COMMUNITY REINVESTMENT ACT AND THE HOUSING MARKET CRISIS OF 2008
In his 2011 book, Back to Work, former president Bill Clinton attributed the housing-market crisis of 2008 to the greed of banks that “were over-leveraged, with too many risky investments, especially in subprime mortgages and securities and derivatives that were spun out of them.” In Clinton's calculus, “the crash occurred because there was too little government oversight of, and virtually no restraint on, risky loans without sufficient capital to back them up.” President Barack Obama, for his part, attributed the crisis to the “failed policies” of “the days when Wall Street,” unencumbered by government regulators, “played by its own rules.” But in reality, the housing crisis was caused by too much government interference in the economy, and by government-mandated policies that actually prevented Wall Street from playing “by its own rules.”
The earliest roots of these government policies can be traced back to the mid-1970s, when progressive Democrats in Congress began a campaign to help low-income minorities improve their economic condition through homeownership. At that time, the homeownership rates of blacks and Hispanics alike were just a shade above 40%, while the white rate hovered near 70%. Seeing these inequalities as prima facie evidence of America's persisting racial injustice, many Democrats pushed for measures to rectify the situation.
Spearheading this endeavor was one of the leading progressives in Congress, Henry Reuss—an anti-war, pro-McGovern Democrat and chairman of the House Banking Committee—who sponsored the Housing and Community Development Act of 1977. Title VIII of this bill, known as the Community Reinvestment Act (CRA), “required each appropriate Federal financial supervisory agency to assess … [each] bank's record of helping to meet the credit needs of its entire community, including low- and moderate-income neighborhoods.” This was a mandate for banks to make special efforts to seek out and lend to minority borrowers—particularly mortgagors—of meager to modest means. The bill was ultimately passed with near-unanimous Democratic support and was signed into law by Democrat President Jimmy Carter in 1977.
Like many government policies, the CRA began small but grew in scope and severity over the years.1 The law was founded upon a planted axiom with far-reaching implications—that government intervention is necessary to counteract the fundamentally racist and inequitable nature of American society generally, and of the free market specifically.
The profound implications of that premise began to hit critical mass in the early 1990s, when studies showing disparate mortgage-loan approval rates for blacks and whites made sensational headlines in the media.2 In 1992 researchers at the Federal Reserve Bank of Boston released the results of the seminal study in this regard, most commonly known as the Boston Fed Study, which found that whites and blacks with equivalent incomes had been denied mortgages at rates of 17% and 38%, respectively.3
In reaction to the study, Attorney General Janet Reno warned in 1994 that “no bank” would be “immune” to an aggressive Justice Department campaign to punish discrimination in lending practices. In a similar vein, Comptroller of the Currency Eugene Ludwig told the Senate Banking Committee: “We have to use every means at our disposal to end discrimination and to end it as quickly as possible.”
The media, too, were quick to cite the Boston Fed Study as proof of discrimination in lending. According to the Boston Globe, the “landmark study” provided “the most damning evidence to date of racial hurdles facing minority homebuyers.” A headline in BusinessWeek read, “There's No 'Whites Only' Sign, But ...”; the accompanying article characterized the study as “definitive.”
Notably, such critics carefully avoided assessing the weighty implications of a second 1992 study that was done for the Federal Reserve Bank of Boston, showing that black loan applicants not only had greater debt burdens and poorer credit histories than their white counterparts, but also tended to seek loans covering a higher percentage of the property values in question.4 The later study found that after correcting for these and other standard credit criteria—income, net worth, age, education, and probability of employment—the loan-rejection gap between racial groups dwindled to 11% for whites and 17% for blacks.5 (Conversely, the approval rates were 89% and 83%, meaning that both whites and blacks were approved for loans most of the time.) Economist Thomas Sowell observes: “The … differential can be expressed by saying that there was a … difference of 6 percentage points in loan approval rates, or that minority applicants were turned down 60 percent more often than white applicants with the same characteristics, since a 17 percent rejection rate is 60 percent higher than an 11 percent rejection rate. The Boston Federal Reserve Bank report chose the latter way of expressing the same facts,”6 and thereby tacitly implied that racism had played a role.
But serious doubt was cast upon the racism theory by the fact that whites were less likely than Asians to be approved for mortgages; that black-owned banks were even more likely than white-owned banks to turn down black applicants; and, most notably, that whites and blacks who were approved for loans went on to have equivalent default rates. If lenders had been discriminating against blacks by holding them to stricter standards than whites (in terms of debt level, expense level, income, and credit history), white borrowers undoubtedly would have had a higher default rate than blacks. The fact that the default rates of whites and blacks were so similar provided strong evidence that lenders were applying race-neutral standards in awarding loans. When asked to comment on this point, the principal author of the Boston Fed Study, Alicia Munnell, acknowledged: “I do not have evidence [of discrimination].... No one has evidence.”7
The Federal Reserve Board in Washington later re-examined the original Boston Fed Study and found its conclusions “difficult to justify.” Similarly, Nobel Prize-winning economist Gary Becker found that the first Boston Fed Study had “serious methodological flaws” that made its results “of dubious value in formulating social policy.”8 Moreover, in 1998 it was reported that the data used by that study contained literally hundreds of errors vis à vis such variables as the net worth of the applicants and the interest rates of the loans they sought. When those data errors were corrected, evidence suggesting that lenders had discriminated against minority borrowers disappeared. In 1999 the Journal of Real Estate Research likewise concluded: “[W]e find no evidence of higher profitability on loans to Black borrowers but find evidence of lower equity for Black borrowers. These results are not consistent with racial discrimination in mortgage lending.”
But none of these facts—the substance of which, as noted above, had largely come to light before the end of 1992—prevented the Clinton administration from essentially transforming the Community Reinvestment Act from an outreach effort into a strict quota system. Under this new arrangement, if a bank failed to meet its quota for loans to low-income minorities, it ran a high risk of failing to earn a “satisfactory” CRA rating from the Federal Deposit Insurance Corporation (FDIC). Such a failure, in turn, could derail the bank's efforts to open a new branch, relocate a home office, make an acquisition, or merge with another financial institution. From a practical standpoint, then, banks had no recourse other than to drastically lower their standards on down-payments and underwriting, and to approve many loans even to borrowers with weak credit credentials.
Additional pressure toward this end was applied by community organizations like ACORN and the Greenlining Institute. By accusing banks—however frivolously or unjustly—of having engaged in racially discriminatory lending practices that violated the mandates of the CRA, these groups could stall or prevent banks from expanding or merging as they wished. Further, the community groups routinely threatened to file lawsuits or negative-publicity campaigns against such banks, which often responded by signing “agreements” pledging to increase, by any means necessary, their lending to undercapitalized nonwhites. Bruce Marks, executive director of Union Neighborhood Assistance Corporation and self-described “urban terrorist,” ominously asserted that if some banks were reluctant to meet the new CRA standards, “we’ll have to start making it in their interest [to do so].”
As a result of such pressures, CRA commitments, which from 1977 to 1991 had cumulatively totaled just under $9 billion, suddenly jumped to $34 billion in 1992 alone. Then, over the ensuing 16 years, those commitments would amount to $6 trillion.
The CRA was by no means the only mechanism designed by government to impose lending quotas on financial institutions. The Department of Housing and Urban Development (HUD), under the leadership of Henry Cisneros, developed rules encouraging lenders to increase their approval rates for loans to minority applicants by a hefty 20% within a one-year period. In 1993 HUD began bringing legal actions against mortgage bankers who had turned down a higher percentage of minority applicants than white applicants, regardless of their reasons for doing so. This, too, caused lenders to lower their down-payment and income requirements for minorities.
Moreover, HUD pressured the government-sponsored enterprises Fannie Mae and Freddie Mac, the two largest sources of housing finance in the United States, to earmark a rising number of their own loans for low-income borrowers. As the Wall Street Journalreports: “For 1996, HUD gave Fannie and Freddie an explicit target: 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.” Further, HUD in 1996 required that 12% of all mortgages that Fannie and Freddie purchased from banks and other direct-mortgage lenders be “special affordable” loans, typically to borrowers with incomes at least 40% below the median for their area. Many of these were subprime mortgages—loans characterized by higher interest rates and less favorable terms in order to compensate lenders for the high credit risk they were incurring. The 12% figure increased to 20% in 2000, 22% in 2005, and 28% in 2008. Nonwhite minorities, because of their comparatively poor credit ratings, were far likelier than whites to be the recipients of such loans. In December 2006, The New York Timesreported: “The most recent Home Mortgage Disclosure Act data from lending institutions show that over half of African-Americans and 40 percent of Hispanics received subprime loans.”
No one supported such reckless lending practices more fervently than Democratic Congressman Barney Frank, a ranking member (and later the chairman) of the powerful House Committee on Financial Services. In 2003 Frank lauded Fannie Mae and Freddie Mac for having “played a very useful role in helping make housing more affordable.” Dismissing the “exaggerate[d]” warnings of critics who exhorted Fannie and Freddie to stop approving and purchasing so many high-risk loans, he preferred “to roll the dice a little bit more ... towards subsidized housing.” In 2004 Frank said that the federal government had “probably done too little rather than too much” to push Fannie and Freddie “to meet the goals of affordable housing and to set reasonable goals.” “I would like to get Fannie and Freddie more deeply into helping low income housing and possibly moving into something that is more explicitly a subsidy,” he declared.
Democratic Senator Christopher Dodd, chairman of the Senate Banking Committee, was of a like mind. In 2004 he called Fannie and Freddie “one of the great success stories of all time” and “caution[ed]” that restricting their activities would do “great damage to what has been one of the great engines of economic success in the last 30 or 40 years.” As late as July 2008, Dodd continued to defend Fannie and Freddie as being “on sound footing.”
Democrats were not alone in calling for lower mortgage-approval standards; a number of Republicans favored such a course of action as well. In 2002 the Bush administration pressed Congress to pass the American Dream Downpayment Initiative (ADDI) to subsidize the downpayments and closing costs of low-income, first-time homebuyers. After ADDI was enacted in 2003, Bush also pushed Congress to pass legislation permitting the Federal Housing Administration (FHA) to make zero-downpayment loans at low interest rates to low-income people, on the theory that “those who can afford the monthly payment but have been unable to save for a down payment should [not] be deprived from owning a home.”
These political pressures entirely restructured the landscape of the mortgage-lending industry. Subprime loans, which had constituted just 7% of all mortgages in 2001, accounted for fully 19% of mortgages by 2006. During the same period, other nontraditional loans (such as zero-downpayment loans) rose from fewer than 3% of all mortgages to nearly 14%.9 Thus the real-estate market became a proverbial house of cards, destined inevitably to collapse. When the indebtedness reached a critical mass, the ensuing financial crash produced a tidal wave of home foreclosures across the United States. “It was ultimately the skyrocketing rates of mortgage delinquencies and defaults,” writes Hoover Institution Fellow Thomas Sowell, “that were like heavy rain in the mountains that caused the flooding downstream.... Government was not passively inefficient. It was actively zealous in promoting risky mortgage lending practices.”10
The situation was exacerbated further by the fact that many banks securitized the risky loans—i.e., bundled them together and sold them to third-party investors. Indeed, an ever-growing number of loans were made for the express purpose of securitization and eventual sale. From 2000 to 2005, private securitization of home and commercial mortgages grew tenfold, reaching a peak of more than $1.5 trillion in 2006. Many of these securitized loans were subprime mortgages. Between 2001 and 2006, the securitized share of subprime mortgages increased from 54% to 75%. The result of these ill-conceived lending practices was a full-blown financial crisis characterized by countless home foreclosures and skyrocketing unemployment rates.
It is notable that the primary victims of these calamities were nonwhite minorities of modest means—the very people who ostensibly were the intended beneficiaries of the CRA, ADDI, and the aforementioned HUD and FHA policies. From January 2007 through the end of 2009, some 2.5 million foreclosures were completed nationwide, the vast majority of which were on properties whose mortgages had originated between 2005 and 2008. Of the two-and-a-half million homeowners who were affected, 56.1% were whites (who had taken out 65.9% of all mortgages), and 27.8% were blacks and Hispanics (who together had taken out just 19% of all mortgages). In June 2010 the Center for Responsible Lending reported that among borrowers who had taken out mortgages between 2005 and 2008, nearly 8% of both African-Americans and Hispanics had lost their homes to foreclosure; the corresponding rate for whites was 4.5%. As of November 2011, approximately one-fourth of all black and Hispanic borrowers had either already lost their homes to foreclosure or were seriously delinquent, compared to just under 12% of white borrowers.
These disparities in foreclosure rates were largely due to the fact that African Americans and Hispanics "because of their comparatively poor credit ratings" were disproportionately represented among those who had fallen into the financial trap of the high-priced subprime mortgages encouraged by the CRA and similar government policies. For instance, 52% of blacks (vs. only 16% of whites) had credit scores low enough to classify them as subprime borrowers.11 Among all borrowers in 2006, some 41.5% of blacks, 30.9% of Hispanics, and 17.8% of whites were recipients of subprime loans. (The notion that such figures reflect lenders' bias against nonwhites is derailed by the fact that the corresponding rate for Asians was only 11.5%.) And across the United States, the very places where subprime loans were most prevalent also had the highest foreclosure rates. As Thomas Sowell observes: “Being granted loans because the bank needs to meet statistical target 'quotas' in order to keep federal agencies off their backs, rather than because you are likely to be able to repay the loans, is not unequivocally a benefit to a borrower.”
Prior to the crash, home ownership accounted for 63% of the average net worth of African Americans, as compared to just 38.5% of average white net worth. By 2009, as a result of the government policies that had caused the housing crisis, the median net worth of black households was just $5,677, a 53% decline from the 2005 figure of $12,124 (in constant 2009 dollars). The median net worth of Hispanic households, meanwhile, had fallen by 66% (from $18,359 to $6,325 in constant 2009 dollars) during the same period. (For whites, the decline was just 16%, from $134,992 to $113,149.) According to a Pew Research Center report, “Plummeting house values were the principal cause [of this] erosion in household wealth among all groups.” The Pew study further found that by 2009 the wealth gap between white households and their black or Hispanic counterparts had grown to its widest point since the government began publishing such data by ethnicity in 1984.
It should be noted that the declines in black and Hispanic net worth from 2005-2009 were not just givebacks of windfalls which those groups had reaped during the housing boom of 2000-2005. In 2000, on the eve of that boom, the median net worths (in 2009 dollars) of white, black, and Hispanic households were $99,250, $9,375, and $12,188, respectively. In other words, the housing crisis would actually leave blacks and Hispanics (but not whites) in a significantly worse economic position than they had been in prior to the five-year boom. In fact, blacks and Hispanics (but not whites) were worse off in 2009 than they had been twenty-one years earlier, when the median net worths (in 2009 dollars) of white, black, and Hispanic households were $78,770, $7,589, and $10,046. In one fell swoop, progressive “benevolence” had utterly wiped out decades of black and Hispanic efforts to rise economically. Nor did 2009 mark the end of the calamity for nonwhites. From 2009 to 2012, the African American community collectively lost another $193 billion, and the Hispanic community $180 billion.
The housing-market crisis cast a heavy cloud over what had been one of America’s greatest success stories—the rise of the black middle class. Between 1949 and 1994, the proportion of African Americans in the middle class had nearly quadrupled, from 12% to 44%—an unprecedented advance for any oppressed group in any society on record. But blacks were now, along with Hispanics, the chief victims of the housing disaster that government programs had created. “These are people who played by the rules,” observed National Urban League President Marc Morial. “They built wealth, went to college and had good jobs. But in a short period of time, they've fallen back.”
Moreover, it should be noted that home foreclosures were only part of the calamity suffered by nonwhite minorities. When the bottom fell out of the housing market, it inevitably fell out of the jobs market as well. In January 2007, the respective unemployment rates for Hispanics and blacks in the U.S. had been 5.7% and 8.0%. By December 2009, those figures spiked to 12.9% and 15.8%. (The white jobless rate also rose, from 4.1% to 9.2%.) In September 2010, unemployment in the black community was 16.1%, including 17.6% for black men and a staggering 49% for black teenagers. The corresponding rates for Hispanics and whites, meanwhile, were 12.4% and 8.7%. By August 2011, the black unemployment rate was at 16.7% overall and 19.1% for black males—figures comparable to those of the Great Depression. For Hispanics and whites, the figures were 11.3% and 8.0%, respectively.
“Government agencies, from the Department of Housing and Urban Development to the Federal Reserve leaned on lenders to lower lending standards, and the Department of Justice threatened prosecutions for discrimination if the racial makeup of people approved for mortgage loans did not match their preconceptions. It worked. In fact, it worked so well that many blacks got loans that they could not have gotten otherwise. Now the statistics tell us, belatedly, that blacks lost out, big time, from this 'favor' done for them by politicians.”
Notwithstanding the colossal disaster which the Community Reinvestment Act inflicted on the American people—and on nonwhite minorities in particular—left-wing Democrats, for reasons of “economic justice,” tried to resurrect the CRA in 2009. That year, Rep. Eddie Bernice Johnson (D-Texas) sponsored (along with 51 fellow Congressional Democrats) the Community Reinvestment Modernization Act “to close the wealth gap in the United States” by increasing “home ownership and small business ownership for low- and moderate-income borrowers and persons of color.” Specifically, the legislation sought to extend the CRA's strict lending requirements to credit unions, insurance companies, and mortgage lenders, and to make its mandates more explicitly race-based by applying lower lending standards not only to low- and moderate-income borrowers, but to any nonwhite minorities, regardless of income.
On April 2, 2013, the Washington Postreported that the Obama administration, in an effort to boost the economy, was pushing banks to make more loans to people with weak credit ratings. Said the Post:
President Obama’s economic advisers and outside experts say the nation’s much-celebrated housing rebound is leaving too many people behind, including young people looking to buy their first homes and individuals with credit records weakened by the recession. In response, administration officials say they are working to get banks to lend to a wider range of borrowers by taking advantage of taxpayer-backed programs — including those offered by the Federal Housing Administration — that insure home loans against default.
Housing officials are urging the Justice Department to provide assurances to banks, which have become increasingly cautious, that they will not face legal or financial recriminations if they make loans to riskier borrowers who meet government standards but later default. Officials are also encouraging lenders to use more subjective judgment in determining whether to offer a loan and are seeking to make it easier for people who owe more than their properties are worth to refinance at today’s low interest rates, among other steps....
From 2007 through 2012, new-home purchases fell 30 percent for people with credit scores above 780 (out of 800), according to Federal Reserve Governor Elizabeth Duke. But they declined 90 percent for people with scores between 680 and 620 — historically a respectable range for a credit score.
“If the only people who can get a loan have near-perfect credit and are putting down 25 percent, you’re leaving out of the market an entire population of creditworthy folks, which constrains demand and slows the recovery,” said Jim Parrott, who until January was the senior adviser on housing for the White House’s National Economic Council....
The effort to provide more certainty to banks is just one of several policies the administration is undertaking. The FHA is also urging lenders to take what officials call “compensating factors” into account and use more subjective judgment when deciding whether to make a loan — such as looking at a borrower’s overall savings. “My view is that there are lots of creditworthy borrowers that are below 720 or 700 — all the way down the credit-score spectrum,” [FHA commissioner Carol] Galante said. “It’s important you look at the totality of that borrower’s ability to pay.”
In November 2014, the Washington Free Beaconreported:
Critics warn that government agencies are making the same mistakes that led to the economic downturn of 2008. Federal agencies have made a series of recent moves that could precipitate another housing crisis similar to the one in 2008, experts say, again threatening the stability of the entire U.S. economy.
Housing regulators and other agencies have announced rulings and proposals in recent weeks that would lower credit and lending standards for home mortgages. Subprime or low-quality mortgages that defaulted in 2008—a majority of which were backed by the government housing giants Fannie Mae and Freddie Mac—were a significant contributor to the economic downturn.
Additionally, Fannie and Freddie currently hand over most of their earnings to the Treasury Department under changes made by the agency in 2012. That means that as home loans become more risky, the companies [Fannie and freddie] known as government-sponsored enterprises (GSEs) would have no capital buffer to absorb losses. Taxpayers could again be called upon to rescue them in the event of another economic shock.
Treasury provided $188 billion during the 2008 crisis to save Fannie and Freddie, which were seized by the government and placed in “conservatorship” by the newly established Federal Housing Finance Agency (FHFA).
“When those two firms fail—as they will, especially when they don’t have any capital—the result will be the taxpayer will have to pick up the bill again,” said Peter Wallison, a fellow at the American Enterprise Institute (AEI) and former general counsel of Treasury during the Ronald Reagan administration, in an interview. “The lessons of the financial crisis have not been learned,” he added.
FHFA [Federal Housing Finance Agency] Director Mel Watt said last month that Fannie and Freddie would soon begin to guarantee loans with down payments as low as 3 percent, though the final details of that plan have yet to be released. The two companies operate by buying loans from lenders, selling those loans in mortgage-backed securities, and then guaranteeing payment to investors if the loans default.
Fannie and Freddie purchased loans with little or no down payments before 2008, but had largely stopped doing so in recent years.
Watt also expressed concerns that lenders had restricted loans to borrowers with lower incomes or credit scores out of concern that Fannie and Freddie would force them [the lenders] to buy back the loans if they [the borrowers] defaulted. He outlined instances where lenders would not have to repurchase the loans, and encouraged them to loosen up lending standards....
Watt sought to assuage concerns that lower down payments would result in more defaults. Borrowers will still need to have “compensating factors” such as strong credit records or lower debt-to-income (DTI) ratios, he said, and the loans will require a form of “credit enhancement” such as private mortgage insurance. “There are creditworthy borrowers in today’s market who have the income to afford monthly mortgage payments but do not have the money to make a large down payment and pay closing costs,” he said in prepared remarks at the National Association of Realtors Conference & Expo. “Purchase guidelines that allow for 3 percent down payments will provide an opportunity for access to credit for some of these borrowers.”
Wallison said he was skeptical that private mortgage insurance firms would accept mortgages with the low down payments, adding that the risk would eventually go back to Fannie and Freddie or the Federal Housing Administration (FHA). The loans could actually be more expensive with the addition of mortgage insurance premiums. “The right conclusion would be to have a good solid down payment and good credit score and the borrower gets a much less expensive mortgage,” he said.
Six federal agencies, including the FHFA, also announced last month that while sellers of some asset-backed securities must retain at least five percent of the credit risk of the assets, other securities backed by “qualified residential mortgages” (QRMs) are exempt from the risk retention requirement. The new criteria for “prime” or traditional mortgages requires borrowers to document their debt and income and meet a DTI benchmark of 43 percent or less.
However, the new rule dropped the tougher credit and lending requirements of the initial proposal in April 2011—which included a down payment of at least 20 percent and a DTI ratio of 36 percent or less. Wallison said the rule “completely destroyed” the risk retention goal of the Dodd-Frank Act that was supposed to make mortgage-backed securities less risky. Those securities were a principal cause of the financial crisis.
1Thomas Sowell, The Housing Boom and Bust (New York: Basic Books), 2009, p. 36.