Who is responsible for the current financial crisis? The finger-pointing has begun with politics playing a large role in defining the culprit. According to the Republican Press it is the Community Reinvestment Act created by Jimmy Carter and strengthened by Bill Clinton – therefore the Democrats who are to blame. According to the Liberal Press it is Phil Gramm and Republican sponsored deregulation – therefore the Republicans are to blame. Everyone seems to agree that Wall Street greed has played a role.
How can the average person who has never heard of derivatives, mortgage backed securities or collateralized debt obligations make sense of all of this? People seem to be lining up based on party affiliation rather than on logic or reason.
It seems like it is time to apply some common sense.
The Community Reinvestment Act
This act was created to encourage financial institutions to serve poor areas:
The Community Reinvestment Act is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound banking operations. It was enacted by the Congress in 1977 (12 U.S.C. 2901) and is implemented by Regulations 12 CFR parts 25, 228, 345, and 563e. (See Regulation).
The CRA requires that each insured depository institution’s record in helping meet the credit needs of its entire community be evaluated periodically. That record is taken into account in considering an institution’s application for deposit facilities, including mergers and acquisitions. (See CRA Ratings) CRA examinations (see Exam Schedules) are conducted by the federal agencies that are responsible for supervising depository institutions: the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS).
– source: www.ffiec.gov/cra/history.htm
So how does this act create the current crisis? According to conservatives, the Clinton administration pressured banks to lend money to the poor, inflating housing prices and creating bad debt.
What does common sense say? If it is true that banks were “pressured” into lending money to poor people then who was pressuring them to create extremely risky loan structures? These included ARM loans with initial teaser rates, interest only ARMs and Payment Option Loans. These loans were not just being offered as an alternative to traditional fixed rate mortgages, they were being pushed as the best choice. The recipients were often not financially sophisticated and considered if they could afford the initial payments without understanding how much their monthly payments might increase. So was the problem the CRA legislation or was the problem unsophisticated borrowers and predatory lending practices?
Republican Led Deregulation
Banking deregulation has also been cited as the cause of our current financial woes. The Republicans are closely associated with deregulation so this gives great fodder for the Liberal Press. However, Bill Clinton was in office and presided over the elimination of the wall between investment and commercial banking. Both parties have made their contributions to deregulation.
What does common sense say? Is it really the ability for banks, brokerages and insurance companies to offer competing products that caused our problems? Is it not more likely that lack of common sense, greed, stupidity and outright fraud put us where we are today? How could anyone think that a Payment Option Loan was a good idea? These loans allowed borrowers to make payments that were LESS THAN THE MONTHLY INTEREST AMOUNT! The amount of interest not paid this month became part of the principal. The LOAN WAS GETTING BIGGER! It is one thing if this loan was issued to a very wealthy borrower, it is a completely irrational decision to issue this type of loan to a subprime borrower. However, mortgage brokers were being offered incentives to do just that. This was happening at a time when fixed rate mortgages were readily available at historically low interest rates. When borrowers tried to refinance, conditions had changed, credit had tightened, houses were declining in value and lenders were no longer willing to issue them a loan. Defaults ensued.
How Do Foreclosures Bring Down Large Financial Institutions?
This is the tricky part that is difficult to follow — mortgages were turned into securities and then leveraged. Essentially, investment companies started to place bets with borrowed money. Eventually, the base on which this structure was built (rising real estate values) collapsed and the system began to falter.
What Have We Learned?
We sadly cannot rely on corporations to behave in a socially responsible way. This should not be a political issue. Both parties have presided over this failure as it was created over time. Rather than using it to further their campaigns and political agendas, it is time for both parties to assess this failure from a non-partisan perspective and to mitigate the damage to the public as much as this is possible.
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