The government is mostly, if not entirely, to blame for the Great Financial Crisis of 2008. Its own documents show why.
Allegations about the financial crisis
In September of 2008, the Bush administration announced the Troubled Asset Rescue Plan (TARP). Bush said then that many banks would fail if the government did not bail them out at once. The votes for and against that Plan cut across Party lines. (In fact, it failed in the House of Representatives on its first ballot.)
Reviews of TARP and how well it worked have been mixed at best. TARP became a by-word for government grants of special privileges. And the Great Financial Crisis of 2008 has not ended. Three years later, hundreds of thousands of home loans have gone bad. Banks are foreclosing—and their borrowers are disputing whether they, or anyone else, even have legal rights to foreclose.
The reason for that last is that banks began to “securitize” mortgages—to sell them to investors who then traded them on the open market. But the real problem was: why did so many home loans go bad to begin with? In plain fact, many of the borrowers were simply not credit-worthy.
So why did so many banks lend to non-credit-worthy borrowers? The banks’ detractors speak of “abusive lending practices” and even “predatory lending.” Their premise is that bankers deliberately lent to people they knew might default. Why? Because they sought to lock in high interest income, acquire a lot of cheap housing stock to re-sell, or both.
Representative Maxine Waters (D-CA) gave the prize example of illogical and inflammatory rhetoric:
[B]ring the gangsters in, put them around the table, and let them know that if they don’t come up with loan modifications and keep people in their homes, that they’ve worked so hard for, we’re gonna tax them out of business.
Lately, the Occupy Wall Street protesters have demanded worse: that the government prosecute bankers (for what?) and send them to prison.
The real cause of the financial crisis
Those detractors, and the mainstream media, have forgotten the real cause of the financial crisis: the Community Reinvestment Act. That Act gave federal regulators the authority to encourage, or threaten, banks into making more loans in “underserved” communities.
The current article in Wikipedia defends CRA against those who have cited it as the true cause:
Some economists, politicians and other commentators have charged that the CRA contributed in part to the 2008 financial crisis by encouraging banks to make unsafe loans. However, every empirical study that has looked at CRA loans has concluded that they were safer than subprime mortgages that were purely profit driven, and CRA loans accounted for a tiny fraction of total subprime mortgages.
But the article also says that the lending of money to risky borrowers might have been an unintended consequence of CRA:
In a 2002 study exploring the relationship between the CRA and lending looked at as predatory, Kathleen C. Engel and Patricia A. McCoy noted that banks could receive CRA credit by lending or brokering loans in lower-income areas that would be considered a risk for ordinary lending practices. CRA regulated banks may also inadvertently facilitate these lending practices by financing lenders. They also noted that CRA regulations, as then administered and carried out by Fannie Mae and Freddie MAC, did not penalize banks that engaged in these lending practices. They recommended that the federal agencies use the CRA to sanction behavior that either directly or indirectly increased predatory lending practices by lowering the CRA rating of any bank that facilitated in these lending practices.
Now more than unintended consequence
Andrew M. Cuomo, file photo from his days as Secretary of Housing and Urban Development.
Until today, this was the only evidence widely available, and certainly the only evidence anyone cited. But today in Investors Business Daily, Mr. Paul Sperry revealed the “smoking gun”:
Rewind to 1994. That year, the federal government declared war on an enemy — the racist lender — who officials claimed was to blame for differences in homeownership rate, and launched what would prove the costliest social crusade in U.S. History.
The weapon: a Policy Statement on Discrimination in Lending. No fewer than ten federal agencies signed it. They were:
- Department of Housing and Urban Development
- Department of Justice
- Office of the Comptroller of the Currency
- Office of Thrift Supervision
- Federal Reserve Board of Governors
- Federal Deposit Insurance Corporation
- Federal Housing Finance Board
- Federal Trade Commission
- National Credit Union Administration
- Office of Federal Housing Enterprise Oversight
This document is available here, here, and here. The PDF file at the first link has a cover letter from the then Acting Director of the thrift office.
The 10 agencies put the Policy Statement into the Federal Register on April 15, 1994.
Mr. Sperry’s article lays out the impetus for the Statement. The Boston Fed, in 1992, issued a report accusing bankers of wholesale discrimination by not lending to minorities (“redlining”).
Nick Purpura, former Managing Director at Bear Stearns, told CNAV this afternoon that one man, more than any other, was the driving force behind the Statement. That man was Andrew Cuomo, then Secretary of HUD.
Andy Cuomo caused the financial crisis. He was the strong-arm guy. He threatened the banks. He said that if they didn’t make those loans, HUD would fine them, regulate them, shut them down. “Lend money to those people, or I’ll come after you,” he basically said.
Clearly, Representative Waters should eat her words. She knows, or should know, better than to blame the banks for a financial crisis that the government caused. That goes double for the man now holding office as President. That CRA might have placed banks at a slight moral hazard was bad enough. But the government gave banks direct orders to make loans that might go bad more often than not. For anyone in government now to blame, or seek to indict, the banks for obeying those orders is worse than hypocritical.