The Community Reinvestment Act Comes Full Circle
The Justice Department is investigating whether the nation’s largest credit ratings agency, Standard & Poor’s, improperly rated dozens of mortgage securities in the years leading up to the financial crisis, according to two people interviewed by the government and another briefed on such interviews.
The investigation began before Standard & Poor’s cut the United States’ AAA credit rating this month, but it is likely to add fuel to the political firestorm that has surrounded that action. Lawmakers and some administration officials have since questioned the agency’s secretive process, its credibility and the competence of its analysts, claiming to have found an error in its debt calculations.
In the mortgage inquiry, the Justice Department has been asking about instances in which the company’s analysts wanted to award lower ratings on mortgage bonds but may have been overruled by other S.& P. business managers, according to the people with knowledge of the interviews. If the government finds enough evidence to support such a case, which is likely to be a civil case, it could undercut S.& P.’s longstanding claim that its analysts act independently from business concerns.
A week ago, Alex J. Pollock noted "The Delicious Irony of the Downgrade" at the Wall Street Journal:
In the wake of all the angst about Standard & Poor's downgrading the credit of the U.S. government, we need to consider what rating agencies are. They are exactly what they themselves say they are: publishers of opinions. In other words, they are one group of scribblers among others, trying to forecast the future and its risks like hundreds of other people, naturally making many mistakes, like everybody else.
It is a delicious irony that the opinions of these particular scribblers get special weight only because the federal government has given it to them. Government regulations require financial entities to use the ratings issued by government-designated rating agencies for investment decisions. Now S&P has turned on the source of its privileged position and profits. If the government does not like the force of this disloyal pontification, that's its own fault.
As Pollock concluded, "From an overall financial perspective, it is perfectly logical to think that internationally diversified, cash-generating, well-managed companies with low leverage are better credit risks than nationally concentrated, negative cash flow, poorly managed, highly leveraged governments."
Heh. Of course, the triple-A rating that S&P supplied for decades helped to ease the government into mortgage equivalent of the corporate junk bond market, via the Community Reinvestment Act, begun under Jimmy Carter, wildly accelerated under Bill Clinton, and continued by President Obama. In 1999, Howard Husock wrote a remarkably prescient City Journal article on the topic:
The Clinton administration has turned the Community Reinvestment Act, a once-obscure and lightly enforced banking regulation law, into one of the most powerful mandates shaping American cities—and, as Senate Banking Committee chairman Phil Gramm memorably put it, a vast extortion scheme against the nation's banks. Under its provisions, U.S. banks have committed nearly $1 trillion for inner-city and low-income mortgages and real estate development projects, most of it funneled through a nationwide network of left-wing community groups, intent, in some cases, on teaching their low-income clients that the financial system is their enemy and, implicitly, that government, rather than their own striving, is the key to their well-being.
The CRA's premise sounds unassailable: helping the poor buy and keep homes will stabilize and rebuild city neighborhoods. As enforced today, though, the law portends just the opposite, threatening to undermine the efforts of the upwardly mobile poor by saddling them with neighbors more than usually likely to depress property values by not maintaining their homes adequately or by losing them to foreclosure. The CRA's logic also helps to ensure that inner-city neighborhoods stay poor by discouraging the kinds of investment that might make them better off.
The Act, which Jimmy Carter signed in 1977, grew out of the complaint that urban banks were "redlining" inner-city neighborhoods, refusing to lend to their residents while using their deposits to finance suburban expansion. CRA decreed that banks have "an affirmative obligation" to meet the credit needs of the communities in which they are chartered, and that federal banking regulators should assess how well they do that when considering their requests to merge or to open branches. Implicit in the bill's rationale was a belief that CRA was needed to counter racial discrimination in lending, an assumption that later seemed to gain support from a widely publicized 1990 Federal Reserve Bank of Boston finding that blacks and Hispanics suffered higher mortgage-denial rates than whites, even at similar income levels.
In addition, the Act's backers claimed, CRA would be profitable for banks. They just needed a push from the law to learn how to identify profitable inner-city lending opportunities. Going one step further, the Treasury Department recently asserted that banks that do figure out ways to reach inner-city borrowers might not be able to stop competitors from using similar methods—and therefore would not undertake such marketing in the first place without a push from Washington.
But for generations, mortgages were a closed loop which would have minimized the damage of the CRA somewhat. Savings & loan executives were known as the 3-6-3 club: pay interest on passbook accounts at three percent; loan money at six percent, hit the golf links at 3:00 PM. It's a relaxing way to do business in small-town America, but Wall Street saw an opportunity to dramatically shake up the banking world in the years before CRA went into overdrive.
As Michael Lewis documented extensively in 1989's Liar's Poker, in the 1970s and early 1980s, while Mike Milken was discovering the myriad wonders of the junk bond market, Salomon Brothers were concurrently creating a system by which previously sleepy S&Ls could quickly bundle their mortages and trade them as just another government-backed bond:
Ranieri & Co. [Lewis Ranieri, then of Salomon Brothers, and the bond traders who worked under him] intended to transform the “whole loans” into bonds as soon as possible by taking them for stamping to the U.S. government. Then they could sell the bonds to Salomon’s institutional investors as, in effect, U.S. government bonds. For that purpose, partly as the result of Ranieri’s persistent lobbying, two new facilities had sprung up in the federal government alongside Ginnie Mae. They guaranteed the mortgages that did not qualify for the Ginnie Mae stamp. The Federal Home Loan Mortgage Corporation (called Freddie Mac) and the Federal National Mortgage Association (called Fannie Mae) between them, by giving their guarantees, were able to transform most home mortgages into government-backed bonds. The thrifts paid a fee to have their mortgages guaranteed. The shakier the loans, the larger the fee a thrift had to pay to get its mortgages stamped by one of the agencies. Once they were stamped, however, nobody cared about the quality of the loans. Defaulting homeowners became the government’s problem. The principle underlying the programs was that these agencies could better assess and charge for credit quality than individual investors.
Back in late September of 2008, just as the financial crisis was simultaneously devouring Wall Street and paving the way for their preferred candidate's victory a month later, Kevin D. Williamson wrote at NRO that for the left, the Community Reinvestment Act was a can't-lose proposition:
Imagine if the housing bubble hadn’t burst, but there hadn’t been all those dodgy subprime loans made and then securitized. We’d be reading stories about how America is having a wonderful housing boom but the poor and minorities are being left out. There’s lots of greed and stupidity in this story, but we shouldn’t ignore the fact that a big part of what is wrong comes from bad public policy designed to encourage homeownership, particularly among the poor. Unintended consequences are not to be denied.
But we’re not going to hear much about ACORN’s role in all this, or, by extension, Senator Obama’s.
That could be changing, Walter Russell Mead recently noted:
According to the Washington Post, President Obama has decided to support a continuing government role in the housing market and plans to keep Fannie Mae and Freddie Mac operating with government guarantees into the indefinite future.
The decision is a GOP dream come true and could play a significant role in the campaign.
If you wanted to link ACORN and community organizers with Wall Street profiteers and nationally unpopular liberal icons like Barney Frank, handing the Fannie Mae issue to the GOP in 2012 is the way to do it. Gretchen Morgenson and Joshua Rosner laid out a GOP roadmap in Reckless Endangerment. According to their (controversial) account, Fannie Mae was a kind of Democratic Enron as poverty hustlers united with Wall Street profiteers to rape the Treasury while abusing the poor; the net cost to the taxpayers for Fannie and Freddie could well reach $389 billion.
Imagine the ads.
As I said on Tuesday, lots of material in this 2008 video to work with, if anybody in the GOP has the brains (yes, that's a risky proposition right there) not to let this crisis go to waste: