Wednesday, December 24, 2008

Charts: The tragic results of the 'Community Reinvestment Act'

12/24/2008 19:53 EST Bumped and updated with new graphs

Chart o' the Day provides this illustration of inflation-adjusted home prices:

Now let's add a couple of important milestones to the chart.

The first vertical line depicts the initial incarnation of The Community Reinvestment Act (CRA) signed into law by President James Earl Carter in 1977. The segment starting in 1995 represents the strengthening of the CRA signed into law by President William Jefferson Clinton. These areas are shaded in blue. The CRA forced banks to underwrite loans to parties that would otherwise not qualify for mortgages: those with undocumented income, those possessing no down payments, etc. In other words, the CRA represented a government experiment into "social engineering."

The purple and red segments delimit the "massive accounting scandals" at Fannie Mae and Freddie Mac, the government-sponsored entities (GSEs) that played a crucial role in packaging subprime mortgages. Fannie and Freddie executives were pushing as many subprime instruments through the system as possible in order to maximize bonus payments.

A few well-connected Democrats including Franklin Raines, Jim Johnson and Jamie Gorelick -- all of whom were former Clinton administration officials -- received payments totaling as much as $200 million for six years of work leading the GSEs.

In May of 2006 the SEC and other regulators arrived at settlements with Fannie and Freddie for their fraudulent activities. And the bad news kept coming through 2007 and the first quarter of 2008.

This coincides almost precisely with the beginning of the end for both the housing and stock markets. For decades, Fannie and Freddie were considered among the bluest of blue chip stocks. An implicit government guarantee ensured that many financial institutions held the GSE equities as core components of their portfolios.

Insurance giant AIG, for example, held $600 million in GSE stock. In total, financial institutions held as much as $5 billion in the GSEs. When the stock values of the GSEs melted down, so too did the capital base used for calculating the financial strength of banks and other institutions.

In short, when the initial dominoes fell -- Fannie and Freddie -- the rest of the system began to crumble.

The charts provide ample evidence of the tragic errors associated with attempts to "social engineer" the free market system. As citizens it is our duty to prevent government from engineering more debacles related solely to central planning. We know that central planning does not work: the Soviet Union and the Community Reinvestment Act offer stark evidence.

Instead, we would be well served to advocate cutting taxes for corporations and individuals; and forcing government itself to down-size. Now there's a radical idea.

Update: The revisionists at The New York Times blame the meltdown on -- wait for it -- George W. Bush.

Update II: Commenter Unquiet asks " question I always have with trend charts and corrolation with events - causation? Not to ask you to shoot holes in your own argument but, if you were on the other side, what other events than those you propose could be considered alternative causes for the trends charted?"

There are obviously many, many variables involved. Several that we might examine:

1) the Fed's Fund Rates (inter-bank lending rate) - it's easy to see, however, that the drop in the FFR has historical precedent. Prior drops didn't cause any anomalies in subprime mortgages!

2) leverage ratio for investment banks - "progressives" love to pin Phil Gramm with writing legislation loosening banking rules to permit investment banks wider leeway. But they purposefully omit any references to the underlying securitized vehicles: subprime loans.

3) inaccurate ratings for mortgage-backed securities (MBS) - There's little question that flawed MBS ratings are an area of concern. But without poisoned mortgages, said ratings would never have been an issue.

* * *
All that said, these factors pale in comparison to the underlying instigator: a changed policy within the Clinton administration. Andrew Cuomo's HUD and Janet Reno's Justice Department threatened banks with a variety of sanctions unless they loosened underwriting standards. Their aim: to hit certain thresholds for loans to the urban poor. Securitization, leverage and poor ratings were all built upon the underlying subprime rot caused by the Clinton administration's egregious experiments.
Update III: The Timeline (YouTube).

Washington Post: Six Years of 'Extensive Fraud' at Fannie Mae
Walter Williams: Subprime Bailout
Community Reinvestment Act: Obamonopoly
Linked by:
Patterico and The Artful Dodger. Thanks!

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