Civics Notes page #1:
Causes of the Mortgage Meltdown & Great Recession:  Not CRA

This is a nearly "raw" page of notes on one issue raised in a letter to editor to El Dorado Hills Village Life, published in May, 2010.  This provides more detail than the responding letter to editor, plus a list of web references. Part of these notes are structure as annotations to excerpts from the earlier letter to editor, which blamed the Community Reinvestment Act and other actions claimed to be regulatory for the subprime crisis and its consequences. It suggested government greed, excessive regulation, and a general objection to regulatory measures expected to be adopted soon by Congress.

Below this point text excerpted from the original May letter to editor is left-adjusted and rendered in black. Notes present only on this SierraFoot web page are indented and are rendered in blue boldface.

The problem in question involved mainly business greed and borrower greed, not government greed.
Wikipedia has pages on several interrelated topics. The best single page for reference with respect to the LTE is Wikipedia page on the Community Reinvestment Act.
That web page includes references to 119 other source documents available on the Web.  The Wikipedia page itself probably would pass peer review for publication in a scientific journal if its references were also in peer-reviewed work.

Clear causes of  the housing bubble crisis include the Fed's continuance of exceptionally low Federal Fund Rates, increased leveraging by very large investment banks (especially in derivatives, and specifically Credit Default Swaps), predatory lending and weaker underwriting, predatory borrowing, business policy dependence on continuing increase of real estate values over time, and securitization of mortgage debt.

Almost all of this was enabled by a chain of Federal actions which substantially deregulated finance and real estate business practices. The most important of these probably were the Gramm-Leach-Bliley Act of 1999, which repealed the Glass-Steagall Act of 1933, the Commodity Futures Modification Act of 2000, relaxation of SEC rules in 2004, and maintenance of the Federal Funds Rates at an artificially low rate following recovery from the dot-com bust a decade ago.

CRA was not the cause. CRA operates by giving lenders a business incentive rather than direct regulation.  It defined rules for Federal regulatory agencies (not for businesses) to evaluate how well lenders serve all segments of their communities, with a goal of increasing lending to low and moderate income borrowers while stating that loans were to be "consistent with the safe and sound operation of such [lending] institutions". The business incentive is that CRA evaluation results are considered in applications for banking business growth by merger, acquisition, or branching.

CRA research citations include [cited in BusinessWeek]
    Findings include CRA market share:  22.8% of all loans in 2006 were by CRA banks, 77.2% by non-CRA banks.
    For high cost loans, 9.2% were by CRA banks, 90.8% by non-CRA banks.
Cites related 2009 report:  The Community Reinvestment Act of 1977: Not Guilty
    For 2006 loans to Low-Moderate Income borrowers by CRA banks in 15 most populous service areas accounted for 16.9%
    of the total.  83.1% were to higher income groups.  => 3.85% of total loans were CRA to low/low moderate income borrowers

Having been in the mortgage banking business since 1967 I had the opportunity to watch the effects of the Community Reinvestment Act of 1977
(CRA). Banks that were likely redlining were now caught and had to begin making more marginal loans in communities heretofore avoided. Mortgage servicing companies were only marginally impacted by this decision. Even with the market turndown in 1990-95 there were not an inordinate number of foreclosures or short sales and the term “loan modification” did not yet exist. What happened?

CRA did not require banks to make more marginal loans.

It introduced no new regulatory requirements. Instead, it sought to reduce credit discrimination against low and moderate income areas through incentives to business, with those incentives supported by requirements on Federal regulatory agencies. The Act itself summarized this in Section 802(b):

"It is the purpose of this title to require each appropriate Federal financial supervisory agency to use its authority when examining financial institutions, to encourage such institutions to help meet the credit needs of the local communities in which they are chartered consistent with the safe and sound operation of such institutions."

That section is explicit in calling for "safe and sound operation" of financial institutions. A paraphrase of this as it could be expressed in computer logic is

For each loan (mortgage) application received by a regulated financial institution (bank)
    If the loan can be granted without undue financial risk
        then the bank will be encouraged to grant the loan on its own authority
        else (if the bank considers the application's risk to be excessive) it is expected not to grant the loan.

The incentive to provide fair service derives from a requirement for Fedeal regulatory agencies to periodically evaluate a bank's performance with respect to the objective. The original CRA defined 12 assessment factors in 5 performance areas, to be evaluated and published. Results are to be considered when the regulated bank applies for expansion by means of merger, acquisition, or branching.
In 1995 the Clinton Administration started tinkering (new regulations being added) with the CRA. Robert Rubin was a major tinkerer in this plan. By 1998 regulatory tinkering created the sub-prime loan.

Actual history of revisions to CRA or to interdependent parts of law is:

1989:  Financial Institutions Reform, Recovery and Enforcement Act of 1989 was adopted to clean up the mess left by that decade's savings and loan crisis. The most significant changes were to establish the Resolution Trust Corporation (RTC) to close several hundred insolvent thrifts and to moge S&L regulation from the Federal Home Loan Bank to the new Office of Thrift Supervision. With respect to CRA, it defined four categories for performance of CRA banks on achievement of CRA objectives:  Outstanding, Satisfactory, Needs to Improve, or Substantial Noncompliance.
[President: George H.W. Bush    Congress majority: Democrat]

1991 (December): CRA details were amended twice, once in connection with the Resolution Trust Corporation Refinancing, Restructuring, and Improvement Act of 1991 and once in loose coordination with the Federal Deposit Insurance Corporation Improvement Act of 1991. The most significant changes were in the nature of RTC-related incentives for providing credit to predominantly minority neighborhoods.
[President: George H.W. Bush   Congress majority: Democrat]
1992: Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (not directly changing CRA) required Fannie Mae and Freddie Mac to support affordable housing through allocating a percentage of lending to affordable housing.
[President: George H.W. Bush   Congress majority: Democrat]

[quoting Wikipedia text] "President Bill Clinton asked regulators to reform the CRA in order to make examinations more consistent, clarify performance standards, and reduce cost and compliance burden." Part of the benefit was to be paperwork reduction. (Federal agencies made corresponding changes in regulations in 1995.)
[President: Bill Clinton  Congress majority: Democrat]

1994: Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 repealed restrictions on interstate banking. This deregulation measure allowed use of out-of-state CRA ratings for mergers, acquisitions, and branching. Activity in mergers and acquisitons increased, contributing to the later issue of whether financial institutions are "too big to fail".
[President: Bill Clinton   Congress majority: Democrat]

1995:  Federal agencies made CRA-related regulation changes in answer to President Bill Clinton's request in 1993. Changes had been reviewed in Congressional hearings. As noted for Bill Clinton's 1993 request for changes, CRA changes were targeted toward improving regulatory consistency and simplicity, in the stated interest of reducing cost and compliance burdens and reducing paperwork.
[President: Bill Clinton  Congress majority split -- House:  Republican  Senate: Democrat]

1999:  Gramm-Leach-Bliley Act ("Financial Services Modernization Act") repealed part of Glass-Steagall Act of 1933. This allowed banks to offer a full range of investment, commercial, banking, and insurance services. Also, smaller banks would be reviewed less frequently for CRA compliance.
[President: Bill Clinton   Congress majority: Republican]

2000:  The Commodity Futures Modernization Act of 2000 exempted derivatives from regulation, including capital reserve requirements. This allowed use of Credit Default Swaps, one form of derivatives, to increase by about a factor of 100 in 10 years, with outstanding CDS's estimated in 2008 to cover total debt in the range of $33 trillion to $47 trillion. Total face (notional) value of all derivatives was reported to be $683 trillion in June, 2008, with 8% of that amount in Credit Default Swaps. As early as 2003 Warren Buffet referred to derivatives as "financial weapons of mass destruction". This was proven when they were key factors in the finance crisis of 2008 which required radical and rapid government response to avert a chain reaction which would have produced a full scale depression instead of "The Great Recession".
[President: Bill Clinton   Congress majority: Republican]

2001: George W. Bush took office as president. Advocating an "Ownership Society", policies and actions throughout his administration tended to promote empowerment of the financial industry and restraint of regulation. See the lengthy New York Times article, "White House Philosophy Stoked Mortgage Bonfire" for a report of many details.
[President: George W. Bush  Congress majority: Republican 2001-2007, Democrat 2008]

2002 & 2003:  Interagency and nongovernment reviews showed that the 1995 regulatory changes had weakened CRA. By 2003 less than 30% of home purchases were included in CRA reviews.
[President: George W. Bush  Congress majority: Republican]

2004:  The Securities and Exchange Commission (SEC) relaxed rules, consequently enabling investment banks to carry higher levels of debt. This allowed investment banks to fund higher levels of debt in subprime loans, whose actual level of risk was being underestimated by rating agencies covering mortgage-backed securities.
[President: George W. Bush  Congress majority: Republican]

2005: Office of Thrift Supervision (OTS) changed rules to permit CRA ratings for companies with more than $1 billion in assets to satisfy CRA evaluation criteria with any combination of lending, investment and services instead of only lending. Democrats in Congress protested.  FDIC, FRB, and OCC changed their regulations to match OTS.x
[President: George W. Bush   Congress majority: Republican]

2008: Higher Education Opportunity Act requires Federal financial supervisory agencies to change CRA rules to recognize low-cost education loans in assessing CRA compliance.
[President: George W. Bush  Congress majority: Democrat]

Overall summary:  Changes in law and regulations have generally been in the direction of decreasing regulation of banks and other financial institutions. Deregulation not directly related to CRA enabled unwise business decisions in the financial sector to produce the crises involving subprime mortgages, foreclosures, financial liquidity, new construction,  poperty values, unemployment, and budget stress at all levels of government.

Politically, what changes happend on whose watch?

YearParty of presidentCongress majorityChanges
1989Republican    George H.W. BushDemocraticDeregulatory, relatively minor
1991Republican    George H.W. BushDemocraticMainly business incentives
1992Republican    George H.W. BushDemocraticNeutral for private sector, regulatory for Fannie Mae & Freddie Mac
1993Democratic   Bill ClintonDemocraticRequest to Congress for deregulatory action
1994Democratic   Bill ClintonDemocraticDeregulatory, major
1995Democratic   Bill ClintonmixedCRA regulatory simplification reducing costs to both business & government
1999Democratic   Bill ClintonRepublicanDeregulatory, major
2001+Republican    George W. BushRepublicanDeregulatory, varying scope
2004Republican    George W. BushRepublicanDeregulatory, highly significant (SEC)
2005Republican    George W. BushRepublicanDeregulatory for CRA
2008Republican    George W. BushDemocraticPro-business CRA linkage with education loans

Up until this time [1998] loans were commonly made with no down payment. They were called Veterans Administration loans.

VA loans were in fact made with zero down. However, Federal Reserve Board statistics for mortgage debt outstanding (currently available on the web only for 2005 and later) show that mortgages held by the Federal Housing Administration and Department of Veterans Affairs (including VA loans) accounted for only .03% of all mortgage debt outstanding ($3,592 million out of  $12,063,864 million, [$3.6 billion out of $12 trillion).

Also, only 4% of FHA and VA mortgage funds were for single family homes, 96% were for multifamily (condominium) residences.  This further suggests that VA mortgages are extremely rare in El Dorado Hills, where almost all residences are single family homes at property values likely to be unaffordable to younger veterans, even with a VA mortgage.

At the time this writer and his wife moved into El Dorado Hills (1990) the standard for minimum down payment had dropped from 30% to 20%. Property values were high enough to require that our first EDH mortgage was a jumbo and that we were required to buy Private Mortgage Insurance.

In later years those standards were further relaxed and dropped, permitting business practices which now are often considered to be predatory lending. An additional risk is predatory borrowing, with the most common abuse being to falsify income level for a stated income loan. Both predatory lending and predatory borrowing in the mortgage market were enabled by relaxation of regulations whose purpose was to protect both borrowers and lenders.

Loans with minimum down payments were insured by the FHA (97 percent). It was common to make 95 percent loans saleable to FNMA. It was not the no down payment issue tha  caused the meltdown, and, please note, these loans all required “verifiable income.” The sub-prime requirements forced the providing of 103 percent loans with no “verifiable income,” commonly known as “stated income.” These government regulatory requirements, made to benefit a particular constituency, were the cause of the sub-prime meltdown. And who did these Democrat inspired government regulations hurt the most? Yes, our minority communities.

It's true that drastically relaxed requirements to qualify for mortgage loans were a major cause of the subprime loan crisis.  An additional cause was aggressive marketing, with below-Prime Rate initial interest rates and with minimal communication to buyers that the interest rate would increase very substantially in a later year. Many home buyers were unaware of the later rate increases. This resulted from a combination of deregulation and <business:  Read with your own choice of language:  Business greed or business optimization of financial results for stockholders and other business ownersand management>.
Another factor was securitization of subprime loans, which hid the level of risk. This was another result of <business> management in the absence of regulation.

The Deregulation in question is more consistent with Republican ideology than Democrat, although Democrats

The new financial regulation bill being considered in Congress will certainly benefit some and hurt others, depends on which side you are on. I don’t think we need our government to have more power; again it was government that created sub-prime. What we need to do is rescind the regulations that created sub-prime mortgages in the first place. After all, if there were no subprime regulations then there would have been no subprime mortgages, no sub-prime securities, no sub-prime derivatives, no sub-prime credit default swaps, no $85 billion bailout of AIG and finally no need for the new financial legislation.

Most sources attribute the primary cause of the subprime mortgage crises to predatory lending and predatory borrowing. The lending factors were issuance of mortgages at unsustainably low introductory interest rates, with the a balloon (rate adjustment) to a much higher rate after a small number of years. Often this was not disclosed clearly to borrowers, many had believed the introductory rate would countinue. Results were especially serious when combined with predatory borrowing, using inflated values of stated income to secure a mortgage loan.

Both of these practices were produced by lenders' changes in conduct of business, enabled by relaxation of government regulations and not by imposition of regulations. A further factor in relaxation of regulations was securitization and mortgage-backed securities, which produced an economic incentive for lenders to process high volumes of mortgages without adequately managing risk. Securitization also tended to hide risk until the consequences became evident.

It does not follow that there lack of existence of subprime regulations would produce lack of subprime loans. In terms of logic, this is at best a nonsequitor fallacy or an axiomatic assertion.

Why aren’t the 1995-98 regulations added to the Community Reinvestment Act of 1977 creating subprime mortgages being rescinded? Because they benefited builders, real estate interests and government control of banking interests, to name a few.

Actually, only the early results benefitted builders, real estate interests, and banking interests. The end result was an economic crash for all of these interests, as well as impacting all the rest of us. 

The harmful regulatory changes accomplished varying degrees of deregulation, not regulation. The ultimate results dramatically reflected short-sighted and negligent business management, with inadequate understanding of its systemic consequences.

The financial sector needs the equivalent of what aerospace engineering uses: Systems for stability augmentation. Both domains need to avoid catastrophic failures while providing a high degree of freedom within a good range of maneuverability.  If done reasonably well, the new legislation should do exactly that for business. Engineers have been doing it for aviation and space systems for a century.

[original letter writer's name redacted for web possting of the annotated letter]
El Dorado Hills

Selected References, web links, most from sequential listings returned by Google, excluding blog links.
Wikipedia pages appear to be the best references on this topic for understanding without extensive reading.
Each Wikipedia page has its own list of references, such as the 119 references in the first page cited below for CRA.


Community Reinvestment Act - Wikipedia, the free encyclopedia

Community Reinvestment Act had nothing to do with subprime crisis ...  

FRB: Community Reinvestment Act
Community Reinvestment Act of 1977: Definition from

FDIC Law, Regulations, Related Acts - Consumer Protection

OCC: CRA Information

The Community Reinvestment Act of 1977: Not Guilty

Community Reinvestment Act

Did Liberals Cause the sub-Prime Crisis?  The American Prospect


Subprime mortgage crisis:

subprime  mortgage crisis - Wikipedia, the free encyclopedia

    Google returns at least 6 additional pages in Wikipedia covering details associated with "Subprime mortgage crisis".
Who Is To Blame For The Subprime Crisis?

Economists Brace for Worsening Subprime Crisis : NPR

The Subprime Crisis

Subprime crisis shines spotlight on mortgage broker practices ...

Making Sense of the Subprime Crisis

Approximately 20 additional references not in the list above were checked when preparing these notes. All were located by using Google to search for different words and phrases related to this topic.

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