9

In this article on Bloomberg, it seems clear that the goverment is forcing banks to issue risky loans.

Is the government really being this stupid, or is there more to it that this article does not mention?

Edit: Clarify: The article seemed to show that the government was again trying to force banks to make risky loans. That sort of activity was one of the things many people pointed to as a cause of the meltdown. Can anyone could show that the gov't wasn't being as imprudent as the article seemed to indicate? Maybe someone could show me that the gov't was just telling them to go into low income or minority areas but still use sensible lending techniques.

  • 1
    Also, from the article:The agencies have refocused on redlining because, in the wake of the subprime explosion and sudden implosion, they are looking at these disadvantaged neighborhoods and not seeing any credit access It seems that this policy was implemented only after the crisis, not before. So the article seems to suggest no as the answer. – apoorv020 May 12 '11 at 3:49
  • 1
    Since when have banks done what the government asks? It all down to fear and greed, like every other bubble. – Jodrell May 12 '11 at 12:09
  • 2
    @Jodrell- Um, they do when the gov't gives them punitive fines as described in the article. – Captain Claptrap May 12 '11 at 12:34
  • 1
    @apoorv020: I'm not into American econmics much, but I'd heard this claim during the sub-prime crisis, not just now. – Andrew Grimm May 12 '11 at 13:04
  • 2
    @Jodrell - since forever. And moreover, they also do what every community activist group demands them to do. – user5341 May 12 '11 at 16:42
5

There are a couple of points to be made here:

  1. Yes. The government did, indeed, force the lenders to make riskier loans in the name of combating real and/or perceived discrimination. The most relevant example is the Community Reinvestment Act (CRA) - most notably, the 1993-1995 changes driven by President Clinton's administration.

    Please note that "riskier" here is a technical financial term. While I don't have a public cite, I have seen first hand reports that showed higher risk on the loans specified to be in red-line zones vs outside them, with all other loan factors being equivalent.

  2. No, CRA did not have any direct major contributions to the 2008 meltdown.

    The most relevant reference is a paper by a former Fed Governor Randall Kroszner titled "The Community Reinvestment Act and the Recent Mortgage Crisis". Too much to cite (and most of it relevant), so only a small quote here:

    We found that the loans that are the focus of the CRA represent a very small portion of the subprime lending market, casting considerable doubt on the potential contribution that the law could have made to the subprime mortgage crisis.

    Second, we asked how CRA-related subprime loans performed relative to other loans. Once again, the potential role of the CRA could be large or small, depending on the answer to this question. We found that delinquency rates were high in all neighborhood income groups, and that CRA-related subprime loans performed in a comparable manner to other subprime loans; as such, differences in performance between CRA-related subprime lending and other subprime lending cannot lie at the root of recent market turmoil.

  3. Interestingly enough, outside of subprime metdown effects question, CRA may not have actually had ANY measurable effect in the first place.

    In a 2003 research paper "The Effects of the Community Reinvestment Act on Local Communities", economists at the Federal Reserve could not find clear evidence that the CRA increased lending and home ownership more in low income neighborhoods than in higher income ones.

    Federal Reserve chair Ben Bernanke has stated in "The Community Reinvestment Act: Its Evolution and New Challenges" that an underlying assumption of the CRA – that more lending equals better outcomes for local communities – may not always be true and is hard to measure:

    The CRA is clearly far from perfect. Although its objectives are broad and ambitious, its net effects on lower-income neighborhoods are difficult to measure with precision.

  4. Interestingly enough, that second reference (Bernanke speech) also notes that at least in some instances:

    "the CRA has served as a catalyst, inducing banks to enter under-served markets that they might otherwise have ignored".

    However, there's no data in that speech to indicate whether that catalyst effect may or may not have had anything to do with the bubble (the speech is from 2007).

  5. However, the anti-discrimination angle contributed to preventing the government from strongly pushing to STOP the proliferation of sub-prime loans by all actors, CRA related or not (as such an effort, pre-2008 crisis, would have had really bad political optics).

    Would such an effort have prevented the crisis? Likiely no - there were many other factors to the meltdown (too many and too far off-topic for the question to list).

    Would it have made the crisis smaller? It would have. Subprime and derivatives based on it were a major driver in the speed of the meltdown - with less of them unwinding the bubble would have been cheaper/easier.

    Would such an effort have been made had the anti-discrimination angle not been in play? Pretty hard to answer objectively.

  • 3
    You cited 2 big shots from the Federal Reserve in making the case that regulation didn't have that much to do with it (vibe I got from your response). Isn't using those sources like a customer going into a John Deere dealership and asking what the best brand of tractor is? Seems like a real skeptic would use sources with a little more credibility or at least a bit less conflict of interest--after all, the Fed Reserve is responsible for regulating the banking industry and thus would lose face if their policies caused the crash. What do you think of the articles Rusty cited in his comment above? – Captain Claptrap May 14 '11 at 22:53
  • @Captain - (1) The policies of CRA (at least the suspect 1993 Clinton anti-redlining ones) had nothing to do with the Fed and were invented by a bunch of political activists. Therefore, 2 Feds (one former) had no reason to defend it (oh, and Treasury was the main regulator, not the fed, on top of that) – user5341 May 16 '11 at 2:39
  • @Captain - (2) to top it off, BOTH of those Feds bigwigs were appointed by Republicans, and Randall Kroszner - which was the main reason I chose to make him the linchpin of the answer - is from Chicago School of Economics. Which is known for its anti-Keynesian stance and basically libertarianish attitude. If a guy with THOSE leanings has nothing bad to say about what is basically a piece of liberal political legislation, you gotta take him seriously. That's like Ford dealer recommending a Ferrari to you, to make a comparison similar to yours but more resembling actual situation. – user5341 May 16 '11 at 2:40
  • 1
    @Captain - (3) Also please note that my answer very carefully distinguished between "direct major contributions" and "possible indirect effects". If you are comparing my answer to Rusty's links, they actually state the same in essence. See the businessinsider (first Rusty's link): "It isn’t losses from CRA loans that drove the crisis (although they are disproportionately responsible for losses at some banks). Instead, the CRA required lax lending standards that spread to the rest of the mortgage market. That fueled the mortgage boom and bust" – user5341 May 16 '11 at 2:41
  • The CRA had a lot bigger indirect effect than its direct effect would suggest. By pushing a few small lenders into insolvency, its effects triggered automatic selling of stock and other instruments invested in larger lenders, which as a result ended up with their own cashflow problems. I worked in the financial services market (data distribution) in '07-'08 and that's what we saw happening life on our screens. It wasn't pretty. – jwenting Apr 10 '13 at 10:20

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .