financial institutions. Of the 25 largest subprime lenders that year, only one was subject to CRA. Those unregulated lenders bear most of the responsibility for the explosive growth in subprime lending.

Fannie and Freddie, created to stimulate lending for homeownership by purchasing mortgages, are also targeted by critics for blame. While their excesses and administrative problems cloud the issue, their role has been to respond to what the public and lenders asked for — more homeownership with easier, more flexible financing terms. They don't make loans to consumers; they make available capital and buy loans from originating lenders, some more regulated than others. Their response and their investors' willingness to put up capital was not driven by the mission requirement to serve more low- and moderate-income persons, but by the compounding phenomenon that real estate investments would continue to exponentially and indefinitely gain in value. Fannie and Freddie got caught up, with the rest of the financial world, in the idea that loans were to make money, not to secure homes.

But note that, between 2004 and 2006, when subprime lending was booming, Fannie and Freddie's share of subprime loan purchases on the secondary market was cut in half.

Vermont has have been lucky enough, largely because of our financial regulatory system and high-quality lenders, to avoid the subprime lending storm. Lost jobs and the other results of an economic downturn are most likely to drive a Vermonter into foreclosure. We have also benefitted from local, state, federal and private-sector investment in affordable housing. We have a development community that is a model for the rest of the country; we have tried to build housing ordinary people can afford to purchase or rent; we created jobs and stimulated economic activity; we helped strengthen our communities; and we helped low- and moderate-income Vermonters take a first step towards building wealth.

We've done this through a network of public and private partners, supported by leadership from the Governor, our Legislature, and citizens across the state.

The present financial crisis is perhaps the greatest economic and social policy challenge America has faced since the Great Depression. Too many lenders looking to cash in on the booming housing market made loans on property with phantom value and to people who may have unrealistically assumed their income growth. Too many complex financial transactions built a web of risk that pulled banks and insurance companies into a futures market that was not sustainable. The focus shifted away from the real mission — providing people with a place to call home.

And too little attention was paid, despite the warning signs, to heading off the crisis before it got this bad. In an interview earlier this year, former bank examiner Diane Buckshnis, who was part of the team that investigated Charles Keating, architect of the 1980s savings and loan scandal, looked at the current mess and said, "Where were the regulators? Where were the auditors? Huge banks don't just collapse overnight. I would have thought [we] would have learned from the 1980s."

Righting our financial markets will be difficult, and there will be more pain for investors and consumers as the ripple effects, from tighter credit to lost jobs, are felt. But let's not make it harder to create a solution by misplacing the blame on the systems that have most helped and the citizens who have been most hurt.

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