By Barry Ritholtz
Two of Donald Trump’s economic advisers, Lawrence Kudlow and Stephen Moore, have revived an idea about the source of the financial crisis that really should have been put to rest long ago.
In a column published and rebroadcast by many politically sympathetic sites, they lay the blame for the credit crisis and Great Recession on the Community Reinvestment Act, a 1977 law designed in part to prevent banks from engaging in a racially discriminatory lending practice known as redlining. The reality is, of course, that the CRA wasn’t a factor in the crisis.
What’s so wonderful about their article, which is an attempted take down of the Clintons, is that they miss the very obvious ways Bill Clinton’s administration did contribute to the financial crisis. But doing that would have been at odds with their anti-regulatory philosophy.
Here’s the heart of the Kudlow and Moore case:
The seeds of the mortgage meltdown were planted during Bill Clinton’s presidency. Under Clinton’s Housing and Urban Development (HUD) secretary, Andrew Cuomo, Community Reinvestment Act regulators gave banks higher ratings for home loans
made in “credit-deprived” areas. Banks were effectively rewarded for throwing out sound underwriting standards and writing loans to those who were at high risk of defaulting. If banks didn’t comply with these rules, regulators reined in their ability to expand lending and deposits.
They then argue that this was part of a broader campaign to make loans to unqualified low-income folk, which in turn caused the crisis.
Let’s just be clear about what the CRA does and doesn’t do. It simply says that if you open a branch office in a low income neighborhood and collect deposits there, you are obligated to do a certain amount of lending in that neighborhood. In other words, you can’t open a branch office in Harlem and use deposits from there to only fund loans in high-end Tribeca. A bank must make credit available on the same terms in both neighborhoods. In other words, a “red line” can’t be drawn around Harlem, a term that dates to when banks supposedly used colored pencils to draw no-loan zones on maps.
Showing that the CRA wasn’t the cause of the financial crisis is rather easy. As Warren Buffett pal Charlie Munger says, “Invert, always invert.” In this case, let’s assume Moore and Kudlow are correct, and the CRA did require banks to lend to unqualified, low-income buyers. What would that world have looked like?
Here’s what we should have seen:
- Home sales and prices in urban, minority communities would have led the national home market higher, with gains in percentage terms surpassing national figures;
- CRA mandated loans would have defaulted at higher rates;
- Foreclosures in these distressed urban CRA neighborhoods should have far outpaced those in the suburbs;
- Local lenders making these mortgages should have failed at much higher rates;
- Portfolios of banks participating in the Troubled Asset Relief Program should have been filled with securities made up of toxic CRA loans;
- Investors looking to profit should have been buying up properties financed with defaulted CRA loans; and
- Congressional testimony of financial industry executives after the crisis should have spelled out how the CRA was a direct cause, with compelling evidence backing their claims.
Yet none of these things happened. And they should have, if the CRA was at fault. It’s no surprise that in congressional testimony, various experts were asked about the CRA -- from former Federal Deposit Insurance Corp. Chairman Sheila Bair to the Federal Reserve’s director of Consumer and Community Affairs -- and none blamed the crisis on the CRA.
If that isn’t enough to dismiss the claim, consider this: Where did mortgages, especially subprime mortgages, default in large numbers?
It wasn’t Harlem, Philadelphia, Baltimore, Chicago, Detroit or any other poor, largely minority urban area covered by the CRA. No, the crisis was worst in Florida, Arizona, Nevada and California. Indeed, the vast majority of the housing collapse took place in the suburbs and exurbs, not the inner cities.
Now consider that much of the rest of the developed world also had a boom and bust in residential real estate that was worse than in the U.S. Oh, right -- those countries didn’t have the CRA.
What's more, many of the lenders that made the subprime loans that contributed so much to the collapse were private non-bank lenders that weren’t covered by the CRA. Almost 400 of these went bankrupt soon after housing began to wobble.
I have called the CRA blame meme “the big lie” -- and with good reason. It’s an old trope, tinged with elements of dog-whistle politics, blaming low-income residents in the inner cities regardless of what the data show.
But if you really want to blame a CRA, I can offer you some help -- check out the credit rating agencies. As the Financial Crisis Inquiry Commission concluded in its autopsy of the crisis: “The three credit-rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval.”
The raters stamped AAA grades -- the same as given to U.S. government debt -- on what they should have known were junk mortgage securities in order to gain market share and win big fees. With the raters’ seal of approval, the country's biggest banks gorged on this garbage. The results, as we now know, were catastrophic.
This column does not necessarily reflect the opinion of the MPA editorial board or Bloomberg LP and its owners.