POLITICAL NARRATIVE: “The housing crisis was a failure of free market capitalism caused by too few government regulations.”
REALITY: What’s often ignored by those looking to blame the market is the role the government played in promoting those “predatory” practices we’re always hearing about. Laws coerced banks into riskier behavior than they would normally undertake, with fines and other punishment if they didn’t meet subprime quotas (subprime loans are typically home mortgages to lower-income borrowers). It’s an astonishing story, and one that continues to be glossed over in the historical discussion of the causes of the housing crisis and Great Recession.
In the early 1990s, a congress gave the Department of Housing and Urban Development (HUD) the authority to set and enforce (through fines) subprime loan quotas at Fannie and Freddie.
The new law required the government-backed agencies to “assist insured depository institutions to meet their obligations under the Community Reinvestment Act (CRA).” The goal was to help banks meet lending quotas by buying their CRA loans. But they had to loosen underwriting standards to do it. And that’s what they did.
Starting in 1995, banks were measured on their use of ‘innovative and flexible’ lending standards, which included reduced down payments and credit requirements. Banks that didn’t meet the Clinton administration’s tough new numerical lending targets were denied merger plans, among other penalties, until they pledged more loans to credit-poor minorities.
In 2000, HUD further hiked mortgage giant Fannie Mae’s affordable housing quotas to 50% and pressed it to buy even more CRA-eligible loans to help meet those new targets.
“We want your CRA loans because they help us meet our housing goals,” Fannie Vice Chair Jamie Gorelick beseeched lenders gathered at a banking conference in 2000. “We will buy them from your portfolios or package them into securities”.
And so, in the run-up to the crisis banks rapidly sold CRA mortgages for securitization by Fannie Mae and Freddie Mac and Wall Street. When the recession struck, there were fully $6.1 trillion in CRA loans to subprime borrowers. A cascade of defaults drove down home prices, triggering further defaults and creating the worst recession since the 1930s.
This assessment of the cause of the housing crisis is backed by a 2012 study by the highly respected National Bureau of Economic Research which found that the Community Reinvestment Act ‘clearly’ led to the risky lending that precipitated the Great Recession.