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The Government-Created Subprime
Mortgage Meltdown
Thomas
J. DiLorenzo
Lew Rockwell.com
Thursday September 6, 2007
The thousands of mortgage defaults and foreclosures in the "subprime"
housing market (i.e., mortgage holders with poor credit ratings)
is the direct result of thirty years of government policy that
has forced banks to make bad loans to un-creditworthy borrowers.
The policy in question is the 1977 Community Reinvestment Act
(CRA), which compels banks to make loans to low-income borrowers
and in what the supporters of the Act call "communities of
color" that they might not otherwise make based on purely
economic criteria.
The original lobbyists for the CRA were the hardcore leftists
who supported the Carter administration and were often rewarded
for their support with government grants and programs like the
CRA that they benefited from. These included various "neighborhood
organizations," as they like to call themselves, such as
"ACORN" (Association of Community Organizations for
Reform Now). These organizations claim that over $1 trillion in
CRA loans have been made, although no one seems to know the magnitude
with much certainty. A U.S. Senate Banking Committee staffer told
me about ten years ago that at least $100 billion in such loans
had been made in the first twenty years of the Act.
(Article continues below)
So-called "community groups" like ACORN benefit themselves
from the CRA through a process that sounds like legalized extortion.
The CRA is enforced by four federal government bureaucracies:
the Fed, the Comptroller of the Currency, the Office of Thrift
Supervision, and the Federal Deposit Insurance Corporation. The
law is set up so that any bank merger, branch expansion, or new
branch creation can be postponed or prohibited by any of these
four bureaucracies if a CRA "protest" is issued by a
"community group." This can cost banks great sums of
money, and the "community groups" understand this perfectly
well. It is their leverage. They use this leverage to get the
banks to give them millions of dollars as well as promising to
make a certain amount of bad loans in their communities.
A man named Bruce Marks became quite notorious during the last
decade for pressuring banks to earmark literally billions of dollars
to his organization, the "Neighborhood Assistance Corporation
of America." He once boasted to the New York Times that he
had "won" loan commitments totaling $3.8 billion from
Bank of America, First Union Corporation, and the Fleet Financial
Group. And that is just one "community group" operating
in one city – Boston.
Banks have been placed in a Catch 22 situation by the CRA: If
they comply, they know they will have to suffer from more loan
defaults. If they don’t comply, they face financial penalties
and, worse yet, their business plans for mergers, branch expansions,
etc. can be blocked by CRA protesters, which can cost a large
corporation like Bank of America billions of dollars. Like most
businesses, they have largely buckled under and have surrendered
to their bureaucratic masters.
Consequently, banks in every community in America have been forced
to hold a portfolio of bad loans, euphemistically referred to
as "subprime" loans. In order to compensate themselves
for the added risk of extending these loans, many lenders have
increased the lending fees associated with mortgage loans. This
is simply an indirect way of doing what banks always do –
and what they must do to remain solvent: charging effectively
higher rates of interest on riskier loans.
But this is discriminatory!, complained the "community organizations."
Thus, if one browses the ACORN
web site, one can read of their boasts of having "predatory
lending laws" passed in numerous states which outlaw such
fees, prohibiting banks from protecting themselves from the added
risk involved in making forced loans to "subprime" borrowers.
These are price control laws, and price controls always cause
shortages. Normally, banks would respond to such laws by extending
fewer riskier loans. But in this case the banks are forced to
continue making the marginal loans by their bureaucratic masters
at the Fed and the other three federal bureaucracies mentioned
above. So-called predatory lending laws therefore force the banks
to "eat" the losses. This is undoubtedly a contributing
factor to the bankruptcy of dozens of mortgage lenders over the
past year.
Then of course there is the issue of the Fed’s monetary
policy having created the housing bubble, characterized by a spectacular
escalation of real estate values in every American city over the
past decade or so. This created a further problem for the financial
institutions that are victimized by the CRA. They are forced to
make a certain amount of bad loans, but because of the Fed-created
explosion in housing prices, many thousands of subprime borrowers
no longer qualified, by a long stretch, for conventional mortgages
based on their incomes.
The only way these borrowers could qualify for their mortgage
loans (even ignoring their bad credit ratings) was to take out
adjustable rate mortgages, some of which had astonishingly low
first-year rates in the 3 percent range, and sometimes lower.
This is what has largely fueled the subprime mortgage meltdown
– the inability of thousands of subprime borrowers to afford
their mortgages now that their rates have adjusted upward. Thus,
the combination of the Fed’s enforcement of the CRA (with
the help of political pressure groups like ACORN) and its post
9/11 monetary policy in general are the reasons for the bursting
real estate bubble and the "subprime" mortgage meltdown.
Don’t expect to read about this in the "mainstream
media," however, which generally views groups like ACORN
as heroic champions of the poor, laws like the CRA as anti-discrimination
laws, and places all of the blame for the subprime mortgage meltdown
on greedy capitalists, especially mortgage brokers. Encouraged
by such reporting, the odious Senator Charles Schumer of New York
has promised federal legislation that will reign in these miscreants,
while the Bush administration is proposing an indirect bank bailout
by having the Federal Housing Administration cover many of the
bad "subprime" loans. This will create what economists
call a "moral hazard" by encouraging even more bad loans
to be extended in the future. Every banker in America will be
glad to extend loans (at high rates of interest) to the most uncreditworthy
borrowers if he thinks there is no possibility of default with
the FHA effectively guaranteeing the loan.
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