Barney Frank’s Confession

Remember my arguments about the cause of the recession?

Now compare what I wrote almost a year ago with Barney Frank’s confession in this video.

Word-for-word, he’s saying almost exactly what I wrote! He doesn’t specifically name the CRA, but talks extensively about the policies which Clinton’s 1995 expansion of the CRA created. I never thought I’d be saying this, but I completely agree with Barney Frank on the cause of the crisis.

On the other hand, we begin to differ again when it comes to the proposed solution. I say abolish Fannie and Freddie and end federal involvement in the housing market. He says abolish Fannie and Freddie and replace it with something entirely government-owned, and this time he’ll use policies that won’t fuck it up because he’s learned his lesson.

So there you have it: once the facts line up, it all comes down to a difference in faith in the government.

EDIT (8/5/11): But of course, Barney Frank’s faith is horribly misplaced.

On Greed and Recessions

Whenever I try to discuss the causes of this recession that we’re in, I always get the same answer: Greed did it. Banks and corporations got greedy and started offering risky loans to people who couldn’t pay them off in the hopes of making a profit off the poor. It was predatory.

But that doesn’t make sense to me. You see, greed is a constant. Greed is what leads banks to want to find people who will actually pay off their loans. Subprime loans are dangerous, and most banking institutions would be very cautious about offering them, absent of any external stimulus. So if banks were always greedy, why were so many risky loans issued all of a sudden? Why had subprime loans never crashed the market before? Something had to have changed to cause such a massive upset of the economy.

Something did change, and it wasn’t greed.

In 1977, US President Jimmy Carter signed into law the Community Reinvestment Act (CRA), a vague declaration of the power of the federal government to oversee and regulate financial institutions and ensure they uphold their “continuing and affirmative obligation to help meet the credit needs of the local communities in which they are chartered.” The act makes clear that race and sex of loan recipients may used as factors in determining whether or not financial institutions are “meet[ing] the credit needs of the local communities.” Essentially, affirmative action in financial loans and mortgages was established to be enforced at the federal level.

In 1995, President Bill Clinton asked CRA regulators to revise their standards to make them more consistent and “focused on results.” This meant establishing specific quotas that lending institutions had to fill in order to receive passing ratings under the CRA. Up to 50% of an institution’s rating would be based on the quantity, effectiveness, and “innovation” of loans to low- and moderate-income individuals and neighborhoods. At the time, the Cato Institute, a libertarian think-tank adamantly warned of the dangerous consequences of the proposed regulations. Most notably, Cato Institute Chairman William A. Niskanen testified that, “The proposed regulation would override any concern about bank soundness,” in its emphasis on helping poor communities. Essentially, banks would be required to provide many overly risky loans (many of them subprime) to people who couldn’t necessarily pay them back in order to meet CRA quotas.

Debate continued through Clinton’s second term as to the real effect of the CRA on financial institutions. Republicans complained that the Act was detrimental, whereas Democrats claimed it wasn’t going far enough. Thus, as a compromise, Congress passed the Gramm-Leach-Bliley Act, expanding the authority of the CRA to other types of financial holding institutions while requiring “a comprehensive study of CRA to focus on default and delinquency rates, and the profitability of loans made in connection with CRA.” This study would be delivered to Congress in March 2000.

The study concluded that nearly 50% of CRA-related home purchase or refinance loans were either unprofitable or barely profitable, compared to 28% for non-CRA loans. This, of course, would be due to the riskiness of the loans being issued. Clinton’s solution to this foreseeable unprofitability was to urge Fannie Mae and Freddie Mac, two government-sponsored mortgaging enterprises (GSEs) which had come under the CRA requirements with the passage of the 1999 Act, to start collecting these risky loans. This was meant to both increase the number of CRA loans available and to provide some insurance for CRA-regulated financial institutions by pooling risky mortgages (similar to the way the FDIC insures savings). Once the full scope of the problem was revealed in the March 2000 report, Fannie Mae and Freddie Mac redoubled their efforts.

And here we have the recipe for disaster. The CRA had filled the veins of the financial lending industry with these risky subprime loans, this poison, which Fannie Mae and Freddie Mac, the liver and kidneys of the system, were gathering up and trying to neutralize. All it took was a small shrug in the housing market to make enough of those bad loans in Fannie Mae and Freddie Mac turn to poison and kill these protective organs. With the liver and kidneys gone, the rest of the body suffered as people bankrupting from the Fannie Mae and Freddie Mac disaster defaulted on loans from other banks. Hence, we had the bank crash, and later, the automaker crash as large-investment segments of the economy fell apart.

So really, it wasn’t greed that caused this recession that we’re in now. It was humanitarianism. It was affirmative action. It was the government’s attempts to redistribute wealth by applying harsh regulations with the CRA.

This wasn’t the first time government regulation and interference in the market caused a recession. Tariffs throughout the 1920’s weakened the US economy by pushing away trading partners and decreasing gains from overseas trade. Finally, speculation started to become pessimistic in September 1929, as Senate committee debates over the Smoot-Hawley Tariff Act became public. This Act would drastically increase tariffs and protectionist measures, effectively placing a 60% tax on any farmer who bought equipment from overseas. The next month, the stock market crashed. In June 1930, despite the pleading of economists and businessmen such as Henry Ford and partners of J. P. Morgan, Hoover signed the bill into law, and US foreign trade started rapidly declining. Nations around the world responded by putting tariffs on their own goods to counter the effects of US tariffs. The Great Depression had begun.

The government cannot be trusted to take control of an economy for what it believes to be “the greater good.” When innovation and individual choice is allowed to flourish, we succeed together. When law forces us into bad choices, even when some realize how bad it could be, that is what causes us to fail together.

EDIT 4/10/16: The 2011 Financial Crisis Inquiry (FCI) Report includes a dissenting view (page 441-538) that fully corroborates my description of events as written here in 2009. Alternate link. Apparently, the majority opinion in that report tries to absolve the CRA of any responsibility, citing this paper by Fed economists Neil Bhutta and Glenn Canner to claim that “only 6% of subprime loans were in any way related to the CRA.” However, that paper completely ignores the role of the GSEs in creating an expansive market for subprime loans through their attempts to insure CRA-regulated institutions by buying up risky assets. This role is a historical fact, proven by the quote from HUD on page 497 of the 2011 FCI report, rendering the conclusions of Bhutta and Canner entirely baseless.