Affordable Housing Institute : US

It’s becoming fashionable, among policy journalists (and even certain ex-CEOs of Fannie Mae) to suggest that the devil made them do it, that somehow pressure to extend affordability overrode all their instinctive prudence and led them down the primrose path to America’s financial ruin.  Don’t blame me, runs the refrain, blame the Community Reinvestment Act that seduced me into making all these bad loans.

 

The CRA made me go down that road!

 

The flare of my intellectual indignation went off as soon as I read the title of a Howard Husock article in City Journal:

 

A generation ago, the government began forcing banks to make bad loans.

 

‘Forcing’?  ‘Bad loans’?  Ay, caramba!

 

To be explicit right up front:

 

It was either this or trying to find a safe Google image for ‘explicit’

 

Don’t blame CRA for bad loans any more than you blame the profit motive for bad loans.

 

To wit:

 

Nobody was forced to do anything.

Lenders had no incentive to make bad loans.

 

Just make sure someone else is holding it when it explodes

 

It seems clear that we have, as a matter of national policy [Or market action? – Ed.], pushed too many households toward homeownership.

 

There’s no question we boosted the homeownership rate too high – but was that policy, runaway financial technology such as securitization, a market drunk on risk-taking, or just bad luck?

 

Nothing in the CRA anywhere recommends, endorses, incentivizes, or rewards make un-creditworthy loans.  Nothing asks banks to lower their standards.  Rather, CRA wants banks to demonstrate they are applying rational credit standards evenhandedly, and uses percentage penetration (relative to deposit-taking) as the test.  If you take money from a community, the community must have enough money so you could lend or invest it back – at suitable spread.

 

Mr. Husock giving a social entrepreneur of the year award

 

What then is Mr. Husock’s case that the CRA ‘made’ lenders make ‘bad’ loans?  He tacitly equates CRA lending with a lowering of credit standards, which it is not and not what it is supposed to be.  In pursuit of CRA market share, banks may lower their profit margins on some CRA loans – they do this for normal loans. 

 

It’s no surprise, then, that as early as 1999, the Federal Reserve Board found that only 29% of loans in bank lending programs established especially for CRA compliance purposes could be classified as profitable.

 

Presumably they’re unprofitable because the spread is narrow, meaning the loans are cheap.  From my perspective, that’s a good thing; it means they’re affordable to the customers.  I’d expect that anyhow; since CRA-qualifying assets are desirable, you’d expect that desirability to be factored into the price.

 

Nor does low profitability worry me.  Banks do lots of things that are unprofitable, if examined solely in isolation.  Open new branches; teaser introductory credit card rates; establish private banking units; advertise.  Like anybody else, banks leaven their product offerings and price points based on an overall strategy of bank profitability.  Getting a favorable CRA rating through large low-profit activity creates merger and acquisition options of considerable value.  Lowering margin is entirely different from lowering credit standards – actually it’s the opposite, since banks normally lower margins on better credits, not worse ones.

 

The once-obscure Community Reinvestment Act, passed during the Carter administration, has recently—in part because of my reporting—become a bogeyman for Republicans, some of whom have proposed its repeal.  Liberal Democrats have defended it as unrelated to the meltdown. The truth lies somewhere in between.

 

As we’ll see, Mr. Husock’s work is less reporting than argumentation from his intellectually entrenched position:

 

Howard Husock, a contributing editor of City Journal, is the Manhattan Institute’s vice president for policy research, the director of its Social Entrepreneurship Initiative, and the author of America’s Trillion-Dollar Housing Mistake.

 

Any doubts about his perspective?

 

While not entirely free from logic or evidence, it is long on assertion and anecdote, short on statistics or balance, and strewn with Crouching-Tiger leaps of logic. 

 

No grounding necessary!

 

His piece reads like a believer searching for confirmatory signs than a disinterested observer weighing the data.  Any question where Mr. Husock stands?

 

Indeed, the numbers he cites he must largely explain away, as we shall see.

 

I can explain that …

 

While it’s a long way from the late-seventies world of the original Act to the twenty-first century’s housing crisis, the CRA’s role was important.

 

At the time of the CRA’s passage, the world of banking was, as Monty Python would put it, something completely different.  Banking was largely a local industry; indeed, interstate branch banking wasn’t legal yet. Mortgage lending, moreover, was largely the province of just one sector of the banking industry—the so-called “thrift” or savings and loan institutions, which had a long-standing deal with government.

 

Accurate so far. Banks were local; they took deposits locally, and they lent locally … but by the 1960’s, ‘local’ meant ’statewide’ and statewide encompassed both the growing suburbs and the shrinking, imploding cities.

 

They would pay relatively low rates of interest to their many small depositors in exchange for charging relatively low interest rates for home loans.

 

He’s making a quid pro quo that I believe is unjustified.  Banks lent cheap because everybody was used to really low interest rates.  Inflation was equally low.

 

The limited earnings spread strongly discouraged risk and, combined with the lack of bank competition, undoubtedly limited many neighborhoods’ access to credit.  This came to be known as “redlining,” which led many advocates for the poor to conclude that only a legislative mandate could guarantee that those of modest means, living in struggling urban areas, had access to credit. (Back then, I was a crusading left-wing journalist pushing for just this kind of regulation.)

 

Whoa, whoa!  That’s not the red-lining I remember.

 

 

Redlining had little to do with banks charging low interest rates on their loans.  It had everything to do with a perception that banks were not making loans in black neighborhoods.  The banks said they were exercising normal credit procedures, refusing loans because values would inevitably decline. 

 

Philadelphia lending map, 1937: don’t lend in red, lend in blue

 

What the banks claimed was prudence, others saw as racism.  I think the truth was two parts economics, one part bigotry, and one part laziness.  Banks didn’t lend in these neighborhoods because ‘those people’ lived there, and I wouldn’t live there, and really, how could you make a loan like that when everybody knew the cities were doomed?  So it was easy, all too easy, to decline credit.  You might take deposits in Roxbury, but you wouldn’t make loans back into Roxbury, you’d lend in Sudbury or Duxbury, the safe white suburbs.  The net effect was a wealth-extraction machine, money taken out of a community and not put back –

 

You won’t be needing those deposits

 

–         and therefore, went the reasoning, you were accelerating the decline of neighborhoods by failing to lend back into them. 

 

For the record, I think that policy reasoning was sound, and is sound today.  Retail banks will take risks presented to them by people in embroidered suspenders; they shy away from risks presented by people with dirt under their fingernails.

 

The legislative justification for CRA was equally straightforward.  Banks operate under Federal licenses; they access a critical Federal resource (deposit insurance via FSLIC).  They used this resource to take the deposits (because people wouldn’t put money in a bank without some confidence of recovering it) which were a critical source of low-cost capital for their lending.  Since banks availed themselves of Federal largesse to collect their money, they had a duty to follow Federal desires in disbursing that money –

 

– Provided that the banks were allowed to exercise normal banking prudence.

 

Nothing in the CRA mandates bad loans. 

 

Nothing in the CRA incentivizes bad loans. 

 

In the long run, nobody ever makes money by making bad loans. 

 

Isn’t this obvious?

 

 

[Continued tomorrow in Part 2.]

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