A History Lesson of the CRA and our current crises. Part 2
With the banks being forced by the CRA to fund these high-risk loans, that left the banks were in a quandary, they could NOT resell these loans due to the high risk involved with them, so once again, in 1995 the Community Reinvestment Act (CRA) was revised to allow for the securitization of CRA loans into the secondary market for mortgages. Along with that Mr. Cisneros of the Clinton administration loosened mortgage restrictions so first-time buyers could qualify for loans they could never get before.
"In a more aggressive pursuit of "social justice," the Clinton administration revised the CRA in April 1995 to mandate that banks pass lending tests in "underserved" communities and suffer tough new sanctions for failing to make enough loans there.
According to the language of the new Clinton regs, banks that used "innovative or flexible lending practices" to address the credit needs of low-income borrowers passed the test. Banks with poor CRA ratings were hit with stiff fines and blocked from expanding their operations. Soon, "flexible" lending became the norm, and banks used subprime loans, which charge higher interest rates, to cover the added risk.
But it wasn't enough. So Clinton ordered HUD to pressure Fannie Mae and Freddie Mac to buy the higher-risk loans from private banks and lenders, while adopting the same "flexible" credit standards. By 2000, HUD had mandated that low-income mortgages - including CRA-related loans - make up half of their portfolios.
To further spread the risk, Clinton legalized the securitization of such mortgages. In 1997, Bear Sterns securitized the first CRA loans - $385 million worth, all guaranteed by Freddie Mac. Thus began the massive bundling of subprime mortgages that wound up poisoning the entire industry.
The cause and effect is clear. As ex-Fed chief Alan Greenspan recently testified: "It's instructive to go back to the early stages of the subprime market, which has essentially emerged out of the CRA."
It strains credulity for top regulators to now say the CRA had "absolutely nothing" to do with the subprime crisis. It smacks of political spin and bureaucratic CYA."
http://www.ibdeditorials.com/IBDArticles.aspx?id=313718923222067
The last part of the perfect storm is that capital requirements favor private mortgage securities. Those securities, even when backed by high-risk mortgages, can obtain attractive risk ratings from credit rating agencies through use of tranches that only are subject to losses if a substantial proportion of loans go into default.
FDIC capital regulations give a lower risk weight to highly-rated mortgage securities, which may be backed by loans with little or no down payment, than to loans originated within the bank with down payments of up to 40 percent.
If capital requirements were identical between banks and Freddie/Fannie, then it is unlikely that Freddie Mac and Fannie Mae would have grown to dominate the mortgage market. It was the reduction of the capital requirements, necessary to implement the CRA that allowed mortgage backed securities to become highly lucrative, yet highly risky investments.
The house of cards came tumbling down when interest rates began to rise, forcing many of these loan holders to see their ARM payments increase. When they could no longer afford to make payments the house of cards started to tumble. At first the numbers were nominal and the investments were able to handle the losses, however as the foreclosed homes began hitting the market they started a small erosion in the current price of houses. Many people who bought houses for investments and were making 10-20% a year were now stuck with several homes and beginning to get upside down on them. And then it began to snowball.
So what happened first was a massive devaluation in the investment houses, since they were the holders of these tranches. Trillions of dollars of so-called safe investments were no longer safe; in many cases they were liquidating them for 20 cents on the dollar.
Many of the banks were hurt because they do had invested in these, so the money they had to loan was now used to cover these losses. Banks that had money to lend stopped lending to other banks, fearing that they would never see their loans paid back and a credit freeze started.
Our economy has fundamentally changed from one of manufacturing to one of service and consumerism, as people saw their mortgage payments rise they had less discretionary income so they stopped or reduced spending. As more and more people spent less then stores needed less merchandise and less employees.
Businesses that were already highly leveraged (circuit city for example) saw their sales begin to drop. Their whole economic model was that they could only make loan payments if the brought in X amount of dollars, and for them to do that they needed increasing sales but instead they were hit with decreasing sales.
I hope that connects the dots in a very brief and easy way.
It was bad in Argentina in the 90's...I really do not know if folks in the USA have the stomach for the cost of necessities rising 20-40% daily!
