Yes, Virginia

Yes, the 2008 financial meltdown was substantially caused by the Community Reinvestment Act, which:

  • Required banks to lend more to low-income communities.
  • Directed Fannie and Freddie to buy up mortgages and turn them into securities.
  • Directed Fannie and Freddie to buy up high-risk mortgages, thereby encouraging banks to make more high-risk loans.

The left is desperate to deny this, since the financial meltdown was their entire pretext, not just for staying in power despite an appalling economic record, but also for ruinous regulation of the financial sector. So far, with the help of their media allies, they have been largely successful at keeping the connection out of the public consciousness.

But that hasn’t kept economists from studying the subject, and a new paper shows a strong connection:

Did the Community Reinvestment Act (CRA) Lead to Risky Lending?

Yes, it did. We use exogenous variation in banks’ incentives to conform to the standards of the Community Reinvestment Act (CRA) around regulatory exam dates to trace out the effect of the CRA on lending activity. . . We find that adherence to the act led to riskier lending by banks. . . These patterns are accentuated in CRA-eligible census tracts and are concentrated among large banks. The effects are strongest during the time period when the market for private securitization was booming.

POSTSCRIPT: Because we ought to be reminded of it every few years, after the jump are some excerpts from the anti-prophetic 1999 LA Times article that covered nearly every aspect of the CRA that caused the financial crisis without seeing any problem with any of them:

Minorities’ Home Ownership Booms Under Clinton but Still Lags Whites

It’s one of the hidden success stories of the Clinton era. In the great housing boom of the 1990s, black and Latino homeownership has surged to the highest level ever recorded. . .

Clinton’s efforts to increase minority access to loans and capital also have spurred this decade’s gains. Under Clinton, bank regulators have breathed the first real life into enforcement of the Community Reinvestment Act, a 20-year-old statute meant to combat “redlining” by requiring banks to serve their low-income communities. The administration also has sent a clear message by stiffening enforcement of the fair housing and fair lending laws. The bottom line: Between 1993 and 1997, home loans grew by 72% to blacks and by 45% to Latinos, far faster than the total growth rate. . .

Lenders also have opened the door wider to minorities because of new initiatives at Fannie Mae and Freddie Mac–the giant federally chartered corporations that play critical, if obscure, roles in the home finance system. Fannie Mae and Freddie Mac buy mortgages from lenders and bundle them into securities; that provides lenders the funds to lend more. In 1992, Congress mandated that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers. . .

Most importantly, Fannie Mae has agreed to buy more loans with very low down payments–or with mortgage payments that represent an unusually high percentage of a buyer’s income. That’s made banks willing to lend to lower-income families they once might have rejected. . .

But with discrimination in the banking system not yet eradicated, maintaining the momentum of the 1990s will also require a continuing nudge from Washington. One key is to defend the Community Reinvestment Act, which the Senate shortsightedly voted to retrench recently. Clinton has threatened a veto if the House concurs.

The top priority may be to ask more of Fannie Mae and Freddie Mac. The two companies are now required to devote 42% of their portfolios to loans for low- and moderate-income borrowers; HUD, which has the authority to set the targets, is poised to propose an increase this summer. Although Fannie Mae actually has exceeded its target since 1994, it is resisting any hike. It argues that a higher target would only produce more loan defaults by pressuring banks to accept unsafe borrowers. . .

Barry Zigas, who heads Fannie Mae’s low-income efforts, is undoubtedly correct when he argues, “There is obviously a limit beyond which [we] can’t push [the banks] to produce.” But with the housing market still sizzling, minority unemployment down and Fannie Mae enjoying record profits (over $3.4 billion last year), it doesn’t appear that the limit has been reached.

(Emphasis mine.)

I guess we reached that limit, huh? You could hardly ask for a more perfect description of everything that led to the financial meltdown. Also note the key role of regulators: Those who wish to deny the CRA’s role in the financial crisis frequently look at the entire 30-year history of the CRA, but the article points out (in support!) that the enforcement of the CRA changed during the Clinton administration.

The New York Times also had a similar article in 1999, including this gem:

The [Fannie Mae] action . . . will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. . . In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.

Yep.

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