Who Exactly is Responsible for the Sub-prime Meltdown?

by David Hinz

We have heard professional Congressional bureaucrats scream about the Sub-prime Mortgage meltdown. We have heard about predatory lenders and unscrupulous mortgage brokers taking advantage of poor and minority homeowners; homeowners who were unqualified for the loans they received.

So who really is to blame for the resulting crisis? Well, while banks and mortgage lenders are not blameless, Congress must bear a large part of the blame as well. It has been Congress, and their (we can only assume) well-meaning meddling with the economy, in the interest of fairness, that has created the fiasco.

Congress, in an attempt to confront discrimination against minorities, enacted the The Home Mortgage Disclosure Act (HMDA) in 1975. The purpose of the act, according to the FFEIC website:

The Home Mortgage Disclosure Act (HMDA) was enacted by Congress in 1975 and is implemented by the Federal Reserve Board's Regulation C. This regulation provides the public loan data that can be used to assist:

• in determining whether financial institutions are serving the housing needs of their communities;
• public officials in distributing public-sector investments so as to attract private investment to areas where it is needed;
• and in identifying possible discriminatory lending patterns.

So, in 1975 the Federal Government decided to monitor lending institutions, scrutinizing them for any perceived discrimination against minorities -- and guaranteeing by their very action, that lending institutions would be lenient in their lending practices toward minorities -- for fear of being deemed to be racist.

Since it's passage, the HMDA has gone through several amendments -- all of which have been detrimental to lending institutions, while providing windfall opportunities for poor and minority homeowners.

In 1980, amendments to HMDA directed the Federal Financial Institutions Examination Council (FFIEC) to compile annually for each Metropolitan Statistical Area (MSA) aggregate lending data by census tract for certain lenders. In addition, the FFIEC was directed to produce tables for each MSA that aggregates the lending activity of institutions by various categories of census tracts, grouped according to location, age of housing stock, income level, and racial characteristics.

Lending institutions in metropolitan areas have been accused of "redlining."

Redlining is the practice of arbitrarily denying or limiting financial services to specific neighborhoods, generally because its residents are people of color or are poor. While discriminatory practices existed in the banking and insurance industries well before the 1930s, the New Deal's Home Owners' Loan Corporation (HOLC) instituted a redlining policy by developing color-coded maps of American cities that used racial criteria to categorize lending and insurance risks. New, affluent, racially homogeneous housing areas received green lines while black and poor white neighborhoods were often circumscribed by red lines denoting their undesirability.

Redlining, discriminating because of race, was made illegal by Congress, and so lending institutions would be naturally fearful of being accused of such a practice. The HMDA, and other subsequent acts of Congress sent "a chill wind" blowing through the lending institutions.

Throughout the history of the act, amendments and revisions have occurred on nearly a yearly basis -- each amendment or revision making it abundantly clear to the lending institutions that it was in their best interests to extend credit to poor and minority homeowners, regardless of creditworthiness.

This government interference in the private lending sector has been a primary cause -- as much or more than greed -- for the sub-prime meltdown we are currently experiencing. A quick overview of some of these revisions and amendments throughout the years;

A congressional act passed on February 5, 1988, amended the law and expanded coverage to nonmajority-owned savings and loan service corporations, mortgage banking subsidiaries of bank holding companies, and mortgage banking subsidiaries of savings and loan holding companies. (Previously, only depository institutions and their majority-owned subsidiaries were covered.)

In 1989, the Federal Reserve Board revised Regulation C, to incorporate amendments contained in the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). The FIRREA amendments accomplished the following: expanded the coverage of HMDA to include mortgage lenders not affiliated with depository institutions or holding companies; required reporting of data regarding the disposition of applications for mortgage and home improvement loans in addition to data regarding loan originations and purchases; and required most lenders to identify the race, sex, and income of loan applicants and borrowers...
...

In 1991, Congress, via the Federal Deposit Insurance Corporation Improvement Act, authorized the Federal Reserve Board, in consultation with the Department of Housing and Urban Development, to develop a new exemption standard for nondepository mortgage lenders that is comparable to the exemption for depository institutions. In 1992, the Board adopted a standard that further expanded coverage of independent mortgage lenders. Under the adopted standard, a nondepository mortgage lender with an office in an MSA is covered if it meets either an asset-size test or a lending activity test.

The Board also revised the instructions for reporting loan applications received through a loan broker or correspondent to make the rule for reporting loan approvals conform to the existing rule for reporting loan denials. This revision applies to all lenders covered by HMDA, not only nondepository mortgage lenders.

...

In 1993, Regulation C was revised by the Federal Reserve Board to incorporate amendments contained in the Housing and Community Development Act of 1992. The amendments required institutions--in response to requests from the public--to make a modified version of their loan/application register data available within 30 days of the date it was due to its regulatory agency...

...

In 1994, Regulation C was amended by the Federal Reserve Board to make HMDA data available to the public earlier, to improve the accuracy of the HMDA data, and to clarify and simplify the reporting requirements...

In 1977 Congress passed the Community Reinvestment Act (CRA), which, like the HMDA was intended to compel lending institutions to "reinvest" profits back into the community in which they have offices. Like the HMDA the CRA had the unintended effect of intimidating lenders into making questionable loans, out of fear of being deemed racist in their practices. As explained on the government CRA history page:

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...

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.

With each subsequent act of Congress, banking institutions have felt increased governmental pressure to provide loans to poor and minority applicants, regardless of creditworthiness; to look the other way regarding unfavorable credit history. To hold that credit history against a minority applicant is to be labeled as racist -- and lending institutions have been loath to be so labeled.

Have there been unscrupulous mortgage lenders who have preyed upon the poor and uninformed? Without a doubt, there have been. But it would be a travesty to look at the lending climate today, and to to exempt Congress from its fair share of the blame.

Congress, holding congressional hearings on the subject will conveniently forget their own culpability in the entire affair. We must not.