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June 27, 2009

Comments

Sebastian wrote: "The CRA is about comparing whether or not you are giving loans in different neighborhoods, not a specific loan classification. One of the major ways of getting your CRA numbers up was giving sub-prime loans."

1. The vast majority of subprime loans were not from companies that needed to worry about CRA.

2. Subprime loans were used because they were cheap, and thus marketable, and helped to drive volume and thus fee income. And mortgage brokers got more money for subprime loans. People were sold subprime loans even though they qualified for prime loans, because the broker wanted the additional fee income.

You can't just assume subprime = poor person.

Seb wrote: "I also think a huge part of the problem was that in the attempt to diversify risk in light of the S&L debacle (where local downturns ended up killing local S&Ls) we got an extreme division between the people taking the risk (ultimately holding the note) and the people making the initial risk analysis."

What you're talking about here is the rise of mortgage brokers, who bore no risk after 6-12 months no matter what happened to the loan. They worked for fees, and only had to find borrowers who could handle the payments for a little while. And, of course, if things went bad they'd just file for bankruptcy.

These outfits, hundreds of whom went bust in the housing crash, were not covered by CRA.

Pithlord wrote: "Maybe the problem can be restated: the models are better than individual discretion (although also more susceptible to fraud and gaming), but if everyone uses the same model, when they fail, it's spectacular."

Part of the problem was over-reliance on FICO. It was used as a proxy for ability to pay, when it's nothing of the sort.

"Would you please quite ducking, Sebastian? I find it hard to believe that when I bold something to reply to you, you don't see it as a reply:

And perhaps more importantly, the CRA, and the mentality behind the CRA, made regulators extremely unwilling to intervene.
And in fact, I bolded the same material as you did in your post. And you really didn't get what I was questioning? Really? Why would you think I bolded that part then? Please answer."

Ah, a direct question that I haven't answered. Umm, since I bolded it in the section you quoted, I didn't think that you bolded it separately. Can you see how that might happen?

And again, I answered it in my response to russell. But to be shorter: regulators tend to regulate with a goal in mind. We tend to get irritated with regulators who get caught up so much that they lose sight of the goal. The goal was to get more people into owning more houses. As such regulations which tended to stop people from getting into houses tended not to get pushed, while ones which tended to get people into houses were pushed.

Pretty much all of the regulations starting with the first amendment to the CRA and in lots of areas outside the CRA were designed with or implemented in such a way as to keep the idea of getting more people into more houses.

Surely you aren't going to argue that housing sales were regulated in such a way that they were over-limiting?

"These outfits, hundreds of whom went bust in the housing crash, were not covered by CRA."

Which has almost no bearing on my argument whatsoever. It wasn't just the CRA, it was the entire regulatory environment, of which the CRA is a part.

The entire regulatory environment was focused much more on getting people into houses, rather than making sure that the loans were financially wise/safe for the economy.

Sebastian,

Are you suggesting that, in the absence of the CRA, companies like Countrywide would have looked at the vast sums of return-seeking money waiting to be invested in MBS and CDO and turned all that money away simply for lack of quality borrowers?

Sebastian,

I think if you are making a general claim that the American emphasis on the desirability of home ownership contributed to a bubble and an over-extension of credit that helped create the mess then I think you have a reasonable point, though I don't think that was as important as you seem to. There was no inherent reason the damage needed to be as bad as it was.

My reading of McArdle is that she is saying something much stronger, along the line of mds' comment, and I think she is trying to pin way too much blame on government.

You can't talk about banks without talking about their regulatory environment. It is a chicken-egg thing, in the long run both are important.

I am suggesting that in the absence of an enormous focus on getting people into houses, including huge government financial incentives, that the regulatory environment would have been vastly different.

Sebastian wrote:

"It wasn't just the CRA, it was the entire regulatory environment, of which the CRA is a part."

Would you please demonstrate how these virtually UNregulated mortgage brokers were driven by the regulatory environment, rather than sheer profit-seeking greed?

These outfits were churning out billions and billions of dollars of bad subprime loans. Not because of regulation. Not because of CRA. They were doing it to make an easy buck.

"The entire regulatory environment was focused much more on getting people into houses, rather than making sure that the loans were financially wise/safe for the economy."

And the housing industry was focused on making money by selling MBS to serve the vast quantity of money flowing into the market.

I'm sorry, but profit is a far more concrete motive than your vague regulatory handwaving. Your model of the mortgage industry operating in cringing servitude to Barney Frank simply doesn't match what was seen in reality.

The "bad loans" respoonsible for the meltdown were the loans made to Wall Street whiz kids by greedy investors who wanted high returns with low risk, and were stupid enough to believe that the Masters of the Universe could "engineer" such outcomes.

Mortgage-backed securities were loans to highly-leveraged deadbeats on Wall Street, who were ... optimistic ... about how much debt they could support. Even if the CRA had positively required non-bank mortgage outfits to issue mortgages to unemployed black people, it would have been irrelevant to the fact that Wall Street sold bond investors a Big Shitpile.

The "mentality behind" lending money to Wall Street was not some altruistic belief in the goodness of wide-spread home-ownership. It was stupidity and greed in equal measure. Whether the bond investors were greedy and the bankers stupid, or vice-versa, is the main question. Neither the CRA nor what Megan has to say about it matters much.

--TP

Sebastian wrote: "You can't talk about banks without talking about their regulatory environment."

Mortgage brokers were barely regulated at all. And nor were their customers on wall street.

Your scenario simply isn't compatible with reality, Seb.

If I understand you correctly, then, the statement that the mentality behind the CRA is responsible for the bubble is as true as the statement that the mentality behind the mortgage interest deduction is responsible for the bubble. No closer connection for one than for the other, but both are policies indicating that government highly values encouraging homeownership.

If that's all you're saying, it seems reasonable, but using the CRA as the only example is going to confuse people.

Sebastian wrote: "You can't talk about banks without talking about their regulatory environment."

While I think I agree with you Seb (that the regulatory environment was too lax), the whole point of MM's post was that too much government regulation led to these outcomes - not too little!!

I quote: "John Carney has been doing a lot of blogging about the role of the CRA in the financial meltdown. That role is overstated by conservatives who are unwilling to admit that markets can have bad outcomes, but it is understated by liberals who are unwilling to admit that regulation, too, can produce hideous unintended consequences."

So, SH, you don't focus on:

the tax advantages for homeownership that have enormous bi-partisan support; or

the failure to regulate derivates, supported massively by Republicans, with Democratic support, and signed into law by Clinton; or

the reprehensible conduct of one A. Greenspan in keeping the cost of money way too low, in recommending ARMs at the height of the bubble, in denying the existence of the bubble, and in failing to exercise his existing regulatory power over financial institutions; or

the active steps taken by the Bush admin to block states from using their regulatory powers to investigate financial institutions.

No, you don't mention any of those things because that might make your side look bad. Instead, you find a tiny little program designed to increase outreach to a historically underserved community and place the blame there.

Ever thought of applying to be a co-blogger with MM? When it comes to govt regulation, you're two of a kind.

(which, at the end of the day, is kinda odd. San Diego is a city completely reliant on govt support, between the Navy, for jobs, and membership in Metropolitan Water District of Southern California, for water.)

"If I understand you correctly, then, the statement that the mentality behind the CRA is responsible for the bubble is as true as the statement that the mentality behind the mortgage interest deduction is responsible for the bubble. No closer connection for one than for the other, but both are policies indicating that government highly values encouraging homeownership."

Absolutely. The mortgage interest deduction (and the change to tax rules on flipping houses) absolutely contributed in a huge way. If there were an easy and fair way to phase those out we should do so. (There probably isn't an easy and fair way to phase those out so I'm not sure what the best policy would be. Probably worrying about a too big housing market isn't a priority anymore).

Eric: "but it is understated by liberals who are unwilling to admit that regulation, too, can produce hideous unintended consequences"

And? These were highly regulated areas. The buying and selling of houses is highly regulated. Making loans is highly regulated. Being a bank is highly regulated. The regulations in this case had an aim in mind. That aim was to promote home ownership. All sorts of rules went that direction with that policy aim in mind. Rules that went against that policy aim *were not enacted even in the easy and smaller scale cases*. You note that Fannie Mae didn't 'cause' the crisis, whenever Barney Frank's horrifically stupid comments are brought up.

But look at it from a regulatory point of view. Even in the case where the government completely controlled the rules--Fannie Mae, it was obvious that the poltics of pushing toward home ownership overrode financial responsibility. The same was true of regulations of the more normal banking market. The government aim was to worry about the outcome of getting more people into houses more than ancillary outcomes about what that might do.

The private market exploited that to the hilt and helped push up the bubble from that side. But that wasn't underregulation. That was regulation with a specific policy priority. And Megan is precisely correct. That regulation policy priority had horrific unintended consequences.

Just because you don't like the current policy outcome doesn't mean that it was underregulation of the housing market. We got the housing regulation that both Democrats and Republicans of the time wanted. Regulation with the goal of increasing housing ownership.

"the tax advantages for homeownership that have enormous bi-partisan support; or

the failure to regulate derivates, supported massively by Republicans, with Democratic support, and signed into law by Clinton;"

I didn't write the underlying post. But yes, all of those things were important. That is exactly what it means to have a governmental regulatory policy which has too much focus on one priority. But that isn't underregulation. That is getting the exact political regulation you want considering your priorities. Calling that underregulation isn't accurate. The reason why it looks like underregulation now is because we've decided that the unintended side effects are worse than the policy aim.

"Regulation with the goal of increasing housing ownership."

You keep saying this. But the CRA had the primary goal of eliminating red-lining practices, which had very large discriminatory effects and were often put in place with discriminatory intent.

So, a better way to characterize the CRA would be: regulation with the goal of increasing housing ownership among those otherwise qualified, but denied credit on the basis of factors irrelevant to the risk.

Sometimes it shows that people can make the right call based on experience without being able to articulate why.

Well, it would be pretty interesting if people always made the wrong call in cases like this. Some ex girlfriends might suggest that I might be chosen as an example for that.

But the problem is not some sort of Gladwell like blink reflex operating here, but that the kind of system you advocate creates an environment that is remarkably resistant to non-insiders getting a loan, which means that they are automatically placed on the periphery of American life. (I've been swayed a bit by Turb's arguments about how home ownership is not a completely unalloyed good, but I think that we can all accept that ownership is a marker of middle class acceptability)

Seb wrote: "Making loans is highly regulated."

No, Seb, it isn't. Hundreds of independent mortgage brokers were not.

Please try to come to grips with this.

" That was regulation with a specific policy priority. And Megan is precisely correct. That regulation policy priority had horrific unintended consequences."

Prove it, Seb. Numbers, please. Please prove that it was this vague "regulatory environment" (meaning *only* the parts of the environment that encouraged home ownership) that was driving the mortgage industry, rather than profit-seeking.

This hasn't been done. You keep avoiding whole swaths of issues, so that you can argue that the meek titans of the banking industry were swayed by George Bush's and Barney Frank's rhetoric into adopting suicidal practices.


I'm not advocating bank manager discretion. I'm just saying there are trade offs.

"Seb wrote: "Making loans is highly regulated."

No, Seb, it isn't. Hundreds of independent mortgage brokers were not."

I don't see the contradiction here: Mortgage brokers don't make loans. They're just a middle man between the banks and the borrowers. If a bank isn't willing to loan you money, the mortgage broker can't do a thing for you.

"If a bank isn't willing to loan you money..."

Brett, in 2006 when Countrywide was originating mortgages as fast as it could, and buying NINJA loans from 3rd party originators as fast as it could, it wasn't because of the CRA. It was because they had investment bankers knocking on their doors willing to buy the loans, so they could collateralize them and sell off the tranches. It was, pure and simple, about making money. Not about ending redlining.

Sebastian, your claim that the industry was highly regulated would be funny if it weren't so painful to the taxpayer. Who was AIG's regulator? Did they even have a clue what the financial services branch was doing?

Button up, dude, your ideology is hanging out.

"...having if anything a lower default rate." How do you figure that?

I suppose it could be considered a little tricky to tease out.

* The Fed noted that only 6 percent of all the higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas.

* CRA banks are 66% less likely than other lenders to make a high cost loan and 58% less likely than other lenders to originate high cost loans to low and moderate income borrowers. [from a study of data and the literature by Traiger & Hinckley LLP]

*Though CRA-covered lenders can meet their obligations by purchasing from non-CRA lenders in their areas, this was unlikely to provide a fertile dumping ground for subprime, as less than 2 percent of the higher-priced and CRA-credit-eligible mortgage originations sold by independent mortgage companies were purchased by CRA-covered institutions. [Fed comments above again]

*The Traiger study found that "CRA banks are twice as likely as other lenders to retain originated loans in their portfolio."

*The Fed study also did some comparisons of subprime default just below and just above the relevant income cutoffs, on either side of CRA boundaries, etc., and found no noticeable difference.

So virtually none of the subprime lending in CRA-covered areas was being done by CRA banks, very little non-CRA paper was being bought by CRA banks to satisfy requirements, loans were much more likely to stay with the originating bank, and CRA-eligible subprime borrowers showed no increase level of default. Not necessarily dispositive, but highly suggestive. And this margin is too small to contain the studies of middle-to-higher income defaults vs. lower-income, which also show the pernicious effect knowing the CRA exists had on borrowers who didn't even remotely qualify for it. Or something.

(Traiger & Hinckley have a news page with links to various PDFs on the CRA's role, or lack thereof, in the crisis.)

The CRA is about comparing whether or not you are giving loans in different neighborhoods, not a specific loan classification.

See above, as there was at the very least a de facto difference, based on likelihood of retaining the original loan. For some reason, holding on to a mortgage tends to make a bank more careful in its lending. Post-1995, there was unfortunately the beginnings of substantial resale of CRA mortgages, but this only really seemed to hit its stride in 2003 along with the big subprime boom.

One of the major ways of getting your CRA numbers up was giving sub-prime loans.

See above.

Meanwhile, regulatory enforcement of CRA declined after 2001, according to 2008 testimony before the House Financial Services committee, and regulations were further eased in Aug. 2005 by 70 Fed. Reg. 44256. Hmm, when did the bubble really get going, compared to when banks were more off the CRA leash?

Seriously, given how little higher cost loan origination was CRA-based, it seems almost laughable to place any blame on the CRA when the overwhelming factor was the deregulation of the mortgage market in 1999, when everyone and their uncle to get into mortage brokerage and securitization. Note the "de-" at the front of the dirty word "regulation" there.

Also, I know that this too is rather tricky, but before you decide to flog the Barney Frank canard repeatedly again, you might want to look into the record of which party controlled the House of Representatives 1993-2006, and the powers wielded by minority party members in that same lower chamber.

Who was AIG's regulator?

The Office of Thrift Supervision. No joke.

--TP

Er, substitute "1995-2006" above. And insert reference to Graham Chapman's King Arthur and his numeracy problem.

Sebastian,

What regulation made Bear Stearns use 97% leverage to buy risky securities? What regulation brought down Lehman? What regulation made S&P (or was it Moody's?) use models that simply didn't admit the possibility of a housing price decline? What regulation made AIG sell Everests of CDS protection, and then be unable to put up collateral when its credit rating was reduced? What regulation made investment bankers assume that AIG's protection was solid without checking to see exactly how much AIG had sold? What regulation made WallStreet in general ignore the massive systemic (i.e., undiversifiable) risks they were running?

Your argument has the tail wagging the dog.

"Would you please quite ducking, Sebastian? I find it hard to believe that when I bold something to reply to you, you don't see it as a reply:

And perhaps more importantly, the CRA, and the mentality behind the CRA, made regulators extremely unwilling to intervene.


And in fact, I bolded the same material as you did in your post. And you really didn't get what I was questioning? Really? Why would you think I bolded that part then? Please answer."

Ah, a direct question that I haven't answered. Umm, since I bolded it in the section you quoted, I didn't think that you bolded it separately. Can you see how that might happen?

Ummm, since you lose all formatting when you do a copy/paste, and have to insert it yourself afterwords -and there's no way you don't know that - no, I can't see how that would happen.


And again, I answered it in my response to russell. But to be shorter: regulators tend to regulate with a goal in mind. We tend to get irritated with regulators who get caught up so much that they lose sight of the goal. The goal was to get more people into owning more houses. As such regulations which tended to stop people from getting into houses tended not to get pushed, while ones which tended to get people into houses were pushed.

No, you didn't answer my question.

Pretty much all of the regulations starting with the first amendment to the CRA and in lots of areas outside the CRA were designed with or implemented in such a way as to keep the idea of getting more people into more houses.

Surely you aren't going to argue that housing sales were regulated in such a way that they were over-limiting?

Posted by: Sebastian

Would you please, please quit ducking, and just tell me what evidence you have for this narrative of yours. Do you have any? You certainly haven't presented any yet. And, what type of evidence can you think of that would theoretically disprove your assertion?

Again, you haven't presented that either. All you've given is an unfalsifiable hypothesis, a narrative which you, personally, seem to be comfortable with. Since you've already agreed that evidence is important, and that the scientific method is what you generally want to go with, could you at long, long last give some scintilla of evidence for your assertions, as well as telling us what would (in theory at least) falsify them?

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