eren’t the majority of the subprime loans made by mortgage service companies not subject to the CRA?
This is true. But it is largely beside the point. A huge driver of the demand for subprime loans was the demand for CRA bonds. Banks operating under the CRA could meet their obligations by buying up CRA loans or MBS built from CRA loans. The CRA created a demand that the mortgage servicers were meeting.
What's more, many smaller mortage service companies hoped to be acquired by larger banks. Increasing their CRA lending made them more attractive take-over targets.
A study put out by the Treasury Department in 2000 found that the CRA was encouraging the mortgage servicers to provide loans to low-income borrowers, in part because the CRA loans had been so successful.
Finally, the Clinton adminstration threatened to subject the mortgage companies to the CRA if they didn't comply voluntarily. They promptly agreed to increase their CRA-type lending in order to escape the kind of public scrutiny that comes with official CRA regulated status.
If the CRA was forcing all this lax lending, why weren't bankers objecting?
Are you really in the dark about why the leaders of large public corporations wouldn't publicly object to a piece of civil rights legislation? Fine. I'll be totally open with you: this would have been career suicide and an open invitation to bias litigation and increased scrutiny from regulators. In this case, silence is misleading.
What's more, no one said the bankers hated the lax lending the CRA was requiring. Sure, some did. But those people were quickly shown the door, while the enthusiasts were promoted. The regulations themselves selected for enthusiasts for the program of lax lending.
How do you explain the fact that CRA loans historically had low levels of default. Doesn’t this mean that loan standards were not relaxed?
Actually, no. We know that lending standards were relaxed under the CRA. The fact that they had relatively low default levels was initially a surprise but it isn’t an indicator that lending standards were secretly high. There are plenty of explanations for this, including the lack of borrower ruthlessness in unsophisticated home owners and a tendency of delinquent low-income borrowers to sell the home and prepay the mortgage rather than default. Especially during a period of rising home prices, the default option was not heavily exercised.
But even during the crisis, CRA loans didn’t default at higher rates than other mortgages. CRA banks aren’t failing more than other financial institutions, CRA areas aren’t hotspots of defaults. What about that?
In part, this is evidence that the lending standards of the CRA had spread to the rest of the mortgage market.
I thought you said CRA loans caused this crisis.
Nope. It isn’t losses from CRA loans that drove the crisis (although they are disproportionately responsible for losses at some banks). Instead, the CRA required lax lending standards that spread to the rest of the mortgage market. That fueled the mortgage boom and bust.
So how and why did the CRA lax lending spread to the rest of the mortgage market?
The structure of the CRA regulations encouraged the spread. Banks that were the best at making CRA loans were allowed to grow by making acquisitions and opening new branches. This created a kind of political-financial Darwinism that reward the biggest enthusiasts for lax CRA lending standards. Of course, the most successful people under this regime were not the types who needed their arms twisted to make loose loans. They were who were predisposed to engage in loosey-goosey finance, who discovered that the CRA had made the world their oyster.
As for the “why” part of your question, the answer is a bit ironic. Banks making CRA loans initially expected that defaults would be higher due to lax lending standards. When they discovered the low-income borrowers had an unexpected propensity to pay their mortgages. After years of data poured in showing that borrowers were paying mortgages despite high LTVs, low down payments and unconventional income measures, bankers began to believe that many of the traditional measure of credit worthiness were overly conservative. Recall what I said earlier about how mortgage service providers started pursuing low-income borrowers in part because of the CRA.
What they didn’t take into account was that different types of borrowers may behave differently, and that much of the data on those lax lending mortgages was warped by increasing home prices. Wealthier, more sophisticated borrowers ruthlessly default when their mortgage goes underwater, for example. What’s more, the reversal of housing prices meant that defaults across all borrower classes increased.
Making matters worse, President Bush pushed hard for lax lending standards. He wanted to expand minority and low income home ownership far beyond what the CRA required. So he pushed even harder for the broadening of these lending standards.
