John Carney has been doing a lot of blogging about the role of the CRA in the financial meltdown. That role is overstated by conservatives who are unwilling to admit that markets can have bad outcomes, but it is understated by liberals who are unwilling to admit that regulation, too, can produce hideous unintended consequences.
The CRA did not singlehandedly cause the meltdown. But the relaxation of credit standards that allowed the meltdown did start, as far as I can tell, with the CRA. And perhaps more importantly, the CRA, and the mentality behind the CRA, made regulators extremely unwilling to intervene. Everyone wanted to make credit more widely available to the poor. Well, the poor aren't good lending risks. So if you want to give them access to credit, you need to relax your lending standards. Any attempt to tighten lending standards on the part of the government would have resulted in a massive contraction in the credit available to core Democratic constituencies. Meanwhile, the Republicans were hoping that turning poor people into homeowners would make them more Republican.
Regardless of how much causal blame you assign it, the financial crisis has certainly proven that the CRA seems to have been a very, very bad idea. Yet Barney Frank is still trying to keep risky loans flowing in the hope that things will all somehow come right in the end if we just pretend, as hard as hard can be, that there isn't substantial risk attached to doing things like buying a condo in a building that is less than 50% occupied.
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Right, I don't think anything singlehandedly caused the meltdown. I think that, based on Ed Glaeser's research, that land-use regulation and zoning make bubble more frequent and more severe, and certainly more restrictive housing supply is associated with worse bubble countrywide. (There are some areas, like DC where restrictive housing areas abut areas that allow building, with a result of prices zooming up in the inner suburbs, and then tons of building in Prince William County.) But bubbles do happen eventually anyway.
What's important here is understanding why, even if it didn't cause the problem, regulation wasn't effective in preventing or solving it, and all the political pressure that prevented regulation from being effective-- and from being so in the future. The problem wasn't just "deregulation," it's that regulation was, if anything, on the other side. Not enough to cause it alone, but it certainly wasn't helping. Barney Frank's comments show that some still haven't learned.
Regardless of how much causal blame you assign it, the financial crisis has certainly proven that the CRA seems to have been a very, very bad idea.
How so? The CRA loans were profitable for 25-years to banks. Do you dispute the original problem of banks redlining districts? That's what the CRA was intended to do and did a pretty good job of it. Non-CRA regulated lenders were the ones who made the majority of sub-prime loans, and nobody was forced into making Alt-A loans to borrowers either. Private investors were not forced to purchase high risk loans from banks. Nobody forced people to HELOC their homes to insane levels
The blame for this lies on borrowers taking on too much debt, bankers for lending it to them and private investors for blindly purchasing that debt.
"The CRA loans were profitable for 25-years to banks."
The numbers show that the problems started in the late 90s with Clinton's enhancement.
Exactly! Clinton changed enforcement of the CRA to a quota system, with Janet Reno essentially telling banks that applying consistent lending standards was no excuse - they had to lower standards as needed to hit their quotas. It wasn't all that hard to predict that the lowered standards would tend to spread beyond just certain special interest groups.
And of course it wasn't just the CRA - politicians later began using Fannie and Freddie to lead the lowering of standards. No one is trying to "blame poor people" - the problem began with political meddling (and of course much of the blame belongs with the banks that, once forced and bribed to lower their standards, continued to apply the lower standards even when politicians weren't trying to buy votes).
I don't get Megan's point. Even Megan's friend(at least I think), Felix Salmon is calling Carney(and by extension Megan) silly by continuing to flog the CRA meme. See here:
http://blogs.reuters.com/felix-salmon/2009/06/25/john-carneys-bizarre-crusade-against-the-cra/
Also see Barry Ritholtz here:
http://www.ritholtz.com/blog/2009/06/cra-thought-experiment/
So stop it already!!
Barry has had enough - he's now throwing down $100K for anyone who wins this argument aginst him in a public forum. Take it, Megan!
But the relaxation of credit standards that allowed the meltdown did start, as far as I can tell, with the CRA.
Did a "relaxation of credit standards" allow the meltdown? I have no doubt that lending money to people with poor credit played some role in the mortgage mess, but I was under the impression that a greater role in the crisis was played by people with good credit (like that NY Times guy) who simply borrowed too much money (and this phenomenon I would guess was in turn caused more than any other factor by turbo-charged securitization). Has anybody done a definitive study on the mortgage meltdown? Perhaps it's simply too early.
Yet Barney Frank is still trying to keep risky loans flowing in the hope that things will all somehow come right in the end if we just pretend, as hard as hard can be, that there isn't substantial risk attached to doing things like buying a condo in a building that is less than 50% occupied.
A bit of a Drudge-style cheap shot at Frank on your part. His concern is not about raising lending standards to follow a 50% occupancy rule. His concern is with a 70% occupancy rule. It does sound pretty onerous in a down market we all should want to recover. Where is it written that loosening is automatically bad, and tightening automatically good? Anyway, Frank is focusing on a particular segment of the property market, not on borrowers as a class per se. I think if he were arguing for looser lending standards with respect to individual borrowers, and their creditworthiness, you'd be on firmer ground. And where is your evidence he's basing the change he wants on "hoping" and "pretending?"
CRA loans were to low income people buying cheap houses. The crisis, as has been explained to you before, has been fueled by over speculation in exurbs driving their prices absurdly high. Poor, urban people DID NOT and DO NOT buy McMansions in outer west Harrisburg.
You're just DYING to blame poor people somehow, aren't you?
I'm pretty sure that Megan is blaming poorly thought out cond constructed government regulations, but you can misinterpret her statement however you like.
And what government regulations are those? She is blaming CRA when CRA never was, and hasn't been, the problem.
But they certainly used their Home Equity Line of Credit to excess. Also many refinanced leaving almost no equity in their urban homes. The CRA was behind this type of lending.
The crisis, as has been explained to you before, has been fueled by over speculation in exurbs driving their prices absurdly high.
So, rich people live in the exurbs, I always thought poor people did... that's why it's cheaper than living closer to the city...? What am I missing?
The crisis, as has been explained to you before, has been fueled by over speculation in exurbs driving their prices absurdly high.
Well, it has also been "explained" numerous times that deregulation (or non-regulation) is behind the crisis. But the only sort of regulation that would have prevented it would have been rules requiring a tightening of lending standards--greater downpayments, for instance. And to do that, you have to gut the CRA.
I personally don't think the CRA itself had much to do with the bubble. But reigning the bubble in would have been impossible because of CRA backers. Maybe there's a magic regulation that would have stopped the stupid exurb loans but allowed CRA loans, but I've been asking someone to tell me what it looks like for months now, and nobody has.
Require lenders to retain a specified fraction of the loans they originate.
You're welcome.
Require lenders to retain a specified fraction of the loans they originate.
My understanding was that the CRA loosened that requirement as well. Which supports Rob's point.
"the only sort of regulation that would have prevented it would have been rules requiring a tightening of lending standards--greater downpayments, for instance. And to do that, you have to gut the CRA."
This seems backwards in terms of timing. Politicians used the CRA originally to begin forcing the lowering of standards. There would have been no need to tighten the lending standards if they hadn't first been loosened, both via the CRA and via Fannie and Freddie. But let's remember that it was politicians that used various tools to lower lending standards - it's not the fault of the tools (except perhaps in the case of Fannie and Freddie, who joined in pretty enthusiastically).
So, rich people live in the exurbs, I always thought poor people did... that's why it's cheaper than living closer to the city...? What am I missing?
There's more than just rich people and poor people in this country. Your comment does hit it right on the head though. The house prices in the exurbs could have only been afforded by the rich, but the rich didn't live there. The only reason they cost so much is that banks were willing to lend people 10X their income for a home when 3X income. Like that NY Times writer, he wasn't rich but he wasn't poor either.
More rigorous lending standards are at odds with lending to poor people (on the basis of both wealth and income) for real estate and other real assets. There is no way to square this circle.
Nonsense.
Try this for starters on the contributors to the problem.
There's a great big list of ways that lending standards could have been tightened while leaving a regime that was perfectly consistent with continued operation of CRA.
Can you give some specific items on that list that would be consistent with the quota regime brought in by Clinton, whereby banks had to hit their quotas regardless of what it took to make the required loans?
Ann-
Bill Clinton and Janet Reno really had very little to do with the lending that took place during the housing bubble.
In answer to your question, CRA never made anybody make a no-interest or teaser rate loan, knowingly use faulty appraisals, not verify income, or make loans at 100% LTV or more in a bubble market.
The evidence is right in front of your nose: lenders did all of this things, willingly and rampantly, for loans not related to CRA. They did this because they were making money hand over fist, for a while, not because any bureaucrat told them to.
"They did this because they were making money hand over fist, for a while, not because any bureaucrat told them to."
So it's just coincidence that the lowered standards followed a concerted effort on the part of certain politicians and activists to force lower standards?
No one is saying that lenders aren't also at fault here. The only question is whether politicians and activists played a role, and it's pretty clear that they did. This isn't 100% due to the greed of bankers - the problems originated with the greed of politicians that wanted to buy votes in a sneaky backdoor manner, and we need to be more careful about allowing politicians to micromanage lending and other business decisions simply to favor certain interest groups.
Obviously the CRA and, really, all government involvement and influence in the housing market had absolutely nothing whatsoever to do with the housing bubble.
The removal of the sensible, sane and, in all honesty, very nearly omniscently clairvoyant government oversight of the financial and housing sectors through years of draconian republican deregulation was the only government contribution to the economic disaster we're seeing. Far and away the primary cause was the evil greedy white republicans on wall street who created this whole house of cards -- probably with the express purpose of hurting poor and minority people. And women, too.
If you want to argue that governmental actions (other than the evil withdrawal of governmental regulation by the nefarious republicans) contributed in even the most minute way to the development of the housing bubble and the economic devesation that has been wrought in its wake, you are clearly a racist, probably an elitist and almost certainly a white, male republican yourself. You are, in short, probably responsible for all the ills of the world and should just admit it, don sack cloth and begin repenting.
years of draconian republican deregulation
That's funny. You do kid's parties?
The counter-argument to "the CRA caused it" crowd seems to be something like "CRA mortgages were a very small percentage of all mortgages and thus couldn't have caused/contributed substantially to the problem." This may be true, but what I don't understand is this: even if the percentage of CRA mortgages was small, wouldn't the lending standards imposed by the CRA affect the rest of the market? If the government required, say, gas stations servicing poor communities to sell gas at $2.00 a gallon rather than the $2.50 rate set by the market, aren't people outside poor communities going to drive to the $2 per stations and/or demand 2 bucks a gallon from other stations? I get that if you're taking a loss at $2.00/gal the gravy train will be short and over quickly absent subsidies, but let's pretend that wouldn't happen.
So in the housing market, would the CRA really be cabined such that it would have no effect on terms and conditions of mortgages other than CRA mortgages? That NONE of the lawyers/engineers/stockbrokers in the exurbs are going to say "hang on, my gardener's unemployed brother-in-law just got a no-money-down ARM on a $350,000 bungalow in Pomona -- if you're telling me you can't get me the same deal, I'll damn well find someone else who can"? This is especially so if the gardener's unemployed brother-in-law has already flipped the bungalow and used the equity to buy into a split-level.
Obviously other factors (loose credit generally, government encouragment of a secondary mortgage market, private development of fancy risk sharing derivatives in that market) had to contribute to the bubble/bust. Nonetheless, I don't get how the fact that CRA mortgages were only 5% or 10% or whatever of the market "proves" it was irrelevant to the housing bubble/bust. Maybe someone has a good explanation.
I'm also w/ Rob Lyman -- I can see how regulation along the lines of "everyone has to put up 20% down/score 650 on their credit reports/have an income of 3 times 30 year mortgage payments before they get a mortgage" could have averted problems. I also see how regulation along the lines of "if you issued the mortgage, you can't sell it" or "if you purchased mortgage obligations, you can't securitize them and re-sell them" could have staved off trouble. However, I would guess they would also stave off "affordable housing" because lenders wouldn't issue risky mortgages if they had to keep them on their books and no one would buy risky mortgages if they couldn't securitize and sell them off. Again, maybe someone can explain what regulation would have averted the bust that wouldn't have also discouraged "affordable housing." (BTW, I lived in apartments for years and always thought they were "housing." I guess not.)
"The blame for this lies on borrowers taking on too much debt, bankers for lending it to them and private investors for blindly purchasing that debt."
This was the case, but Barney's new gig is for Fannie to make the loan, and the taxpayer to fund it. If Fannie and Freddie, along with their regulators, couldn't say no before, what do you suppose they are going to do in the current environment?
The assertion that a law that fixed a serious discrimination problem, and provided profitable business to banks for 25 years, bears any responsibility for the meltdown stretches my credulity to the breaking point.
In terms of loan origination, the CRA didn't forbid banks to check documentation on the applicants, or require a down payment. Lenders weren't being forced by the CRA to make risky loans against their will - the lenders were pushing risky loans as hard as they could. The biggest problems in loan origination were anyway with non-bank institutions, which are not covered by the CRA.
The practices that turned high mortgage default rates into a catastrophe had nothing to do with the CRA and everything to do with fancy-pants financial engineering.
"the CRA didn't forbid banks to check documentation on the applicants, or require a down payment"
No, but beginning with Clinton, banks were required to meet their CRA quotas one way or another. Many banks were forced to make loans against their will, or else their merger or other deal would be blocked.
So what you're saying is the banks didn't do the hard work of attracting the multitude of applicants needed from low income families to find less risky loans. Instead, they took shortcuts to satisfy CRA requirements to make more money in other ventures. I have no problem with people taking risks to make money, but those risks needed to be better understood.
In any event, there's enough blame to go around for everyone in my opinion. I don't buy the "banks were forced to make bad loans" meme but that doesn't mean I don't think the lending environment that included the CRA was very healthy either. Borrowers made as many bad choices as the lenders and both were at the very least strongly encouraged to make as many transactions happen as possible by government agencies and policymakers without considering human nature and long term consequences. Par for the course in DC, isn't it?
While CRA is a manifestation of a major cause of the debt problem - the cause being that we have a political culture that it is appropriate for the government to subsidize home ownership - it is a very, very, very, very, small manifestation of that. And it is not the first manifestation of that. That was the creation of Fannie Mae and Freddie Mac, whose contributions to the problem dwarf the CRA's, the way the Empire State Building dwarfs a soda can. I am sympathetic to the high level concern but it is critical to maintain credibility on these issues and not let ideology inflate a particular concern.
I do agree with your Barney Frank concern though.
I suggest that CRA was one of the straws on the camel's back.
CRA was relatively harmless as long as banks couldn't resell the risky mortgages. This limited their willingness to write too many.
Nobody would buy those risky mortgages except at a steep discount until they could slice and dice them and mix them with less risky mortgages in a mortgage backed security. With a mortgage-backed security most of the component loans would continue making payments, even if the dicey ones didn't.
Once there was a market for risky mortgages, more lenders started writing them.
That was OK, but then mark-to-market accounting rules set in. The value of a security is what you can sell it for *today*.
Mark-to-market is perfectly reasonable, except that if a panic set in and nobody anywhere is buying those securities at any price, they are by definition worthless.
Suddenly banks with low reserves couldn't use those suddenly worthless securities as collateral for loans to cover their daily cash needs.
It takes just one falling pebble to start an avalanche.
First, as others have noted, it is not rich people who buy big houses in the exurbs
Second, there's also a gigantic foreclosure problem in emerging areas--the areas where I might want to buy are about 70% bank-owned or short sales from the last four years.
Third, part of the secondary market for subprime loans was apparently banks which can carry the loans as part of their CRA burden.
Fourth, right now, at least in DC, a 70% owned condo is in big trouble, because the remaining 30% isn't going to sell, and the building may well to end up in receivership. Normally, not such a big problem. But these days, there's a condo glut.
Fourth, right now, at least in DC, a 70% owned condo is in big trouble, because the remaining 30% isn't going to sell, and the building may well to end up in receivership. Normally, not such a big problem. But these days, there's a condo glut.
And this is the fault of CRA? Or is it stupid builders and bankers who overestimated supply and demand?
Fourth, right now, at least in DC, a 70% owned condo is in big trouble, because the remaining 30% isn't going to sell, and the building may well to end up in receivership...
Well, I'm not condoning relaxed creditworthiness standards for borrowers. But Frank's concerns on the 50% vs. 70% issue sound plausible to my ears. Fannie/Freddie no doubt have numbers they've analyzed (and certainly nobody blames them for being cautious). But Frank may have numbers, too. And the point is, as long as lending standards with respect to things like the borrower's credit and income have become sufficiently stringent, it seems to me just as likely that 50 is the optimal number as 70 (when all things are considered, including, of course, the need to get the country's economy growing again). The main reason I'd cite for optimism about mortgage lending on 50% occupancy condo projects is the existence of auctions. If an auction is run right, it's nearly a sure thing you'll sell all the units, though some of the folks who bought in at higher prices may be peeved, and the developer, of course, can end up taking a bath.
If an auction is run right, it's nearly a sure thing you'll sell all the units, though some of the folks who bought in at higher prices may be peeved, and the developer, of course, can end up taking a bath.
But isn't that a case of the market working correctly? The developer is taking a bath because he over developed. The folks who bought in at higher prices should have known they were buying in a bubble(The signs are usually there if you know how to look for them).
The reason that Fannie/Freddie want to limit mortgages in condo buildings with low occupancy isn't because of the price of them, it's because of the co-op/HOA/maintenance issues that come with condo ownership. When you buy a unit in a condo, you are also usually agreeing to pay monthly condo fees - fees that are usually several hundred a month or more. Those fees pay for things like maintaining shared spaces, shared walls/hallways, roofs, mechanical systems like heat and plumbing, and other things. If half the units are unsold, then half the condo fees aren't being collected - probably more than half, if some of the current owners are deadbeats or in foreclosure.
If a condo board isn't collecting the fees it needs to keep a building maintained, there is pretty much no price that would clear the market for condos - nobody wants to own a condo in a building where the heat doesn't work or that lacks hot water or where the roof is about to collapse, at any price. When you buy a condo, you are buying a set of liabilities that you don't have any control over (unlike buying a single-family house, where you buy a set of liabilities that you have some control over).
An interesting point that I had not heard discussed, before seeing it in Carney's thread is that one of the unintended consequences of the CRA was extrapolating the performance of CRA loans when modeling future sub-prime borrower behavior. This extrapolation turned out to be a very bad idea.
Why is everyone so eager to make an ideological issue out of an empirical issue?
Obviously defaults by poor, middle-class and pretty wealthy folks all contributed to the mess -- and there are numbers out there that can be crunched to indicate who did what and to help us learn some lessons.
Why not actually crunch said numbers and learn said lessons rather than making unsupported assertions that the crash just proved what each of you already thought you knew about markets/regulation/rich people/poor people/white males/minorities/politicians/bankers/etc.?
Andrew, because reasoning from evidence is hard, and it may turn up evidence that I find uncomfortable.
It's much more fun (and a lot easier) to see all difficult policy questions as more evidence for why I'm morally superior than whomever my preferred cartoonish scapegoat is this week. Because isn't self-satisfaction and intellectual masturbation the point of politics?
This week, I'm blaming "rich exurban homophobic hedge-fund managers"...no, I don't really have an example of an actual one, but I really hate that guy nonetheless. Next week I'll blame "hippy stoner deadbeats with bad credit." Ahhh...it's like candy for the ego!
"Why not actually crunch said numbers"
Follow Megan's link.
Follow Megan's link.
Except Carney has been debunked and shown to be an idiot.
See here(for the 2nd time!!):
http://www.ritholtz.com/blog/2009/06/cra-thought-experiment/
and here:
http://blogs.reuters.com/felix-salmon/2009/06/25/john-carneys-bizarre-crusade-against-the-cra/
Yes, Megan's friend(Felix) is one of the debunkers.
As noted in the comments, the CRA has been around for quite a while, and was relatively harmless for quite a while. What is not noted is that the Clinton Admin significantly tightened enforcement of the CRA, putting a lot of pressure on banks to lend to subprime borrowers unless they wanted to end up on the wrong side of a civil rights lawsuit. To do this, the Feds partnered with groups like ACORN. There was no new law passed in the 1990s, instead the power of the Executive was used to give new teeth to an old law. In order to make it easier for the banks to comply, the Feds made it easier for the banks to offload these crappy mortgages by encouraging the development of the secondary and tertiary mortgage markets. When it turned out that there was a willing market for these crap mortgages, the bank (and non-bank lenders) figured that this market would also absorb other, non-CRA crappy mortgages. The first crack hit doesn't put you straight into rehab, but once you develop a habit...
The Dems were happy - poor people were getting mortgages, the banks weren't "discriminating" and they could pack the boards of Fannie and Freddie with political cronies with minimal useful experience (Ms Gorelick, please stand up). The Repubs were pretty happy too - Wall Street was making lots of money and all kinds of new people were becoming homeowners.
Unfortunately, all this demand for housing created a scarcity, especially in key urban areas where local government uses green rules to exaggerate the scarcity. This scarcity, sparked by excess demand and fueled on a mix of loose monetary policy and excess Asian savings, inflated the bubble.
Was the (Clinton-enhanced) CRA the only cause of the Bubble? Of course not - there was poor risk assessment on Wall Street (leading to irrational greed (the bad kind)), excess Asian savings, poor/corrupt management at the GSEs, loose Monetary policy and a bi-partisan willingness to look the other way. Well, we need to work to fix all of those things (or at least the ones we can - it is getting harder to tell China what to do with its ducats), and CRA enforcement has to be part of that fix.
Excellent summary! There's plenty of blame to go around, but we're missing an important lesson if we pretend that political meddling in bank lending policies had nothing to do with the crisis.
The "CRA provided profitable business for 25 year meme" sort of misses the point. Until 2007, the reckless lending/borrowing spree provided gargantuan profits to the financial system, or did until they didn't.
CRA is a symptom of a disease, not the pathogen itself.
Yancey:
Don't you read Barry Ritholtz or Felix Salmon?
Sigh...I guess it is worth reading through these threads;
I have learned a lot, but have one question:
Does a graphical plot of defaults onto geography really
show major concentration in maybe 6 states, and if so, does
this not suggest a scam that would make Madoff look minor ?
Why is everyone so eager to make an ideological issue out of an empirical issue?
Because it's a lot more fun that way. No point in analyzing it, when it's easier and more politically convenient to do otherwise.
Obviously defaults by poor, middle-class and pretty wealthy folks all contributed to the mess
It's not so much the defaults per se, as it was the lack of collateral to protect the lenders who were impacted by the defaults. A lender that has enough collateral cushion is protected; the lender should be able to foreclose and make itself whole. A lender with high LTVs is naturally carrying a toxic portfolio in the making, as a mortgage with collateral that isn't worth enough to make the lender whole in the event of a default is not really a mortgage at all, but an unsecured loan with a bogus inadequate asset attached to it.
Defaults are predictable and inevitable. A lender who doesn't prepare for instances of non-payment is as smart as an insurer who bases a business on having no claims. It makes no sense, and it's disingenuous of lenders to blame borrowers when it's the lenders' job to forecast and plan for default.
We had a spree of loans that were inadequately secured, at all credit levels. Those involved in the system felt that they could run amuck because they believed that they were hedged. The only problem with that thinking is that it is impossible to hedge for systemic risk; systemic risk can be contractually reallocated in theory, but it can't be eliminated by fiat in practice.
CRA is an anti-redlining law. There is nothing in it that required that money be lent stupidly. Blaming it is a cop out; dumb loans were being across the spectrum, because they were profitable. As is true with any actuarial pool, risk could have been managed by pricing it into the pool. Banks obviously underpriced risk thanks to the fee income, and were unprepared for the logical outcomes that come from a down cycle.
The core problem is the degree of leverage in the system. A high LTV necessitates that there be no down drafts, which of course is a dumb assumption for any portfolio manager to make. High degrees of leverage also make cycles of deleveraging more brutal; the bigger they are, the harder they fall.
Lending should be a boring business, but deregulation and globalized markets increased the impetus to pursue higher profits. Higher profits can only be created through increased risk taking, so more risks were taken, justified through hedging and securitization. We're going to have to make lending boring again if we wish to prevent a future crisis, but that would lead to a lower homeownership rate and less consumption because debt is the only resource left for boosting a mature, moribund economic system, so that just ain't going to happen. The next housing bubble will be even more fun than this one.
"CRA is an anti-redlining law. There is nothing in it that required that money be lent stupidly."
Again, this is not correct, at least not after the Clinton changes. Mergers and other deals could be held up unless the banks hit their quotas by whatever means necessary.
Your PLP should definitely be higher than 5; no we don't measure it by RIA. But your LTV, is that related to your high BMI or do do you just have a fat a**?
In a lab or technical notebook, people, like I suppose stenographers, shorten phrases or nouns they use repeatedly. We know you have a notebook when you start using such abbreviations. That was your point? OTOH, since you don't use stenographic symbols, are you a sexist?
LTV is a very common term. How common? I just LTV into google and got this:
Hasn't LTV been one of those terms that entered into the popular consciousness, oh, well over a year ago?
As Tanta has explained, mortgage lending is about the three C's: collateral (i.e., you put 10-20% down), capacity (i.e., you have sufficient income to make your mortgage payments), and creditworthiness (e.g., your FICO scores). The original concept of subprime loans was that subprime borrowers -- i.e., borrowers with tarnished credit history and who could not satisfy the creditworthiness requirement -- would get a loan with traditional underwriting standards with respect to collateral and capacity. Then, after making mortgage payments for a couple of years, their credit scores would increase, they would have prime FICO scores, and they could refi into a prime loan. In exchange for the increased risk of having low creditworthiness, but with sufficient collateral and capacity, the borrowers would pay a slightly higher interest rate, usually less than 1% more.
ARMs were not a part of the deal. Nor were no down payments, low down payments, no doc, low doc, negative amortization, option payments, etc. Also, the loan officer didn't simply make a subrpime loan just because collateral and capacity were satisfactory. Rather, the loan officer actually looked at the borrower's credit history and made a determination that the hit on the borrower's credit score was due to unforeseen circumstances, a one time event, or something similar, i.e., the loan officer made a subjective determination that the borrower has the ability to be a creditworthy borrower, and likely will become a creditworthy borrower if given the chance, but had an unfortunate development that affected his score.
So, that was the original idea behind the subprime loan, and that was the type of loan that were made under the CRA, at least originally. Although subprimes constituted more "liberal" underwriting standards, it was rational and logical and made sense from a risk management perspective.
So where did no down payments, low doc, no doc, negative amortization, etc, come from? Alt-A loans. Alt-A's were the opposite of subprimes: Alt-A's went to borrowers with high FICO scores, so the borrower didn't need to meet traditional underwriting requirements for collateral or capaicty. Hence, Alt-A borrowers didn't need to put down a down payment (collateral), or could take out an option ARM (collateral), or take out a 105% loan (collateral), or show no or little documentation of income (capacity). These loans made no sense. With subprimes, there was a rationale for how creditworthiness would eventually be achieved (by making payments, increasing your credit score, then you refi). With subprimes, you had skin in the game and sufficient income. Alt-A's made NO sense. There was no rationale for how collateral or capacity would ever be achieved. Once the loan was made, those requirements went out the window.
And remember, Alt-A's were the opposite of subprimes: they went to borrowers with high FICO scores. They were not part of CRA programs or Fannie/Freddie low-income mandates/programs. They went predominantly to middle class, upper middle class, non-minority borrowers. So they had nothing to do with the CRA or housing affordibaility programs.
Why were Alt-A's made? How did they start? Why did lenders abandon decades of traditional and historical underwriting standards all of a sudden in the late 1990s, early 2000s? Because Wall Street needed these Alt-A's. Traditional loans weren't sufficient for Wall Street to make the kind of sophisticated and complex securities (i.e., MBSs and CDOs) it was selling. Wall Street needed exotic loans so that it could make all the more exotic securities (explaining this would require a whole nother, long post, if anyone is interested in the explanation, just ask, and I'll post it). As the securitization market exploded in the late 1990s, Wall Street created the demand that the lenders satisfied and Wall Street bought. And then Wall Street realized it could create even more exotic securities by buying subprime loans with those Alt-A characteristics. That's how those lowered underwriting standards spread to subprimes. That's how you got subprimes with no doc, low doc, no down payment, etc.
So it did not start with the CRA. Yes, underwriting standards were more liberal for CRA, subprime loans, but there was a rationale for it, there was a perfectly reasonable risk-management explanation for how subprimes would become primes. It was the underwriting standards in Alt-A's that made no sense and caused the lowered underwriting standards that led to this crisis. Anyone who claims that lowered underwriting standards spread from subprimes to the rest of the market is a liar or woefully ignorant. It started with Alt-A's, based on Wall Street demands, and for reasons that had nothing to do with the CRA, Fannie/Freddie, housing affordability programs, or any of the other right-wing scapegoat.
Janice Doe has it very right on most of what she says about the alt-As,but the analysis might be extended further to an examination of the motivations of many of the alt-A borrowers. In a word, speculation. A nation obsessed with flipping houses and making great profits found a mortgage vehicle that gave quick paper turnaround and generated more cash than value, so those quick improvements could be made. Or a speculator could find a lender to cover the buy-to-let investment or the condo or Las Vegas/Phoenix/Broward County housing development pre-build down payment. In the late summer of 2006 we saw the first signs of failure in the Las Vegas market as the home builders with excess inventory, the speculator/flippers, and the poor folks who just had to sell a house all fought to cut prices and salvage something. It just spread from there.
Do not give CRA a pass. It was a very effective tool to be used against the money center banks as they tried to expand their deposit networks across the country. Branch expansion came with a price, the demonstration that the bank had an ever-increasing volume of loans on 'affordable housing' in moderate and low income neighborhoods. So the banks in need of branches in richer areas bought securitizations to satisfy the CRA folks. That encouraged the flipping ande cheating that we have seen destroy parts of Cleveland and other inner cities.
"Why did lenders abandon decades of traditional and historical underwriting standards all of a sudden in the late 1990s, early 2000s?"
Fannie and Freddie worked hard to lower standards in the overall market, not just for a limited number of special low-income loans. I don't have the link with me now, but there was a NY Times article that quoted Franklin Raines bragging about how he had led the reduction in down payments.
It's too simplistic to blame everything on the CRA (and I don't think that anyone really has tried this). But politicians used the CRA, Fannie and Freddie and other tools to lower lending standards. Their goal was simply to buy votes for themselves with someone else's money, but the banks got carried away (since Wall Street can be almost as greedy as politicians), and the lowered standards spread. There are many lessons we should learn from the financial crisis, and one of them is that Barney Frank should not be allowed to interfere with specific bank lending decisions, or GM's decisions, or other specific business choices (as opposed to setting broad laws that apply equally to all relevant businesses). Politicians can cause a lot of damage by micro-managing private businesses.
To put another way, where were the politicians in 2005 that really wanted to limit the growth in subprime and Alt-A loans? I don't remember them.
Ron Paul wanted to deflate the housing bubble as early as 2002.
Fannie and Freddie worked hard to lower standards in the overall market, not just for a limited number of special low-income loans. I don't have the link with me now, but there was a NY Times article that quoted Franklin Raines bragging about how he had led the reduction in down payments.
If you think it was just Fannie and Freddie, think again. Why do you think Countrywide and WaMu went up in smoke? or IndyMac? Or a host of other mortgage lending institutions?
Of course it wasn't just Fannie and Freddie. Countrywide, WaMu and IndyMac followed the lead of the GSEs. But the fact that others followed them doesn't somehow disprove the idea that Fannie and Freddie were leading.
Regardless of how much causal blame you assign it, the financial crisis has certainly proven that the CRA seems to have been a very, very bad idea.
I'm skeptical anyone advocating it actually cares. The need for social justice trumps little questions of whether we're creating system risk.
From Felix Salmon:
"His second attempt finds something concrete: an OCC pamphlet from 1996 — a good decade before the fullest flowering of the subprime bubble. The pamphlet praises banks for working with local housing authorities to help low- and moderate-income individuals buy affordable housing."
So some regulatory change that happened today can't take 10 years to cause serious damage? That sort of idiotic statement from Salmon is in in the first paragraph. It is laughable that this is a take down other than to throw out some unproven statements on defaults.
Sorry, I'm not going to give the turd Barry the time of day.
Also, may I inform people who have short memories that the bubble didn't start in 2004. The previous housing cycle bottomed in 1995 at around 76 according to CS composite 10 index. In the next 9 years, ending in Jan 2004, it more than doubled to 162. At least from the data I looked(it would take time to look at data from the bottom again), the bottom tier of CS index for MSA outperformed other tiers. That is it was the segment of the market which CRA was designed to channel credit into.
The 2004-2006 was the blow off period of the bubble it happens in all of them and that's when you know you are in one. The parabolic rise in prices whether its houses or stocks is probably the generally accepted measure by which they are identified.
Another fact, Subprime did explode in the 2004-2006 but the market begin to grow in the mid-nineties. In fact, they were securitized at basically, actually a little less, the same rate during some those of years as they would be in the mid-2000's. Subprime hit a roadblock in the last part of the 90's and that's when the industry began to consolidate.
A couple of more points; nobody knows the actual profitability of CRA loans. The Fed governor's talk didn't include hard empirical evidence. Conclusive data from banks about the level of profitability doesn't exist as the Feds don't require a specific stat to be report separately. One study the Fed guy sites is a survey conducted that asked banks about profitability. It had a very poor response rate. Some of the results did show that banks overall found that CRA was at least marginally profitable for most of them. Here's the good part. The study also showed that large banks by a majority found CRA to be unprofitable. I wasn't going to find the study but I did here is a quote:
"For example, while 39 percent of the smallest banking institutions in the sample report that the profitability of their CRA-related home purchase and refinance lending is either somewhat lower or lower than the profitability of their non-CRA-related lending, 69 percent of the largest banking institutions report this experience."
So banking merger requiring intense scrutiny may have led to banks making more CRA loans that weren't viable. There more, even stuff that one could interpret to saying that CRA isn't a problem.
http://www.federalreserve.gov/BoardDocs/Surveys/CRAloansurvey/cratext.pdf
"Regardless of how much causal blame you assign it, the financial crisis has certainly proven that the CRA seems to have been a very, very bad idea"
Really Megan. CRA was passed in 1977 as part of efforts going back to the 1960's to deal with a very real problem--people in poor neighborhoods had less access to credit than an unbiased assessment of their income would warrant. Throughout much of the 20th century red lines were literally drawn around neighborhoods and loans were unavailable even to residents with income equal or greater than residents of less colorful areas. Just outlawing redlining had not fixed the problem. The idea behind CRA was "to encourage regulated financial institutions to meet the credit needs of the local communities in which they are chartered, consistent with safe and sound operation" [emp. added] What is bad about that idea? All that Megan mentions are "hideous unintended consequences". Even though I'm a liberal I hate those things, even when they sometimes result from regulations designed to further values I support. But unintended things are tricky. By definition, they don't happen all the time, otherwise they couldn't be called unintended. And it seems you can avoid them only by doing things of no consequence; even ignoring or refusing to address societal inequalities can have unintended consequences.
"Everyone wanted to make credit more widely available to the poor. Well, the poor aren't good lending risks."
How about trying to make your point without needless hyperbole. Its just silly to say everyone wanted to lend to poor people. Too many people inside, and outside, the banking system had no problem denying credit to whole classes and communities of people. The second goes beyond silly into stereotyping. Some poor people are good credit risks. Some have devoted more than 30% of their income to rent for decades. The kind of thinking that lumps them in with the many poor people who are less than creditworthy has historically been the reason their hard earned wages have generated wealth for landlords rather than their heirs.
"[T]he relaxation of credit standards that allowed the meltdown did start, as far as I can tell, with the CRA. And perhaps more importantly, the CRA, and the mentality behind the CRA, made regulators extremely unwilling to intervene."
The CRA clearly relaxed existing credit standards--because they unfairly excluded some poor people from the American dream. And perhaps this was the first loosening of credit requirements in the nation's history, though I doubt it. But, are you really implying that the deregulation and mis-regulation of the banking industry would not have occurred or would not have caused problems absent CRA? That regulators would have clamped down on predatory lending had they not feared the wrath of ACORN? Really? I think perhaps it's the other way around and that fair housing advocates were more concerned than the regulators were about predatory lending.
Just what was the mentality behind CRA. I think commenter Janice Doe makes a persuasive case that it was a different mentality than the one that led to Alt-As. Commenter RW notes that nothing about anti-redlining requirements forced banks to make stupid loans and Ann responds that Clinton era quotas on CRA loan created bad incentives. Well even if true, that seems to be a quota mentality or a lack of caution on the part of banks eager to expand too far too fast rather than a CRA mentality. And even if there was some identifiable CRA mentality, I don't think it is really serious to argue that it was the only reason the regulators were unwilling to act and that removing CRA would transform regulators from kittens into tigers.
"The CRA did not singlehandedly cause the meltdown."
This sort of understates it. I went and at looked at the one source you quote: John Carney. In response to a comment that he was laying too much blame on CRA, he responded that it was an important factor and can't be exonerated. He than listed 16 other factors (ending the list with ...) that were also required: "It took a lot. But the CRA was important." Carney recommends not scrapping CRA, but "re-assessment of the CRA and its role in contributing to lax lending standards." I take his point, but not Megan's.
OK, the CRA, along with at least 16 other factors, was important. That lends credence to the conclusion that conservatives overstate its role. As a liberal I'll admit Carney has a point that it played some role in the loosening of standards that snowballed into crisis. In my middle age I find I'm growing skeptical that government regulation can work well. But one can also be excessive in selectively raising fear of unintended consequences. Carney cites two unintended consequences regarding CRA regulation. Not consequences of CRA itself, and not of tight regulation under it. "In early 2005, largely at the behest of the banking sector, the Office of Thrift Supervision implemented new rules that were widely perceived as weakening the CRA...This had two unintended consequences..." So the unintended consequences Carney mentions as proving costly to the system followed bankers efforts at weakening CRA regulation.
Megan points to typical failings of conservatives and liberals and then demonstrates libertarians are human also, as susceptible to ideological blinders as the rest of us.
O.K., I didn't realize I had opened a window for the Turd's website. I saw his definitive take down and well let's see:
1) Home sales in CRA communities would have led the national home market higher, with sales gains (as a percentage) increasing even more than the national median;
I'm not sure why this is important. I'm not sure I have ever seen data stating home sales numbers in CRA Communities. However, CRA communities are mostly built out
2) Prices of CRA funded properties should have risen even more than the rest of the nation as sales ramped up.
Again nobody really knows the answer to this. It is fact that according to Case-Shiller index of metro broken down down by 3 tiers that the bottom tier outperformed the other 2. In fact, in only 1 city did the middle and top tiers exceed the highest point in the bottom tier that city is Denver.
I can't find the study mentioned right now but here is Ellen Seidman saying that CRA did cause an appreciation:
http://www.newamerica.net/blog/asset-building/2008/its-still-not-cra-7222
"It's even more outrageous because of the good CRA clearly did in between. The 1990s were the heyday of CRA enforcement-for a variety of reasons including the raft of mergers and acquisitions that followed the 1994 Riegle-Neal Interstate Banking and Branching Act, increased scrutiny of lending practices by the media and activism by housing advocacy groups and tougher enforcement by the Clinton Administration. That period saw increased home mortgage lending to lower income households and in lower income communities by the banks and thrifts covered by CRA, and a steady increase in the homeownership rate, especially for lower income and minority families.
New research by Ingrid Gould Ellen and Katherine O'Regan of NYU Wagner, presented at a conference sponsored by the Philadelphia Federal Reserve Bank, convincingly demonstrates that property values went up dramatically in low and very low income urban census tracts during the 1990s, reversing severe declines during the prior two decades."
3) After the market peaked and reversed, Distressed Sales in CRA regions should lead the national market downwards. Foreclosures and REOS should be much higher in CRA neighborhoods than the national median.
This is news to me. It has been the bottom tier that has gotten hit the hardest. The West-Side of LA is only down 20%. How much is South Central LA down?
4) We should have reams of evidence detailing how CRA mandated loans have defaulted in vastly disproportionate numbers versus the national default rates;
We don't because the data hasn't been collected.
5) CRA Banks that were funding these mortgages should be failing in ever greater numbers, far more than the average bank;
Bank of America said that CRA loans make up 7% of their mortgage portfolio, but yet account for 24% of their losses. Is this enought o shut the turd up?
6) Portfolios of large national TARP banks should be strewn with toxic CRA defaults; securitizers that purchased these mortgages should have compiled list of defaulted CRA properties;
See above
7) Bank execs likely would have been complaining to the Bush White House from 2002-08 about these CRA mandates; The many finance executives who testified to Congress, would also have spelled out that CRA was a direct cause, with compelling evidence backing their claims.
What good would it have done? CRA goals were consistent with Bush's ownership society. What deregulation legislation even passed during Bush's 2 terms?
Finally:
"The biggest foreclosure areas aren’t Harlem or Chicago’s South side or DC slums or inner city Philly; Rather, it hs been non-CRA regions — the Sand States — such as southern California, Las Vegas, Arizona, and South Florida."
I agree. The bubble existed in 4 state and the losses associated with the actual panic last year came from them. I'm not even saying it is and neither is John Carney and neither is McCardle that CRA caused the crisis. However, there was a systematic effort by regulators beginning in the mid-nineties to lower credit standards. The CRA is emblematic of it. In fact, Carney had posted how regulators warned the mortgage companies that if they didn't serve these communities they would be next.
Well Ms. McArdle comes pretty close to saying CRA caused the crisis: "the relaxation of credit standards that allowed the meltdown did start, as far as I can tell, with the CRA". She asserts CRA to have been a very, very bad idea. She doesn't quite say CRA caused it, just that a CRA mentality led regulators to let it happen.
On the other hand, she has previously urged caution in asserting any one factor as cause: "Moreover, it is meaningless, in a mixed economy like ours, to attribute a massive failure like this to either 'the market' or 'government regulation'. The people who think that this can all be traced back to the CRA are wrong. But so are the people who think that the only problem was too little regulation." Libertarianism is dead . . . vive le libertarianism! - Megan McArdle.
Mr Carney has also further clarified just what can be blamed on CRA. Felix Salmon reports on an IM exchange they had:
FS: but how do you explain how the loose lending standards jumped the wall over to non-CRA loans?
JC: Because the CRA loans were performing so well!
FS: LOL
JC: So, ironically, the poor were paying off their loans so well that bankers made similar loans to the relatively wealthy.
And that blew up the world.
FS: So really the CRA worked — it got banks to make good loans to people who would pay them back
and then the banks, fools that they were, started extrapolating
JC: I don’t have data on that.
But, yes.
Bankers believed they were working.
On this we agree: CRA loans weren’t the bad loans So I guess this is where we are now. Neither the market nor regulators could have caused such a massive failure, but CRA worked so well at its goal of helping poor people that banks just had to reduce standards for upwardly mobile flippers and speculators and regulators were so captivated by the CRA mentality that they were powerless to require ordinary prudent banking practices. CRA succeeded by modestly relaxing standards so it is emblematic of all the excesses that led to the meltdown.
I'm glad that's all cleared up.
naranjo:
Carney really said that in an IM exchange? I knew he was dumb but that exchange takes the cake.
"CRA worked so well at its goal of helping poor people"
You've offered no evidence of this! You quoted someone's random assertion, but that's not evidence. Did you read deer god's 6:08 comment before replying to it?
More important, no one is claiming that the crisis was caused by the CRA alone. The lower standards began with a concerted effort on the part of certain politicians and political activists (including ACORN) to force lower lending standards. This was accomplished both through the CRA and later through Fannie and Freddie (and how have Fannie and Freddie done, thanks to political meddling?). Once banks got used to the lower standards, and the subprime market had been developed, banks began applying the lower standards more broadly. But clearly the lowering of standards began through pressure from politicians. Without the lowered lending standards, there may or may not have been a bubble. Even if the bubble had still occurred (as they do, periodically), the aftermath wouldn't have been as bad if there weren't so many bad loans out there, thanks to the lowered lending standards.
There's nothing inconsistent with Megan or others saying both that there were many causes, and that the lowering of standards began with the CRA. It all started with the Clinton administration, but many others played a role before it was over.
The original purpose of the CRA seems worthwhile, if indeed there was still redlining. But the shift in the 1990s towards wanting poor people to get loans regardless of their ability to repay surely should be reconsidered. I have a hard time seeing that these loans necessarily help poor people. If the government wants to flat out give money to these people, it should do so openly and through the usual process. Politicians like Barney Frank shouldn't be able to buy votes by forcing banks to make loans, and people don't usually benefit from getting loans that they can't repay.
I offered exactly as much evidence as Megan did, not that I expect my opinions to carry as much weight. But then since I'm not paid to do this, I didn't think I needed to make more of an effort than she did.
"someone's random assertion"
I only considered John Carney's thoughts interesting because Megan referenced his blogging on the subject. And because he disagrees with her (random?) assertion that poor people aren't good credit risks. He looks at the role of CRA as reason to reassess it. Megan jumps to the conclusion that it is a very very bad idea "regardless of how much causal blame you assign it". Mr. Carney seems to believe it was one among at least 17 causal factors and that CRA loans performed well. If that is the case I'd assert it was not a very very bad idea.
Yes I read deer god's post. In par. 2 he has a long quote in support of the proposition that CRA caused an appreciation in the value of lower income homeownership. "[The 1990's] saw increased home mortgage lending to lower income households and in lower income communities by the banks and thrifts covered by CRA, and a steady increase in the homeownership rate, especially for lower income and minority families." Did you consider this before deciding CRA couldn't help poor people?
"Once banks got used to the lower standards, and the subprime market had been developed, banks began applying the lower standards more broadly"
For the sake of arguement I'll assume with you that the first lowering of mortgage standards began with CRA and Clinton broadened the effort to expand low-income homeownership via other mechanisms. But this only establishes a timeline, ie. correlation. It does not prove CRA caused the later shaky loan practices that fueled the meltdown. You say bankers got used to CRA and later applied lower standards across the board. This implicates the bankers, not CRA. Even if you view CRA as some kind of candy, these bankers weren't schoolkids, they were responsible adults. CRA is just an excuse, not a cause. Or am I missing something?
Mergers and other deals could be held up unless the banks hit their quotas by whatever means necessary.
I'd appreciate a reference to a(n accurate, trustworthy) source for comments like this.
(Of course, since one won't be forthcoming, perhaps a link to some bogus political blog might do, instead.)
"mentality behind the CRA..."
That's not a good-faith style of argument. It seeks to make a case, allegedly nuanced, against the CRA but when it comes up against the lack of evidence behind even the most nuanced claim, it resorts to something amorphous and, if you could defame a law, defamatory. Let's saw there was a generalized belief in the 1970s that too many people were being denied credit for homebuying. For all sorts of reasons: race, institutional inertia, outdated standards, what have you. The CRA was brought in to address the most susceptible-to-legal-change reason, which was almost laughably obvious racial redlining. The other reasons were less susceptible to legal change, or were only addressed much later, in the 1990s with the wholesale legalization of new financial instruments which permitted the repackaging and obfuscation of mortgage risk.
It's a complex story--but there's still the CRA, which addressed the only part of that story that was an outright race-defined injustice, as opposed to the more generic "I wish I could do/have that!" And what does the CRA get for its trouble? It's saddled with the blame for our financial meltdown, not just by people who are comfortable with racial prejudice like Steve Sailer, but by pleasantly post-racial libertarians who ought to know better but who weirdly don't.
Ann-
Accepting, for the sake of argument, your characterization that politicians and activists were trying to force lowered lending standards (in the 1990s), I would say that yes, this was a coincidence.
How else to explain that the lowering of lending standards occurred primarily at institutions that were not subject to CRA regulation?
Competition? Not when the non-covered lenders massively increased their market share during the period in question.
Just what is the causal mechanism you are proposing?
SteveL -
As I've said several times now, politicians also used Fannie and Freddie, who built up the subprime market pretty much from scratch and were trying to lower overall standards. Once the subprime market was established, Fannie and Freddie had to pull back because they were caught in accounting regularities, and other banks flooded in out of greed.
The comparison I've used before is with a doctor forcing patients to use an unnecessary and highly addictive drug. Once addicted, they go on to convince others to use and become addicted also. Even if the patients later go on to get much of their supply elsewhere, the doctor that got them addicted still bears part of the responsibility, in my opinion.
Fannie and Freddie built the sub-prime market pretty much from scratch?
This is just not untrue, it's backwards.
A sub-prime loan is one that, originally, was not eligible for purchase by Fannie or Freddie. Their standards were relaxed after they began losing significant market share to non-GSE participants in the market.
When? Can you give years? I've talked to people who've done academic research on this and who said that in the 1990s the subprime market was almost all Fannie and Freddie. Other banks really only moved in after 2000. Do you have any evidence to the contrary? Can you be more specific regarding the decade to which you're referring?
And maybe we're having a problem with terms. How could Fannie and Freddie begin losing significant market share before they moved into the market? Are you saying that Fannie and Freddie only moved into subprime after they lost overall market share (which, by the way, was in large part because they were caught in accounting fraud and had to pull back)? Again, are you talking about the 1990s or 2000s?
There are three C's to a loan risk, while you seem to only see one - Credit score. That makes a loan 'subprime'. There are also Collateral and Capacity. Someone who has a great credit score but a 50% DTI is not a good risk, while someone with a poor score but 15% DTI is less risky. Also, if you give a loan on a home that sold 2 years ago for $200k but your loan now assumes a value of $400k, you will have much steeper losses than the home selling for non-bubbly values.
The banks Carney lists are all small banks outside of bubble areas. An overwhelmingly large proportion of the credit crisis's losses are in bubble areas, but the CRA applies everywhere.
Maybe you shoult put-up and debate Ritholtz.
Ann-
Subprime has many meanings, but perhaps the single most significant one is failure to meet Fannie and Freddie standards for purchase.
So, I don't know what your friend means by subprime as applied to the 1990s (and that history would be virtually irrelevant to the meltdown of the last decade, in any case), but those loans met Fannie and Freddie standards, which many loans involved in the current crisis did not.
Yes, when I refer to market share, I mean share of the entire mortgage market, and no, Fannie and Freddie's loss of market share was not in large part because they were caught in accounting irregularities - corporations fudge the numbers all the time and this has no necessary impact on business operations - it was because the mortgage market was exploding and the GSE's could not participate in large parts of it.
Well, obviously if we define subprime as "non-Fannie-and-Freddie", then the GSEs weren't a significant part of the market at any point. But Fannie and Freddie made substantive shifts in the 1990s to include people who hadn't qualified before, lowering their standards to include more and more borrowers that didn't meet standard requirements. If we use an objective standard, as opposed to a "let's deliberately exclude Fannie and Freddie regardless of what they do" standard, then Fannie and Freddie made strong moves in the 1990s to increase lending to traditionally-subprime borrowers.
I found an interesting article posted on ssrn (the social science research network, where economics, finance, accounting and now law academic working papers are often posted), at:
http://ssrn.com/abstract=1162456
The report is dated June 29, 2001. I don't know anything about the author except that he's at Graham Fisher & Co, which is some sort of independent research firm. Since the report is from 2001, it shouldn't be an ex post attempt to tilt the current debate. It's trying to forecast the future of the housing industry, and warns about the changes in the 1990s to lower downpayments, reduce credit underwriting standards, reduce documentation requirements, etc., in order to allow more people to get loans that traditionally didn't qualify. Changes were also made to reporting to make home loans look less risky. For example, Fannie Mae's "Home Saver Solution" software helped to lower the foreclosure numbers by reclassifying them as having been 'worked out' or modified. Data on what later happened to the many loan modifications wasn't made available.
The report begins with a quote from Franklin Raines that, in order to keep increasing home ownership rates, "we have to keep bending financial markets". Fannie and Freddie actively worked to lower downpayments, lowering the downpayment requirements on loans that they purchased from 10% to 5% to 3% to 0%. They also worked to make mortgage insurance cheaper and easier to get. Fannie and Freddie developed loan underwriting software that greatly reduced traditional documentation requirements, for example collecting only one month of bank statements and paychecks rather than three, records of utility bill and rent payments rather than credit reports, and alleviating the two year employment history check, in part because such a history might be difficult for immigrants to document. Because of their special status, Fannie and Freddie were able to largely crowd out fully private companies offering competing automated loan underwriting systems.
Again, there was a determined effort on the part of politicians to lower lending standards, and Fannie and Freddie openly claimed to be leading these changes. If the standards had been lowered only for low income people, the results would have been much less costly. But such segmentation would have been difficult and would have taken effort, and those leading the push to lower standards never even gave lip service to wanting them to be only for low income people.
Bankers that made bad loans are clearly at fault here, but so are politicians that worked so hard to get banks to lower their lending standards and are now trying to disavow their own success.