Subprime Scapegoats

Published on
by
the Boston Globe

Subprime Scapegoats

by
Boston Globe Editorial

AMID A GLOBAL financial crisis that began with unsustainable loans to people with bad credit, it was only a matter of time before apologists for Wall Street excesses would try to pin the blame on the poor - and on government policies meant to help them.

Sure enough, the Community Reinvestment Act has emerged in recent weeks as a favorite target of conservatives and others who oppose any government intervention in the market, for it requires banks to lend in neighborhoods they might otherwise avoid.

And yet the Community Reinvestment Act has nothing whatsoever to do with the subprime mess.

The law applies specifically to commercial banks, which in recent months have been the least volatile part of the financial-services industry. The measure was passed in 1977 to combat redlining, the practice of banks refusing to write mortgages in poor neighborhoods - even when they were taking deposits from residents of those neighborhoods.

To meet Community Reinvestment Act requirements, banks do make loans to low-income homebuyers - often in concert with community groups that provide financial advice and other crucial training. While banks at first had to be "dragged into participating," said Tom Callahan, executive director of the Massachusetts Affordable Housing Alliance, loans made under the auspices of the reinvestment law have performed remarkably well. One key initiative of this sort, the state's SoftSecond mortgage program, has a delinquency rate of 1.8 percent - compared with about 5 percent for all mortgages in Massachusetts.

The subprime mortgages that have failed left and right are the antithesis of the carefully designed, well-supervised loans provided by tightly regulated banks. No law forced a mob of unregulated lenders to make loans in poor neighborhoods. Rather, mortgage companies and Wall Street financiers saw a business opportunity in subprime lending, where the risk of default was high but so were the interest rates.

Never mind that subprime mortgages were once considered as disreputable a business as check-cashing stores and payday loans; big-time investors took a keen interest once the potential rewards became clear. When financial firms began buying up and bundling mortgages, redividing them into securities, and selling them off, individual brokers had no incentive to make sure any given mortgage would be sustainable if housing prices fell.

Far from being forced to write new loans, brokers competed to sell home mortgages to lower-income customers. Nadine Cohen, a senior attorney in the consumer unit of Greater Boston Legal Services, has a client who had been living in public housing in Cambridge for $350 a month - before getting a $500,000 home loan.

In that case, as in so many of today's mortgage horror stories, the lender wasn't a traditional bank. According to Callahan, 98.4 percent of the subprime mortgages in Massachusetts in 2006 were made by lenders whose operations in the state are not subject to the Community Reinvestment Act.

To be sure, the act isn't the only vehicle by which government officials have sought to influence lending behavior. President Clinton and his Housing and Urban Development secretary, Henry Cisneros, did seek to raise homeownership rates among low-income and minority buyers. Fannie Mae and Freddie Mac, the two government-chartered mortgage wholesalers whose practices were closely watched within the lending industry, did face political pressure to ease their lending standards.

But those were hardly the only factors behind lax lending standards. There was enormous pressure within the marketplace. As The New York Times recently reported, Fannie Mae was losing business because of competition from Wall Street and elsewhere, and mortgage lenders and Fannie Mae's own shareholders were pushing the firm to dive deep into the subprime loan business.

The subsequent meltdown of the nation's entire financial system could not have happened without a huge - and entirely voluntary - inflow of money from Wall Street into a sketchy sector of the mortgage market. Nobody forced investment firms to wager billions of dollars directly on these loans, or to build an elaborate web of complex financial transactions dependent upon their continued performance. But they did.

The recent animosity over the Community Reinvestment Act, in short, simply can't be explained by the facts. Among the law's critics, there's more than a whiff of social Darwinism - the certainty that only a government policy aimed at helping losers could lead the whiz kids of Wall Street so far astray. Hogwash. The current financial crisis grows out of loose regulation that gave big investors plenty of freedom to make foolish bets, and then force their losses upon the taxpayers. 

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