GSEs and the Housing Crisis: Studies Ignored

by Guest Author Fabius Maximus

Summary: Among our most serious problems is the success of well-funded engines of propaganda at manipulating public opinion, making effective public policy reforms almost impossible. Here we examine one example, convincing Americans that the government caused the housing bubble. This is a follow-up to Facts are an obstacle to the reform of America.

People become easily led once they are trained to believe appealing lies. Not just the occasional myths in the belief structure of every political movement, such as the Left’s doomster exaggerations about global warming, and their faith in the phantasm of the Social Security Trust Fund. Sometimes a movement’s leaders find that their followers have abandoned their skepticism, lost confidence in society’s experts, and become credulous about stories that confirm their biases.

It’s a national tragedy that this has happened to America’s conservatives. Their leaders invest large sums wisely and patiently, building a structure of plausible-sounding institutions to propagate well-constructed propaganda. After years of indoctrination, gradually they’ve spun increasingly wilder falsehoods.  From misrepresentations about the adequacy of western Europe’s healthcare to outright lies about Obama’s religion and citizenship.

So most discussions about public policy, especially economics, devolve into a debate about interlocking layers of falsehoods, exaggerations, and misrepresentations. Worse, conservative positions have become solidified — immune to facts.  Obama’s citizenship is the extreme example.  Here we look at another: the government’s role in the housing bubble and collapse.

Below are links to reports that examine the role of the and the 1977 Community Reinvestment Act (CRA) Government-sponsored enterprises (GSE).  I am aware of no analytical works coming to other conclusions. There are many books and articles blaming the government, mostly anecdotal in nature — and not remotely similar in depth of data and analysis to these studies.  Yet to no effect, as faith-based conservatives hold to comforting stories told them by well-funded engines of disinformation.

Introduction to the subject

(1) An excellent introduction to the subject: “Did Fannie Cause the Disaster?” Frank Partnoy (Professor of Law and Finance at the U of San Diego) and Jeff Madrick, New York Review of Books, 27 October 2011

(2) One of the two most extensive studies done today: Report of the Financial Crisis Inquiry Commission, a bi-partisan inquiry, January 2011 — Excerpt:

In conducting our inquiry, we took a careful look at HUD’s affordable housing goals, as noted above, and the Community Reinvestment Act (CRA). The CRA was enacted in 1977 to combat “redlining” by banks — the practice of denying credit to individuals and businesses in certain neighborhoods without regard to their creditworthiness. The CRA requires banks and savings and loans to lend, invest, and provide services to the communities from which they take deposits, consistent with bank safety and soundness.

The Commission concludes the CRA was not a significant factor in subprime lending or the crisis. Many subprime lenders were not subject to the CRA. Research indicates only 6% of high-cost loans — a proxy for subprime loans — had any connection to the law. Loans made by CRA-regulated lenders in the neighborhoods in which they were required to lend were half as likely to default as similar loans made in the same neighborhoods by independent mortgage originators not subject to the law.

(3) The other definitive analysis to date about the effect of the CRA on the housing bust: “CRA Lending During the Subprime Meltdown“, Elizabeth Laderman and Carolina Reid, Federal Reserve Bank of San Francisco, November 2008. It based on this Fed Working Paper: Lending in Low- and Moderate-Income Neighborhoods in California: The Performance of CRA Lending During the Subprime Meltdown. Excerpt:

… {We} believe that this research should help to quell if not fully lay to rest the arguments that the CRA caused the current subprime lending boom by requiring banks to lend irresponsibly in low- and moderate-income areas.

First, the data show that overall, lending to low- and moderate-income communities comprised only a small share of total lending by CRA lenders, even during the height of subprime lending in California. Second, we find loans originated by lenders regulated under the CRA in general were significantly less likely to be in foreclosure than those originated by IMCs. This held true even after controlling for a wide variety of borrower and loan characteristics, including credit score,income, and whether or not the loan was higher priced.

More important, we find that whether or not a loan was originated by a CRA lender within its assessment area is an even more important predictor of foreclosure. In general, loans made by CRA lenders within their assessment areas were half as likely to go into foreclosure as those made by IMCs (Table 2). While certainly not conclusive, this suggests that the CRA, and particularly its emphasis on loans made within a lender’s assessment area, helped to ensure responsible lending, even during a period of overall declines in underwriting standards.

(4) Some conservatives argued before the crash that the CRA was ineffective, and blocking access to credit by low-income households: “Should CRA Stand for ‘Community Redundancy Act?’”, Jeffery W. Gunther, Regulation, Cato Institute, 2000.

(5) Update: The global nature of the housing bubble shows little role for US-specific factors, such as the Community Reinvestment Act and the government-sponsored enterprises

See this from “A Global View of the Housing Bubble“, McKinsey Quarterly, October 2009:

Although the current crisis started with the bursting of the US housing bubble, other economies around the world are feeling the effects of their own real-estate booms and busts. From 2000 through 2007, a remarkable run-up in global home prices occurred (see exhibit). But that trend has reversed abruptly. In 2008, the value of US residential real estate fell 10 percent; the global average fared only somewhat better, declining by almost 4%. We estimate that falling home prices erased more than $3.4 trillion of household wealth in 2008. And because home prices are slow to correct, the current slide may persist for some time, which could depress global consumption.

Other studies

(6) Here is a pre-crash paper. Note that it does not even mention the CRA (blaming the CRA was a post-crash exercise): “The Evolution of the Subprime Mortgage Market“, Souphala Chomsisengphet and Anthony Pennington-Cross, Federal Reserve Bank of St. Louis Review, January/February 2006 — Abstract:

This paper describes subprime lending in the mortgage market and how it has evolved through time. Subprime lending has introduced a substantial amount of risk-based pricing into the mortgage market by creating a myriad of prices and product choices largely determined by borrower credit history (mortgage and rental payments, foreclosures and bankruptcies, and overall credit scores) and down payment requirements. Although subprime lending still differs from prime lending in many ways, much of the growth (at least in the securitized portion of the market) has come in the least-risky (A–) segment of the market. In addition, lenders have imposed prepayment penalties to extend the duration of loans and required larger down payments to lower their credit risk exposure from high-risk loans.

(7) The Community Reinvestment Act: A Welcome Anomaly in the Foreclosure Crisis“, Traiger & Hinckley (attorneys), 7 January 2008 — “Indications that the CRA Deterred Irresponsible Lending in the 15 Most Populous U.S. Metropolitan Areas” (PDF, 21 pages).

(8) No, Larry, CRA Didn’t Cause the Sub-Prime Mess“, Ellen Seidman, New American Foundation, 15 April 2008. Seidman headed the Office of Thrift Supervision from 1997 – 2001, and has long experience in this area (bio), and this article has links to additional evidence.

(9) Another early look at the problem. It does not even mention the CRA, and gives little blame to the GSEs. “Understanding the Securitization of Subprime Mortgage Credit“, Adam B. Ashcraft and Til Schuermann, Staff Report of the Federal Reserve Bank of New York, March 2008 — Abstract:

In this paper, we provide an overview of the subprime mortgage securitization process and the seven key informational frictions that arise. We discuss the ways that market participants work to minimize these frictions and speculate on how this process broke down. We continue with a complete picture of the subprime borrower and the subprime loan, discussing both predatory borrowing and predatory lending. We present the key structural features of a typical subprime securitization, document how rating agencies assign credit ratings to mortgage-backed securities, and outline how these agencies monitor the performance of mortgage pools over time. Throughout the paper, we draw upon the example of a mortgage pool securitized by New Century Financial during 2006.

(10) Remarks by Governor Randall S. Kroszner (Governor of the Federal Reserve System) At the Confronting Concentrated Poverty Policy Forum, 3 December 2008 — Excerpt:

Some critics of the CRA contend that by encouraging banking institutions to help meet the credit needs of lower-income borrowers and areas, the law pushed banking institutions to undertake high-risk mortgage lending. We have not yet seen empirical evidence to support these claims, nor has it been our experience in implementing the law over the past 30 years that the CRA has contributed to the erosion of safe and sound lending practices. In the remainder of my remarks, I will discuss some of our experiences with the CRA. I will also discuss the findings of a recent analysis of mortgage-related data by Federal Reserve staff that runs counter to the charge that the CRA was at the root of, or otherwise contributed in any substantive way, to the current subprime crisis . . .

“This result undermines the assertion by critics of the potential for a substantial role for the CRA in the subprime crisis. In other words, the very small share of all higher-priced loan originations that can reasonably be attributed to the CRA makes it hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis.

(11) Housing Policy, Subprime Markets and Fannie Mae and Freddie Mac: What We Know, What We Think We Know and What We Don’t Know“, Jason Thomas and Robert Van Order (Prof Finance, George Washington U), Federal Reserve Bank of St Louis, November 2010 — Abstract

We explore the role of housing policy in the collapse of Fannie Mae and Freddie Mac, the role of Fannie and Freddie in subprime markets and the sources of their default losses. We do not find evidence that their crash was due much to government housing policy or that they had an essential role in the development of the subprime mortgage-backed securities market, which occurred outside of the normal mortgage origination channels and which was funded by non agency or “private label” securities (PLS).

They did build a large portfolio of AAA-rated PLS, probably in response to affordable housing goals, but such investments were unlikely to have had much of an impact on subprime mortgage origination volume because the AAA pieces f PLS deals were not the important part of the deals. Rather than brewing for a long time, their downfall was quick and had to do with purchases of risky-but-not-subprime mortgages and insufficient capital to cover the decline in property values.

Other posts about the housing bubble

  1. Diagnosing the eagle, chapter I — the housing bust, 6 December 2007
  2. “Idiots Fiddle While Rome Burns” – comforting and facile rhetoric, 24 July 2008
  3. A must-read for every American citizen: “The Fannie Mae Gang”, 25 July 2008
  4. A vital but widely misunderstood aspect of our financial crisis, 18 September 2008 — Too many homes.
  5. Knocking down houses in order to save the village, 20 October 2008
  6. Destroying houses in order to boost home prices, 16 December 2008
  7. The housing crisis allows America to look in the mirror. What do we see?, 9 March 2009
  8. Another step to solving the housing crisis: downsize cities by destroying neighborhoods, 2 April 2009
  9. Sparks of justice still live in America – cherish them and perhaps they’ll spread, 11 September 2009 — About foreclosures.
  10. Who should we blame for the mortgage crisis?, 16 January 2010
  11. Cutting through the fog to clearly understand the housing crisis, 8 July 2010
  12. Housing Update – dynamite to blast us out of our lethargy?, 27 July 2010
  13. Here’s an opportunity for the Tea Party: fighting foreclosure fraud by banks!, 22 September 2010
  14. A briefing about the foreclosure fraud crisis: its origin and impacts, 14 October 2010

Related Articles

Six Rebuttals to the Argument that Congress or Fannie and Freddie Caused the Crisis by Mike Konczal

Lenders Put the Lies in Liar’s Loans and Bear the Principal Moral Culpability by William K. Black

The Great Debate©: Wallison vs. Black on the FCIC by William K. Black

How Wallison is Blind to Accounting Control Fraud by William K. Black

Fannie and Freddie Acquitted by Karl Smith

CBO Documents History of Fannie and Freddie (GEI News)

Analysis blog articles on the GSEs

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