I’d like to take a little time to address an issue which, I thought, was pretty much common knowledge – the way we got into the economic mess we now see ourselves in. I have been keeping at least a passing attention on the economy since, well, just about forever, and am astonished by the lack of respect some people have for the general population’s ability to retain information over the course of several years, but even more amazed by a general willingness to soak it up.
Mostly what I am referring to is the misplaced belief that somehow the economy was moving along swimmingly, and then Freddie Mac and Fannie Mae came out of left field and just messed the whole thing up for all of us. The truth is the economy has been struggling for quite some time. Heck, earlier this year Bush had to convince America that, based upon a very technical meaning of the word “recession,” we were merely in an “economic slowdown.” This was months before the bailout of Freddie Mac and Fannie Mae. We don’t argue about technical meanings of the word “recession” when everything’s going fine. And meanwhile the American dollar was decreasing in value while American’s purchasing power was being decreased by, among other things, the high cost of energy and oil for a couple of years. So how people can believe that the economic mess is being caused by the collapse of the housing market, and not the other way around, is a little confusing to me.
But the reaction du jour for the far-right conservative movement has been to deny that any economic uncertainty was taking place, and throw the burden of the current economic crisis directly on the shoulders of 1977’s Community Reinvestment Act, with the proverbial back-breaking straw coming in the form of a Clinton amending bill in 1995. This does not seem to be done as a means to blame Bill Clinton for our current economic strife per se, but rather to shift the responsibility from the economic policies of the Bush administration to a much more wide-reaching ideology; that in an attempt to destroy American capitalism and replace it with a neo-socialist liberal agenda which rewards the lazy and indifferent at the expense of the hard-working, God-fearing aristocracy (a la the beautifully poetic dung slinger Ayn Rand), the liberal left has destroyed America’s economy under the name of – get this – equal housing legislation (poor people owning homes: how delightfully evil!!)
A succinct illustration of this argument is an article supposedly passed from an economic professor to a Republican State Senator and former Governor, to the fun loving people of the internet (probably not – these things are seldomly written by those whom it’s attributed to.)
First, it says that the base for this problem was first laid in 1977 with the Community Reinvestment Act (CRA). It tells you to look it up, but doesn’t actually provide any evidence or reasoning to back up the claim. Evidently, since it says to look it up we’re just supposed to blindly accept that this statement is true without any sort of validation whatsoever. I called their bluff.
The bill was actually designed to prevent lending institutions from denying credit to deserving applicants based solely upon the location of the applicant or the general economic status of those in his or her area. The bill specifically stated that these loans be “consistent with safe and sound operation.” In other words, contrary to the implication of the article, the bill was not designed to provide credit to those who should not get it, but rather to force credit agencies to end discriminatory practices which denied credit to those who would have been approved if they lived in another area.
And as for that heinous 1995 adaptation? Well, in 1995 both the House and the Senate was under Republican control. So this wasn’t something those socialist liberals could have passed without Conservative agreement on the issue. In fact, according to an article from 1995, most of the law was written by Republicans in Congress, and was almost vetoed by Clinton. But again the argument damming the liberal agenda makes a claim that it doesn’t bother even attempting to substantiate, and hopes that it’s not checked out by making the assertion that you should. I did.
The majority of the 1995 amendment was actually aimed at changing the regulatory practices to make them more streamlined, easier, and cost-effective for the lenders. So the claim that it was targeted towards people who cannot afford to buy a house is patently false. Contrarily, the biggest impact this bill had on the current economic crisis was the inclusion of subprime securities (which I’ll get to later). Democrats were originally against these new rules, while the securities lobbyists fought hard for it.
We’re supposed to take it on faith that because the bill was passed during Clinton’s Presidency, he must be to blame for any problems it caused. In reality, the bill that was passed was a mostly Republican bill with appeasements to Democrats to allow its passage and veto-less escape.
At any rate, CRA loans are typically profitable and safe for the companies which provide them, according the Federal Reserve. Also, most of the sub-prime loans were not held under CRA oversight, so it couldn’t have been to blame, anyway. According to an article in Business Week, over 50% of the bad loans were made by an independent lenders not privy to the CRA, and up to 30% were made by lenders associated with CRA institutions but not under CRA regulations.
Finally, it should be noted that CRA lenders were some of the most heavily regulated institutions, and these regulations were becoming more and more lax under the Bush administration. Since virtually all of the loans which were bad were made during the lessening of the CRA, and not very many were even a part of this program, it’s simply not logical (never-the-less factual) to blame the mess on the CRA at all.
But I’ll let Ben Bernacke, the chairmen of the Fed who was put into place by George W. Bush sum up the “mess” caused by the CRA:
“The managers of financial institutions found that these loan portfolios, if properly underwritten and managed, could be profitable. In fact, a Federal Reserve study found that, generally, CRA-related lending activity was at least somewhat profitable and usually did not involve disproportionately higher levels of default.”
Now, as far as the Freddie and Fannie claims – it is true that some Republicans wanted to change the regulations but ultimately failed in part due to the opposition of some Democrats. But just as in 1995, to blame this solely on the Democrats is to ignore the makeup of Congress. As in 1995, both Chambers of Congress were under Republican control, so ultimately if the Republican Party had wanted these reforms they could have just outvoted the Dems on the issue and that would be that.
Also, the changes in regulation which Bush and McCain wanted would have changed the agency under which they would have reported, and would have been a far cry from guaranteeing the defaulted loans would not have occurred.
However, even ignoring that, and even if the claims that the CRA caused the high number of faulty mortgages are true (which they aren’t), it still doesn’t explain the mess that everything’s in now. Why? Because if that was the case then Freddie and Fannie would have been bailed out and that would have been the end of the story. The truth is that, in an attempt to assign blame to the current economic problems on a specific ideology (the evil, communist idea that people in poor neighborhoods should be able to own their own homes, too), the argument misrepresents one major factor in the subprime mortgage crisis, and completely ignores the real crux of its effect on the economy as a whole.
The biggest problem here is not regulation, but deregulation. The most guilty acts of deregulation fall under Bush’s terms, but also Clinton’s last term, so it is fair to say Clinton shares some of the blame. In the late ’90’s, regulations put in place after the Great Depression started to be relieved due to a perception (real or imaginary) that American banks could not compete with European and East Asian banks. This lead to two problems – speculation and securitization.
First, the problem started with the housing boom that began in the 1990’s and continued for upwards around a decade. Some market correction was going to occur after a while, and that is neither the Democrats or Republicans faults. But the economy never completely recovered from the tech-bubble bust in 2001 (and has a completely partisan comment, Bush’s economic policies caused downward trends to continue and increase), and interest rates were seemingly being lowered every quarter. This had the very intended consequence of making credit exceptionally easy to obtain, which played a much bigger role in the ability of people to obtain mortgages they couldn’t afford than the CRA ever could.
As the economy started to tumble lower and lower in 2005, credit started tightening and interest rates rose. The worsened economy caused many people in sub-prime mortgages to default, but the real killer was the adjusted-rate mortgages (ARM), which were given to many people who actually could have afforded their mortgages with higher, fixed-interested rates. While it is true that the people who signed these mortgages have some culpability and should be held responsible, there is virtually unanimous consent that many or most of these individuals were at least somewhat victimized by unscrupulous lenders and policies whose risks were not made clear. And as interest rates climbed and some of the sub-prime mortgages started to go bust, ARMs rates were getting unreasonable and forced many people who otherwise could have afforded their mortgages to default. (I thought this was pretty well understood, but evidently I’m mistaken.) This can in no way be attributed to the CRA, especially considering most of these ARM issues were centered in suburbia and were typically causing defaults by lenders not covered under CRA regulations.
When this occurred, housing prices started to plummet. This caused an even larger problem because people now owed more on their houses than they were worth. For the average homeowner, this is probably not a big deal because (assuming they have the more traditional fixed-rate mortgage) it doesn’t actually affect their ability to pay the bills. But at this time speculation was a major wealth builder for many people, who viewed their mortgaged property not as homes, but investments. When people could no longer turn over their investments for profit, they panicked and got out from under them, causing housing values to fall even lower. This was a major contributing factor in the collapse of the housing market and since banks could no longer make up the loss on a faulted loan due to recessed pricing in the open market, ultimately helped create the necessity of a Freddie and Fannie bailout.
But even though all this is the case, it’s still not really what caused the extent of the wider impact on the economy. The real reason why it hit so hard was the securitization of these loans.
Lenders were able to take these sub-prime and ARM mortgages, cut them into little pieces, pool them with other mortgages and types of credit, and then sell these pool on the open market. This is called securitization, and due to Clinton and Bush deregulation, they were able to inflate the market value of these securities to make them more appealing. In theory, this spread the risk of these mortgages along to several investors, but in practice some banks were either keeping the securities on their own books, or buying up large amounts of them, centralizing the risks. And again, though this started under the Clinton administration, it was a Republican addition to the bill, not a Democrat.
In fact, during the Bush years, the percentage of these loans which were securitized rose from just over half to over 75%.
When the mortgages started to go bad, it was this centralization of the risks by the use of securities which caused the most trouble, not the defaulting of the mortgages themselves. When these securities defaulted, credit froze, causing a halt on the issuance of corporate paper, which locked up the credit market. The biggest impact on the market was not caused by the loan the bank made, but how they proceeded to package that loan to other investors.
But you don’t have to take my word for it. A Mr. Alan Greenspan, nominated by Reagan and head of the Fed through the W. Bush administration, agrees, claiming not only that “subprime mortgages are risky, but they are worth it,” but also that the economic downturn was caused by “not the subprime problem itself, but to the securitization of subprime.”
I tried to keep it relatively unpartisan. (Note that my position is bolstered by the comments of two conservative Republican Federal Reserve Chairmen.) But since I can’t resist, here’s the partisan timeline of events:
Bush’s failed policies cause the economy to falter. This causes poor people to lose their homes. This causes interest rates to increase. This causes ARMs to become unmanageable. This causes subprime securities popularized by conservative ideology (i.e. blanket deregulation regardless of original necessity of regulatory action) to fail. This causes the credit market to lock up. This causes the Stock Market to suck.