Don’t blame the victims

As the cost of Wall Street’s credit crisis has mounted, the hunt for villains has intensified and the accusations of fault have widened. At first the focus was on greedy profiteers among lenders and investment bankers, who were an easy (and deserving) target. Then the finger-pointing became politicized, with Democrats blaming deregulation advocates in the Bush administration and previous GOP-controlled Congresses, and Republicans citing influential Democrats at Fannie Mae and Freddie Mac and their allies on Capitol Hill. Lately, even former Federal Reserve Chairman Alan Greenspan, who once incited hero-worship among lawmakers, has been heaped with blame.

But it’s not just the rich and powerful who’ve been held up for scorn. Some politicians have also started pointing fingers toward the bottom of the economic ladder, associating the problems in the financial markets with irresponsible low-income borrowers and advocates for affordable housing. The latter include the controversial group ACORN, the Assn. of Community Organizations for Reform Now, which was best known as a lobbyist for low-cost housing before it gained infamy for its fraud-tolerant voter-registration drives. Had banks not been forced to make loans to minorities and people with lower credit scores, some say, the subprime meltdown would not have occurred.

Underlying this point of view is the belief that government regulation and intervention in markets cause more problems than they solve. In particular, these critics maintain that the 1977 Community Reinvestment Act pushed banks to make bad loans by requiring them to serve low-income neighborhoods. Although the law set no lending quotas or even targets, it enabled community groups to extract concessions from banks that sought to expand or acquire rivals. ACORN, for example, has used the CRA as leverage to compel banks to create pools of loans for low- and moderate-income families. Its efforts have generated about $6 billion in loans to these borrowers, while also generating funds for ACORN’s nonprofit housing corporation. Supporters call that a win-win scenario; critics say it’s legalized extortion.

Linking the credit crisis to the push for more affordable housing, however, is blaming the victim. Had banks covered by the CRA been the driving force behind the boom in subprime lending, or had Fannie Mae and Freddie Mac been true to their mission of promoting affordable homes and apartments, the housing market wouldn’t have inflated as dramatically, and the pain wouldn’t have been as great when the bubble burst. Borrowers made their share of mistakes and reckless decisions, but the more fundamental problem is that too many mortgage brokers, lenders and investors stopped caring whether loans could be repaid. They abandoned the underwriting standards that would have protected borrowers and lenders alike.

It’s easy to dismiss the rap against the CRA if you understand why Congress enacted the law. Commercial banks’ reluctance to serve minority and low-income communities had left these areas open to exploitation by less savory sources of credit, such as payday lenders. Consumer advocates pushed Congress to end this redlining because they wanted banks’ good lending practices to drive predatory lenders out of those communities. The law and subsequent regulations made clear that banks and thrifts were being asked to try harder to find capable borrowers, not to make loans that were more likely to default. As the Federal Reserve Board put it in Regulation BB:3.0.1.1.9&idno;=12%2312:3.0.1.1.9.1.8.1, “[T]he board anticipates banks can meet the standards of this part with safe and sound loans, investments and services on which the banks expect to make a profit. Banks are permitted and encouraged to develop and apply flexible underwriting standards for loans that benefit low- or moderate-income geographies or individuals, only if consistent with safe and sound operations.”

Here are three more data points that show the CRA or affordable-housing efforts in general can’t be blamed for the growth in subprime loans. Most subprime loans :TcA9Tzx4aqgJ: www.house.gov/apps/list/hearing/financialsvcs_dem/barr021308.pdf+subp rime+University+of+Michigan%27s+Michael+Barr& ;hl=en&ct;=clnk&cd;=1≷=us&client;=firefox-a”> www.house.gov/apps/list/hearing/financialsvcs_dem/barr021308.pdf+subp rime+University+of+Michigan%27s+Michael+Barr& ;hl=en&ct;=clnk&cd;=1≷=us&client;=firefox-a started with brokers and lenders not covered or affected by the CRA, such as now-defunct New Century Financial. Such loans went mainly to middle- and upper-income borrowers . And the vast majority were for home refinancing, not new purchases. The problem with these refinancings was that they were built on sand -- they existed to generate fees for brokers and lenders and/or to tap equity that would evaporate soon after the bubble burst. Beyond that, a recent study found that loan programs aimed specifically at low-income borrowers have significantly lower default rates than subprime loans in general.

The last things anyone wanted from the CRA were the exotic mortgages that have failed at alarming rates, including “liar loans” and “negative amortization” mortgages whose low payments pushed borrowers deeper into debt. So why did those types of loans and other questionable practices proliferate? Because they generated higher returns for lenders and investors.

Consider what happened at Fannie and Freddie. Since 2000, the Department of Housing and Urban Development has required that at least half of the mortgages purchased by the companies go to low- and moderate-income borrowers. To hit those targets, Fannie and Freddie -- whose underwriting standards prevented them from buying most types of exotic loans -- invested hundreds of billions of dollars in subprime-backed mortgage securities. The loans underlying those securities, however, had little to do with helping low- and moderate-income families buy homes. Instead, they were refinancings that pulled money out of homes people already owned. No question, Fannie and Freddie’s demand for securities poured gas on the red-hot subprime market. But the companies lost half their share of that market during the boom years from 2004 to 2006, so they clearly weren’t the only sources of fuel. Congress needs to resolve the tension at Fannie and Freddie between shareholder returns and HUD targets. But as they do so, lawmakers shouldn’t pin the rap for the larger credit crisis on affordable housing.