Laying Blame At The Wrong Place

In today's Wall Street Journal  former US Senator from Texas, Phil Gramm, opined on the economy.  Now, this is the same Phil Gramm who said this summer that we had become a nation of whiners.  And this is the same Phil Gramm whose wife was on the board of directors of Enron during the whole period of criminal activity led by Jeff Skilling and Ken Lay.  So, keeping that in mind, Mr. Gramm talked about what he perceives to be the two causes of the economic meltdown (another note, here, Mr. Gramm is an economist by training).

The first cause, he asserted, was monetary policy related to moving inventory which had stockpiled due to the September 11th recession.  By lowering interest rates as an incentive for businesses to borrow and acquire computers, machines, materials, the Federal Reserve also, in Gramm's opinion, threw fire on an already stable housing market, thus causing a sustainable market to become a boom.

But it's the second cause that I dispute.  Gramm has always been an opponent of the Community Reinvestment Act (CRA) which was originally signed into law by President Jimmy Carter as a result of glaringly obvious discriminatory lending practices by FDIC insured banks.  These discriminatory lending practices were known as redlining.  Essentially banks looked at maps, determined where the "poor sections" were and rarely if ever made a loan in those neighborhoods.  A redline was drawn around the area.

Now, the CRA was more of a feel good law than anything with regulatory teeth.  It simply "asked" banks to look at their loans and attempt to make investments in areas that they had previously redlined, as long as the investments were made with sound lending practices.  

It was not until 1989, under a Republican president, that some teeth was added to the law, which allowed community groups and researchers to access the lending information and perform more rigorous quantitative analysis on a bank's lending strategies.  But really, the whole idea of the CRA was more carrot than stick.  If a bank wanted to merge or to open more branches, the CRA was a vehicle for community groups to protest the expansion if the institution was not making investments in previously redlined communities.  However, not one bank merger or expansion was held up because of CRA complaints.

President Clinton further sought to open up the information on CRA based lending but did not promote any further regulatory bite.  In 1999, Mr. Gramm lead the charge to repeal the Depression era banking laws, commonly known as Glass-Steagall, and forced President Clinton to back off his ideas of strengthening the CRA by giving the FDIC and Office of Thrift Supervision more power to examine banks CRA compliance.  

In fact, in 2005, the Bush Administration did loosen the CRA requirements, allowing banks to include the acquisition of mortgage backed securities as a means of compliance.  In other words, banks looked at the zip codes of loans within the pool of mortgages and essentially said: "hey, there are some loans within a poor neighborhood, we're all good here!"  They were also allowed to include all of their services as part of the CRA "investments," so if a bank sold an annuity or a CD to someone within a suspect neighborhood zip code, it met the CRA "obligations."

Now folks like Mr. Gramm are maintaining the the CRA is responsible for sub-prime loans.

In fact, over 50% of all sub-prime loans made in the past 9 years, particularly those which are causing so much trouble, were made by non-federally regulated institutions.  Institutions not under the umbrella of CRA.  Another 25% to 30% came from banks, like Countrywide Bank (part of the infamous Countrywide "family") which are only partially obligated to follow the CRA.  

On the other hand, banks that did follow the traditional CRA requirements have significantly lower default rates.  They followed "sound business and lending practices."  They educated their borrowers on issues of credit, borrowing, and homeownership, instead of seeking the fast buck and selling the mortgage way down the road.

To blame a toothless law, intended to guide banks toward viewing the whole communities in which they lend, is gutless.  It reeks of sound bite moments that we witnessed during debates over welfare or other issues, when it became fashionable among some politicians to blame the poor because they didn't have expensive lobbyists in Washington, DC.  

In fact, if the numbers are accurate, it seems to me that strictly following the CRA may have saved some lenders from the crisis larger banks are now experiencing.  And those borrowers who were the beneficiaries of true CRA lending are also smiling as they sit at their kitchen tables in their homes.