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Did "minority lending" drive the crisis?
This is one of the queries I receive, in varying forms, every day. Did policies such as the Community Reinvestment Act significantly worsen the housing bubble and the subsequent collapse? Basically not, although in my view these were bad policies for other reasons. They contributed to our current problems by only a small amount and of course these policies have been around for a long time before the housing bubble ever got started. Here is one back-of-the-envelope debunking of the "diversity recession" idea. Matt Yglesias links to some other debunkings.
You can, however, cite the general obsession with extending home ownership as strong evidence that putting Democrats in charge does not suffice to solve our regulatory problems.
Only polite comments will be left standing...
Posted by Tyler Cowen on September 30, 2008 at 11:25 AM in Economics | Permalink
Comments
I still say the biggest factor was the capital gains tax cut (and it's timing occuring a few years before the stock bubble popped). Those two started everyone in to invest in housing (even though the legit reason was priced in) and the demand was fueled by the low post 9/11 interest rates.
Posted by: nelsonal at Sep 30, 2008 11:30:03 AM
My experience is in tankers though, where a change in demand of a couple percent can have huge impacts on the market price of the assets. I wonder what a 10% increase in marginal demand would be on the market clearing house price?
Posted by: nelsonal at Sep 30, 2008 11:31:56 AM
I'd say the biggest factor was keeping interest rates too low for 7 years, with allowing Fannie/Freddie to purchase Alt-A/subprime as a distant second.
Posted by: David at Sep 30, 2008 11:45:20 AM
There is more to the "minority lending" issue than these back-of the envelope calculations suggest. As one person points out:
"Your commenter is probably right that blacks and Latinos themselves probably had a small impact on the housing bubble, but attempts to weaken lending standards on their behalf probably had a much bigger impact, as marginal white borrowers took advantage of them too."
Perhaps we have forgotten how powerful the feeling of entitlement was during the housing boom. Many politicians and Fed officials such as Alan Greenspan encouraged such feelings by weakening lending standards and promoting adjustable rate mortgages.
Posted by: megapolisomancy at Sep 30, 2008 11:50:42 AM
Can anyone explain why the Dow is UP almost 300 points today?
I know that still means a net loss of over 400 points for the past two days, but I thought not passing a bailout would mean massive financial meltdown. It doesn't seem to be happening.
Posted by: at Sep 30, 2008 11:51:07 AM
I was reading somewhere that at the start of the housing bubble, the Fed had lowered interest rates such that adjusting for inflation there was actually NEGATIVE interest rates. Is this true?
Posted by: Rex Rhino at Sep 30, 2008 11:52:26 AM
This post actually gets to one of my biggest problems with honest conservatives. You don't push back hard enough on the wackos in your camp.
This very issue is being used as the reason for this crisis on talk radio across the land. My dad brought it up to me as the PRIMARY reason why we are in this crisis.
With power and NYT editorials comes responsibility and this post is not enough of a response to this issue.
Posted by: mickslam at Sep 30, 2008 11:53:54 AM
So...
1) people got rich as their house values skyrocketed
2) people got rich as they flipped properties
3) people got rich as the construction industry boomed
4) people got rich making craptacular loans (no down payment, no verification of income, interest-only mortgages, etc)
5) people got rich buying, packaging, and selling these craptacular loans
6) people got rich rating these packaged securities as sure bets
7) people got rich insuring these craptacular securities
8) people got rich making big financial bets "capitalized" by these securities
But now people are losing money. What went wrong? I'm sure affirmative action and dark-skinned people have to be involved somehow. How did they trigger this chain-reaction?
Posted by: Barbar at Sep 30, 2008 11:59:48 AM
Thanks for saying this, Tyler.
The CRA story has become the preferred explanation for too many people.
Posted by: bernard Yomtov at Sep 30, 2008 12:00:18 PM
Everyone should check out the posts at Cafe Hayek about this. It appears that changes made to the CRA in the 1990s and HUD's quotas given to Freddie and Fannie for affordable housing, along with allowing them to count purchased subprime loans as "affordable housing," contributed greatly to creating a market for these risky mortgages and their securitization. Also remember that market prices are set at the margin, so artificially expanding the number of "qualified" buyers could have helped set the bubble in motion.
Having said that, I believe there were many factors. But I would not so easily dismiss CRA and HUD.
Posted by: Dave at Sep 30, 2008 12:01:04 PM
I tend to agree that this is a multi-causal event, but reading isteve's post I was surprised that Tyler cited a "back of the envelope" arm-chair "guesstimate" of demographics to explain away this problem. Furthermore, the American Prospect piece that Yglesias cites really only serves to underscore that CRA was only a smaller part of the problem - not without blame. Quotes like "pleasantly low" default rates could mean a lot of stuff. I'd rather see more concrete research and avoid phrases like "significantly" until we know what the betas are.
Posted by: Fundman at Sep 30, 2008 12:05:40 PM
//I know that still means a net loss of over 400 points for the past two days, but I thought not passing a bailout would mean massive financial meltdown. It doesn't seem to be happening.//
Maybe a massive meltdown is not exactly on the horizon as some are suggesting.
Then again, it's only been 14 hours...
Posted by: at Sep 30, 2008 12:08:57 PM
I'm starting to wonder if the relaxing of mortgage rules at Fannie and Freddie help start things. They are the government rule-makers for mortgages. Other mortgage companies wouldn't get in trouble if they did the same things Fannie and Freddie did.
I'm picturing something along the lines of how Medicare reimbursement rates affect Medical Insurance reimbursement rates.
Posted by: Xmas at Sep 30, 2008 12:12:08 PM
I bought a home from a "diversity" owner who would have defaulted had I not needed a house. The bank (WaMu) had no interest in talking to me about a short sale. How could they know that I was going to buy the house? It was FSBO and she would have been even more underwater were I not a nice guy, in a hurry, and a weirdo who eschews all things realtor.
So, my opinion is colored by my experience, and I have no idea why marginal buyers were coaxed into buying, but is it really not conceivable that a lot of reasons stacked up, including this one?
Is it really just the wacko conservatives? Sure, anyone who claims to know THE reason for the problem is nuts, but no more nuts than those claiming the solution is more regulation, especially on the cusp of an economic contraction when if we need any government action it is to be as hands-off on business as possible.
Posted by: Andrew at Sep 30, 2008 12:12:50 PM
The timing is wrong for the CRA to be a major factor in the credit crisis. But the timing is right for two other things to be a major factor.
First, the housing bubble resulted when numerous states passed growth-management laws that created artificial shortages of housing. By 2000, almost half of all housing prices were being inflated by such shortages. In states lacking such laws, prices did not bubble. See "The Dog That Didn't Bark."
Second, from 1995 on, HUD -- whose mission is to promote homeownership but which also had oversight authority over Fannie and Freddie -- directed Fannie/Freddie to dramatically increase their purchases of mortgages made to low-income buyers. By 2004, HUD was requiring that 56 percent of mortgages that they purchased were made to "low- and moderate-income buyers." This ;ed them to buy hundreds of billions of dollars worth of subprime mortgages, legitimizing the secondary market for risky loans. See "HUD's conflicting missions."
Land-use regulation caused the bubble. HUD regulation of Fannie and Freddie created the subprime market. Other actions contributed, but without both of these actions, there would be no credit crisis today.
Posted by: Antiplanner at Sep 30, 2008 12:19:28 PM
Why can't we accept that this crisis was not caused by bad government at any level? It was caused by Wall St.
The people who work for Wall St. screwed up. They did the math wrong and miscalculated how much those securities were worth. I'm sure it was a difficult calculation that I couldn't do either. Nor could 99.9% of the population. But nevertheless that was the cause of this crisis: deficient math skills among the bankers.
Posted by: Dirk at Sep 30, 2008 12:23:44 PM
I tend to find the "CRA as the root cause" argument fairly compelling.
I would not argue a racial angle beyond that, except to the extent that passing the CRA may have been racially motivated.
Steve Salier's point seems well made. Black and Latino owners alone may not be enough to account for the entire amount. Then again, they may have been. The analysis is extremely informal.
Yglesia's point, as well as the more detailed "debunking" (loaded term) he links to are extremely uncompelling, and would better be described as politics, not economics.
Posted by: Jay at Sep 30, 2008 12:24:31 PM
For the people who think the CRA contributed to the housing bubble...
If Congress passed a law requiring that everyone make the same hourly wage, what do you predict would be the effect on employment levels and business profits?
Do you really think that there would be an employment bubble as employers rush to hire everyone that they can (so that they can conform to the law)? I thought that this was an economics blog.
Posted by: Barbar at Sep 30, 2008 12:30:29 PM
But nevertheless that was the cause of this crisis: deficient math skills among the bankers.
Deficient math skills... that led to them earning billions and billions of dollars in bonuses. For years.
Posted by: Barbar at Sep 30, 2008 12:34:34 PM
The inputs into the system should not matter. Garbage in, Garbage out. Apparently there was a fault in the system itself. Garbage in, AAA+ rating out. How does that work?
Posted by: at Sep 30, 2008 12:35:44 PM
Respectfully, I think you misstate the position, which makes the counter-argument easier. Let me try:
Many politicians wanted more loans made to minorities, but framed it as helping the poor get loans. Fannie executives wanted to buy sub-prime loans to increase their earnings. Both groups exerted influence on more agnostic or disiniterested politicians. They combined, over much accurate, on the money and (it must be said) Republican (a video of same) objections, to loosen the GSE standards for risky loans.
With their size as buyers, the GSEs fueled the market. Those loans did what was expected-- tank at high rates-- and triggered the asset devaluation.
So, those pushing for diversity loans were an imporatnt part of the consensus that rammed through the GSE's lower standards.
Posted by: $9,000,000,000 Write Off at Sep 30, 2008 12:37:20 PM
Awful, awful analogy Barbar. Thanks for playing though
Posted by: err at Sep 30, 2008 12:40:43 PM
Anti-planner:
Also, in the late 90s, Congress pressured Fannie/Freddie to increase their purchases of subprime loans.
See: http://query.nytimes.com/gst/fullpage.html?res=9C0DE7DB153EF933A0575AC0A96F958260&sec=&spon=&pagewanted=print
and http://articles.latimes.com/1999/may/31/news/mn-42807
The purpose was for the same policy goals that were the motivation for the CRA rules changes - but the pressure of Fannie/Freddie arguably had much more effect.
As to the loose money by the Fed - obviously a factor - but how much of a factor was all of that foreign money coming in to buy the mortgage-backed securities? I don't have a link for it, but there was a WSJ story from April 25, 2005, that talked about all the foreign money, particularly from Asia, coming in to buy the securities right when we were starting to worry a lot about a housing bubble. The title of the article was "Housing-Bubble Talk Doesn't Scare Off Foreigners", it was on page A1, and it was by Ruth Simon, James R. Hagerty and James T. Areddy.
Posted by: CJS at Sep 30, 2008 12:40:49 PM
If we define it narrowly enough then the case for a "diversity recession" is easy enough to debunk. But didn't the relaxation of rules not only expand the number qualified for mortgages, but also simultaneously expand the size of a mortgage others could take on? And weren't politicians (e.g., Frank) saying to Mankiw and others don't criticize Fannie and Freddie policies lest you cause what you predict?
If I'm reading through the lines correctly, Mankiw seems to give some credence to a "diversity recession" broadly defined:
http://gregmankiw.blogspot.com/2008/09/distorting-history.html
Posted by: John B. Chilton at Sep 30, 2008 12:43:44 PM
Dirk, you're serious right? You know that many of the people on wall street who did these analyses had Ph.D.'s in Math, Physics, Economics, or Statistics. Presumably, innumeracy was not one of the issues there.
The main problem with the math, from what I am able to gather, is that Wall St was using historical default rates for the rate of default on a mortgage. They then increased that by a small factor to account for potential errors, and voila, they got a price on Senior and Super-senior CDO tranches (which is what a lot of the banks ended up holding because the par price for these tranches was computed to be too low for any investor to want to buy it).
Now, part of the issue is the severe deterioration of underwriting standards that affected the 2005 and 2006 vintages of mortgage bonds that underlied the CDO's. It made the default probability assumptions wildly off since those assumptions assumed underwriting standards as before. The deterioration of underwriting standards was largely the fault of Fannie and Freddie since they set the tone for such standards by requiring lenders who did business with them to sell certain kinds of products and underwrite them in a particular way. The great article in the Village Voice about Andrew Cuomo as HUD secretary, as well as the deal Barney Frank struck with FM^2 years later in exchange for looking the other way on the accounting scandals helped create this.
No, black people aren't at fault. And I'm not sure that anyone has claimed that black people were at fault. If they did, they're nuts and racist. I think the claim was that in attempting to satisfy racialist constituencies like ACORN, Rainbow/PUSH, etc., the government helped loosen underwriting standards. In particular, this happened at Fannie and Freddie who pressured lenders to offer products (to people of all races, but in the name of ending supposed racial discrimination in mortgage underwriting) that were suspect. I'm not sure that one can deny that this happened and was one of the three major causes of the crisis (along with Wall Street being more than happy packaging these into CDO's to make a killing off fees and bid/ask, and stupidly low interest rates... which apparently John McCain wants at near 0).
See also the report put out by HUD/Justice under Deval Patrick's watch that even Clinton's FDIC and other government economists disavowed (claiming that lower lending rates for blacks is evidence of discrimination). See also Deval Patrick's subsequent sweetheart job with Ameriprise (the lender that recently ran into lots o' subprime trouble in Massachusetts) as a result of his persecution of the firm under his watch.
Posted by: Gene2 at Sep 30, 2008 12:45:53 PM
