One might have hoped that one collateral benefit of the end of the election season would be the end of the attempt to pin the financial crisis on the Community Reinvestment Act, a 1970s law designed to prohibit redlining (the widespread practice of not lending money to people in poor neighborhoods). Unfortunately, Peter Wallison at the American Enterprise Institute (thanks to one of our commenters for pointing this out) has proven that some people will never give up in their fight to prove that the real source of society’s ills is government attempts to help poor people. Regular readers hopefully realize that we almost never raise political topics here, but sometimes I just get too frustrated.
Many people who are more expert than I in the housing market have already debunked the CRA myth. Here are just a few: Janet Yellen, Menzie Chinn, Randall Kroszner, Barry Ritholtz, David Goldstein and Kevin Hall, and Elizabeth Laderman and Carolina Reid. Mark Thoma does a good job keeping track of the debate.
One of the main arguments against the CRA-caused-the-crisis thesis is that the large majority of subprime loans, and delinquent subprime loans, and the housing bubble in general, had nothing to do with the CRA; it was done by lenders who are not governed bythe CRA, and was done in places like the exurbs of Las Vegas or the beachfront condos in Florida, not poor neighborhoods (which generally saw less price appreciation than average). So Wallison comes up with a new argument: relaxed lending standards, encouraged by the CRA, caused lending standards to be relaxed in the rest of the housing market. Really, I’m not making this up.
I’m going to give you a long quote so I can’t be accused of selective quotation:
The key question, however, is the effect of relaxed lending standards on lending standards in non-CRA markets. In principle, it would seem impossible–if down payment or other requirements were being relaxed for loans in minority-populated or other underserved areas–to limit the benefits only to those borrowers. Inevitably, the relaxed standards banks were enjoined to adopt under CRA would be spread to the wider market–including to prime mortgage markets and to speculative borrowers. Bank regulators, who were in charge of enforcing CRA standards, could hardly disapprove of similar loans made to better qualified borrowers. This is exactly what occurred. Writing in December 2007 for the Milken Institute, four scholars observed: “Over the past decade, most, if not all, the products offered to subprime borrowers have also been offered to prime borrowers. In fact, during the period from January 1999 through July 2007, prime borrowers obtained thirty-one of the thirty-two types of mortgage products–fixed-rate, adjust-able rate and hybrid mortgages, including those with balloon payments–obtained by subprime borrowers.”
After some more evidence that rich people were offered (and accepted) new mortgage types, he concludes with this:
Although it is difficult to prove cause and effect, it seems highly likely that the lower lending standards banks were required to adopt under the CRA influenced what they and other lenders were willing to offer to borrowers in prime markets.
At its core, the argument is that the government forced lenders to make bad loans in one market, so they went and decided to make bad loans in other markets. Even conceding some of the premises for the sake of argument, this is illogical. Wallison says “it would seem impossible–if down payment or other requirements were being relaxed for loans in minority-populated or other underserved areas–to limit the benefits only to those borrowers.” It doesn’t seem impossible to me: if you’re running a business, you should be able to understand that you have different target markets, and you have different products for those markets. In fact, if you (the bank) truly thought that you were being forced to make bad loans in one market, you would damned well keep those loans out of your other markets. If lenders are as stupid as Wallison’s argument implies they are, then the entire premise of the American Enterprise Institute – that government should leave businesses alone – starts to look shaky.
You can also tell an argument is shaky when an author says “it is difficult to prove cause and effect.” In areas like business, finance, and economics, where there actually are a lot of data, that generally means that it can’t be proven, or it would have been. Wallison’s evidence is that flexible mortgage products became available to the prime market. (Disclosure: I got an ARM when my wife and I bought our house, and we refinanced it into another ARM.) The most obvious explanation of that phenomenon is not that the CRA induced banks to make those products available to some customers, and that put them on a slippery slope to making them available to all customers, but that bank executives decided to make those products available to all customers. Still hoping to pin this on regulators, Wallison says, “Bank regulators, who were in charge of enforcing CRA standards, could hardly disapprove of similar loans made to better qualified borrowers.” I don’t know where to start here: someone who is against regulation is trying to argue that the CRA tied the hands of regulators who otherwise would have clamped down on flexible mortgages to rich people? I’m in favor of tighter regulation of abusive mortgage products, but I don’t think the CRA is to blame for lack of regulation.
There’s no need to grant the premises, either. The root of the problem, according to Wallison, was that the CRA forced lenders to lower standards in one market. The vast majority of subprime loans were made by institutions that were not even governed by the CRA in the first place. If institutions governed by the CRA chose to follow the behavior of those not governed by the CRA, that was their choice, pure and simple. So not only does the argument suffer a mid-air accident, it never gets off the ground.
And there’s another reason for that: the large majority of low-income loans made under CRA were traditional fixed-rate loans, not subprime, and they weren’t even bad loans. Wallison says:
There is very little data available on the performance of loans made under the CRA. The subject has become so politicized in light of the housing meltdown and its effect on the general economy that most reports–favorable or unfavorable–should probably be discounted.
This is a very clear rhetorical tactic: when you can’t find data that you need to support your argument, say the data don’t exist, or that they are so politicized that they should be discounted. (This is the “two sides to every story” argument used so effectively by, among others, people who say that global warming is not happening.) Wallison does, however, cite one study:
One of the few studies of CRA lending in comparison to normal lending was done by the Federal Reserve Bank of Cleveland, which reported in 2000 that “respondents who did report differences [between regular and CRA housing loans] most often said they had lower prices or higher costs or credit losses for CRA-related home purchase and refinance loans than for others.”
This is the sentence immediately before the one Wallison cites, plus the one he does cite:
A large proportion of respondents in all bank-size categories reported that CRA-related and other home purchase and refinance loans have very similar origination and servicing costs, credit losses, and pricing on a per-institution basis. However, the respondents who did report differences most often said they had lower prices or higher costs or credit losses for CRA-related home purchase and refinance loans than for others.
Read that first sentence again: a large majority of banks say CRA loans do just fine. This is Wallison’s source I’m quoting. This is the best evidence Wallison can find, and presumably (since this is his specialty, not mine) he went looking for it. Not only does the plane not get off the ground, but the airline canceled the flight before boarding.
OK, I’ve already spent more of my morning on this than I wanted to, and I haven’t even gotten to the section on Fannie and Freddie.