Pernicious Nonsense

(updated below)

The emerging right wing narrative about how our country came to be embroiled in the current economic crisis is not only completely inaccurate, it's downright insidious. It needs to be nipped in the bud right away.

Jim Geraghty at the National Review sums up the emerging narrative pretty well:

[T]he market wasn't running free; the government, through Fannie Mae and Freddie Mac, loaned billions of dollars to people you wouldn't loan $200 to because you didn't trust them to pay it back. Then, through the Community Reinvestment Act, they punished banks that didn't make enough loans to people who do not have the credit, assets, income, or down payment to qualify for a normal mortgage, a.k.a. the subprime market.

No one in their right minds loans money to somebody who they think won't pay it back. But the government said banks had to, for reasons of "fairness".

There is so much inaccuracy here that it's hard to even know where to begin. But let's start with the Community Reinvestment Act (CRA), which was passed in 1977, almost 25 years before the housing bubble started to form. The purpose of the CRA was to eliminate discrimination in lending practices. It didn't force or require financial institutions to make risky loans. Moreover, the law only applies to banks and thrifts. As Tim Westrich points out:

[W]hen CRA was passed in 1977, it was designed to cover only depository institutions—commercial banks and savings-and-loans institutions, or thrifts—that made the lion’s share of home mortgages back then. As subprime lending exploded in this decade, CRA lost its relevance because it doesn’t cover the more loosely regulated non-bank mortgage companies, which increasingly took the mortgage market away from banks and thrifts.

The notion that the CRA pushed financial institutions into the subprime market is just not remotely accurate.

Even more pernicious, though, is the implication that our current troubles stem from an obsession with political correctness, that financial institutions were somehow guilted or prodded into making risky loans to minority communities. This is nothing but despicable racial scapegoating and it has no basis in fact.

First, the bad loans at issue here weren't just made to minorities. They were made across the board. And the folks who contributed most to the growing housing bubble were not the people trying to buy their first homes, but the speculators who started buying and "flipping" houses and condos for investment purposes.

Second, the focus on Fannie Mae and Freddie Mac is also misguided. While there were problems with those institutions, most of the bad loans at issue were originated in the subprime market--i.e., outside the Fannie/Freddie box. Fannie and Freddie were largely reacting to their market share being taken away by a new breed of lenders.

A lot of factors contributed to this mess, but by far the biggest were 1) the Fed's monetary policy--keeping interest rates abnormally low for an extended period of time, and 2) the failure of the government to step in and regulate the mortgage industry and the emerging market for mortgage back securities and similar collateralized debt obligations. That, combined with the 1999 repeal of Glass-Steagall--which freed the way for banks to engage in more risky investments--led us down the road to where we are today.

The bottom line, though, is that nobody forced these financial institutions to do anything. They all freely rushed into this market, disregarding all the warning signs along the way. And for a while, it was insanely profitable. That's how bubbles form.

To attempt to pin all the blame for this calamity on minority home owners--many of whom were badly victimized by this process and are now losing their homes--is nothing short of vile. History has shown over and over again that when banking practices and markets are not regulated in a sensible fashion, things eventually get out of control. On a macro level, there's not much difference between what happened here and what happened in the lead up to the Great Depression. Following that calamity, we stepped in and imposed a number of laws and regulations that should have been there in the first place. We created the FDIC and imposed capital requirements on depository institutions. We restricted the types of investments banks can make with depositors' money. In the wake of the current crisis, similar steps are going to have to be taken in the areas not covered by existing laws.

This really isn't rocket science. When markets fail, free market ideologues search for scapegoats. That's what is happening now. It's understandable. But that doesn't make it any less pernicious.

UPDATE: Barry Ritholtz writes the definitive take down of this nonsense. If you really want to understand this stuff, go read this post. Here's an excerpt:

CRA is not remotely one of the proximate causes of the current credit crunch, Housing collapse,and mortgage debacle. As I detailed in Barron's, there is plenty of things to be angry at D.C. about -- but this ain't one of them.

If you were to ask me to reveal the prime causative factor for the Housing boom, I would point you to Fed Chairman Greenspan taking rates to 1%, and then leaving them there for a year. The prime factor in the bust was nonfeasance on the Fed's part in supervising bank lending, allowing banks to give money to people who couldn't possibly pay it back.

The root legislative cause of the credit crisis was excessive deregulation. From exempting derivatives from regulation (2000 Commodities Futures Modernization Act) to failing to adequately oversee ratings agencies that slapped a triple AAA on junk paper, the pendulum swung too far away from reasonable oversight. By taking the refs off of the field and erroneously expecting market participants could self-regulate, the powers that be in DC gave the players on Wall Street enough rope to hang themselves with -- which they promptly did.

There are too many people who are trying to duck responsibility for the current mess, and seeking to place blame elsewhere. I find this to be terribly important, as we seek to repair the damage amidst an economic crisis. Rather than objectively evaluate the present crisis in an attempt to craft an appropriate response, the partisan hacks are trying to obscure the causes of the current situation. Like burglars trying to destroy the surveillance tape, they are all too aware of their role in the present debacle.

Shame on them for their foolishness or cowardice.