At the crisis' core are loans that were made with virtually nonexistent underwriting standards - no verification of income or assets; little consideration of the applicant's ability to make payments; no down payment. Most people instinctively understand that such loans are likely to be unsound. But how did the heavily-regulated banking industry end up able to engage in such foolishness?
From the current hand-wringing, you'd think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job. In fact, it was the regulators who relaxed these standards - at the behest of community groups and "progressive" political forces.
In the 1980s, groups such as the activists at ACORN began pushing charges of "redlining" - claims that banks discriminated against minorities in mortgage lending. In 1989, sympathetic members of Congress got the Home Mortgage Disclosure Act amended to force banks to collect racial data on mortgage applicants; this allowed various studies to be ginned up that seemed to validate the original accusation.
In fact, minority mortgage applications were rejected more frequently than other applications - but the overwhelming reason wasn't racial discrimination, but simply that minorities tend to have weaker finances. Yet a "landmark" 1992 study from the Boston Fed concluded that mortgage-lending discrimination was systemic.
That study was tremendously flawed - a colleague and I later showed that the data it had used contained thousands of egregious typos, such as loans with negative interest rates. Our study found no evidence of discrimination. Yet the political agenda triumphed - with the president of the Boston Fed saying no new studies were needed, and the US comptroller of the currency seconding the motion.
No sooner had the ink dried on its discrimination study than the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: "discrimination may be observed when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants."
Some of these "outdated" criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification. Instead, the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant's ability to manage debt.
Sound crazy? You bet. Those "outdated" standards existed to limit defaults. But bank regulators required the loosened underwriting standards, with approval by politicians and the chattering class. A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities. It also let community activists intervene at yearly bank reviews, shaking the banks down for large pots of money.
Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department. Flexible lending programs expanded even though they had higher default rates than loans with traditional standards. On the Web, you can still find CRA loans available via ACORN with "100 percent financing . . . no credit scores . . . undocumented income . . . even if you don't report it on your tax returns." Credit counseling is required, of course.
Amazing.
29 comments:
That article makes one excellent point: business often wants a proper, fair, regulatory system to secure fair competition but various zealots/ignorant people in government stand in the way of one.
The answer is simpler, better standards properly enforced. The have now, buy later society should be brought to an end and a new era of personal responsibility, self-discipline, and living within one's means (this can be linked to greening: sustainable lifestyles without automatically reaching for more cars/houses/sheds/children that we can't support).
I think Cameron has grasped this by now. Economic stability has to be established.
Why did so many banks lend to so many with a real potential for default?
Laurence Auster’s article, dramatically entitled Racial socialism and the subprime mortgage crisis , links to an at least superficially informative article by Thomas DiLorenzo The Government-Created Subprime Mortgage Meltdown
The thousands of mortgage defaults and foreclosures in the "subprime" housing market (i.e., mortgage holders with poor credit ratings) is the direct result of ... the 1977 Community Reinvestment Act (CRA), which compels banks to make loans to low-income borrowers and ... "communities of color" that they might not otherwise make based on purely economic criteria.
... The CRA is enforced by four federal government bureaucracies ... any bank merger, branch expansion, or new branch creation can be postponed or prohibited by any of these four bureaucracies if a CRA "protest" is issued by a "community group." ... use[s] this leverage to get the banks to give them millions of dollars as well as promising to make a certain amount of bad loans in their communities.
Banks have been placed in a Catch 22 situation by the CRA: If they comply, they know they will have to suffer from more loan defaults. If they don’t comply, they face financial penalties ...
banks ... have been forced to hold ... bad loans, ... "subprime" loans. In order to compensate themselves for the added risk of extending these loans, many lenders have increased the lending fees associated with mortgage loans. ... So-called predatory lending laws therefore force the banks to "eat" the losses. This is undoubtedly a contributing factor to the bankruptcy of dozens of mortgage lenders over the past year. etc.
Any American financiers know of the validity of this?
Iain,
It wouldn't happen here, would it?
You bet it did!
Call me cynical but this item will be picked up and hurled into the long grass by the likes of the BBC. As with Climate Change, the Credit Crunch is solely due to greedy western capitalists (roll stock Enron footage and swimming polar bears). That is the consensus view of those who know better than the rest of us and no other opinion will be tolerated.
Political correctness caused the credit crunch, eh? And here was me thinking asylum-seeking paedophiles were responsible!
This was one of the main points made in the ground breaking Dispatches documentary a short while ago about the Northern Rock situation and sub-prime crisis in america.
An interesting example of how all those "leftists" who decry the influence of Big Business & its allegedly undemocratic power. In fact business is a very weak reed when facing government regulation & the bigger the business the more vulnerable it is. Power lies with government - the only major power business has is to create the wealth government lives off of.
Never happen in the UK - why it's almost as ridiculous as creating interest-free mortgages to conform with Sharia....
Oh.
Oh so it was nothing to do with the Republicans persistent call for deregulation - I wondered how long it would be before they tried to switch the blame onto someone else.
Of course all the banks were forced to lend to risky customers against their will - and all those innvestment banks designed all those complicated structures so that the risky debt could be repackaged into supposedly high quality bonds, and they were forced to give their fat fees to the PC lobby??? Not even the banks which have suffered the losses are blaming it on political correctness.
So weak!
Yes it's all a global conspiracy by drug crazed leftie loons who mock our sufferings from their tropical island lair. See how they infiltrated the White House and installed their hapless puppet. This problem has nothing at all to do with a bunch of over-ambitious bankers.
Must go and chat to the elves at the bottom of my garden for some more of their insightful analysis of the global financial situation.
I read similar, but with a lot less detail and evidence, months ago. The most amazing thing is that this hasn't been a major story in the news media.
Of course there is nothing amazing about the BBC ignoring evidence of the failures of socialism! However there are other news sources out there, and it seems Dispatches managed to work it out. What are the professional reporters doing with their lives?
The New York Post is subprime toilet paper.
No one in their right mind reads it, let alone quotes from it.
I would suggest that this crisis will not manifest itself in the UK - we have a relatively small percent of high risk loans on the banks books.
But PC is to blame for other crises in this country, here are just a few PC driven crises
1) Disablity Welfare Crisis - where real disabled people are treated the same as somebody who has a bad back.
2) Prison Crisis - where criminals are treated as victims and not sent to jail if they knife a pensioner when they are on drugs - because REALLY the mugger is just a little-ickle victim.
3) Gang crisis - where politicians are too afraid to say "black kids are out of control with guns and knives"
4) Family break down crisis - where children can't be disciplined at home or at school.
5) Human Rights crisis - where people demand rights but shirk responsibilies
6) Divorce crises - where 2/3 of fathers loose touch with their kids because all women are angels and all men are bastards.
7) Feminist crisis - where woman realise that succeding at work isn't so much fun and have now burnt their bridges and can't be allowed to be good housekeepers - so all women are left with is their sexuality - and young children see Britney flashing her privates in the back of a cab as being a rol model.
8) Add your own crisis here ... etc
martinusher at CIF posts:
The Best Way to Rob a Bank is to Own One
"In this expert insider's account of the savings and loan debacle of the 1980s, William Black lays bare the strategies that corrupt CEOs and CFOs--in collusion with those who have regulatory oversight of their industries--use to defraud companies for their personal gain. Recounting the investigations he conducted as Director of Litigation for the Federal Home Loan Bank Board, Black fully reveals how Charles Keating and hundreds of other S&L owners took advantage of a weak regulatory environment to perpetrate accounting fraud on a massive scale. He also authoritatively links the S&L crash to the business failures of the early 2000s, showing how CEOs then and now are using the same tactics to defeat regulatory restraints and commit the same types of destructive fraud."
Iain, this comes right back to the point I was making on your post about maternity/paternity rights.
Business is NOT an arm of the state, and should not be used as one. It is not the role of financial bodies or banks to advance Government social policy, tackle 'social exclusion' or inequality!
Banks and financial institutions exist to make decisions which are in the best interests of the shareholders.
When a business tries to be a social worker, it goes tits up very quickly!
That is not to say that sub-prime lending is inherently bad. Indeed, it can be profitable for both the business and wider society, and have the beneftical by-product of getting people into property ownership who wouldn;t usually be able to dream of it.
But there needs to be proper oversight if it is going to be successful.
Afterall, those who were lent this money now have their houses repossessed and they are in a far worse situation than they were before - all because some do-gooder decided to 'right a wrong', and make the situation worse.
And now we are all paying for it!
shame the government were never so demanding about banks loaning to small busineses! Try and get a smal frims loan and it;s like pulling teeth with tweezers
Comical to read Gordon Brown's piece in the FT after Davos claiming that the answer to the sub-prime crisis is more regulation, and the creation of an international super-regulator to intervene in national markets when risks are being incorrectly priced!
Under Basel 2, banks were encouraged to repackage and sell on the risks they were holding to others, the idea being to spread risk. Banks who did this were observing the instructions from international regulation.
It sure as hell spread it - right round the world until no one knows where it is any more.
It was regulation which caused the sub prime crisis, and a failure on the part of anyone to take responsibility for what was happening until it was too late.
Having just read through the Fed's 1992 Policy Note on this, it's pretty clear there was pressure from the regulators for lenders to flex their normal underwriting standards for minority groups.
Did it cause the subprime crisis?
On its own it was probably not enough (after all, lenders would still wan to get repaid). But once it got coupled up to slice and dice structured finance in the global wholesale markets (ie the divorce between loan origination and risk bearing), greed took care of the rest.
And as Javelin says, we've got our own stack of unintended consequences from similar PC action (take a look at the London Drivel Agency).
Nonsense! Nonsense on Stilts!
At best you could say that for SOME cases PC attitudes and legislation were a contextual with regards the Credit Crunch.
However, the "cause" of the Credit Crunch is too much money chasing too few good borrowers.
Why?
Because as corporate profits rise (and they are (or at least were until last year) at record highs), the amount firms need to borrow decreases. At the same time they pay more out to shareholders in dividends and share buy backs.
The result is that banks and investors both have more money than they know what to do with.
The result is that in order to get "worthwhile" returns, the banks take bigger risks with their capital. Eventually, many banks and investors take very high risks with their capital. Pricing does not adequately reflect this risk and if it did: the problem would continue - the banks would have too much money and their risk adjusted returns would still be low (as the Economic Price of the loans, being higher than the market price, would result in the bank making fewer high risk loans).
Thus it's less a credit crunch and more a credit cycle.
Admittedly, we can look to blame poor Bank screening and the rating agencies.
We can also bemoan the compensatory environment within banks and investment funds.
But that's the way it is.
There is no law saying you have to lend money to anyone who asks for it.
Putting the two together and the claim that PC leanings and Positive discrimination drove the current crisis is ludicrous!
Big Andy
Big Andy
Errrrmmm, if you read the piece and others I have seen, the point is that yes, there is a law that says banks should lend to those who ask. Or in effect there is. Banks who don't lend to minorities because of the credit risk would be penalised byt he regulators.
Richard Dale:
Do you think this "law" is the driving force of the lenders behaviour?
Or do you think the ability to make loans and then sell them onto others letting them shoulder the losses is more of an issue?
How come none of the banks themselves have clamoured to make these regulations known (at the current time?), now that the chickens have supposedly come home to roost? How come the Economist/FT, staunch opponents of anti-market regulation and interferance have not referenced it (at least to my knowledge)?
Do you know if this law has been tested in court? I find it hard to believe a bank would be censured in a US court if it could demonstrate that it based its lending criteria purely on default probability.
All I can see is a ludicrous suggestion that PC politics has led DIRECTLY to the current credit crisis.
Consider: it's illegal to work longer than 42 hours a week on average in the UK (I think that's the figure - regardless - the EU working time directive is what i am referring to) unless you sign an opt out.
How many firms have been taken to court for breach of this? How many city/law firms have been exposed for "forcing" their employees to sign the waiver?
My experience is that there is a tacit understanding that if you are not prepared to work to the client's deadlines, you are not able to work in certain teams within these industries. I can't imagine an employee clocking off at 6 everyday whilst his team remain till 10-11 pm as well as the occasional saturday, and the firm is unable to refuse him promotion - let alone sack him - on the basis that he is not putting the hours in!
The relevance? That just because there is a regulation - does not mean it is: a) enforced; or, b) taken seriously.
PC politics and positive discrimiation are at best an excuse for lazy lenders, and at worst, an attempt to deflect blame by the deeply unprincipled people who sold these loans in the first place.
Big Andy
It is a well documented fact of life and has been for hundreds of years that the Big Banks control government policy, especially when it comes to finance, not the other way round.
If countless amounts of British PMs and American Presidents knew this as a FACT of life, over the last few hundred years. Then ask yourselves why you do not know this. Personally I largely blame the BBC, but thats another matter.
The Biggest Bankers, who I prefer to call Banksters control the Central Banks. The Central Banks Control the money supply of not just this country but the entire world. They promote the political party that suits there particular plan at the time.
If they are told to inflate they inflate or are dumped by the markets they control.
If they are told to deflate they deflate or are dumped by the markets they control.
Therefore for anyone to claim that it is something as superficial as not at all democratically inspired PC that has caused this problem is just involving themselves in a smoke and mirrors exercise. Either because they are being bribed, paid, of threatened to, or are simply as thick as two short planks.
Remember the same thing has happened for the same reason in both The America Republican Party and The British Labour Party. They simply chose to INFLATE a slightly different way. If you go around certain other countries you will also fine these generally similar policies have been going down all over the world.
If PC, mass uncontrolled immigration, wars in the middle east, the EU, etc etc etc were not policies agreed by The CFR The TLC or The Bilderburger's, (all organizations controlled by the biggest banking corporations,)in advance. They would not have been allowed to happen. It really is a simple as that, whatever some loony brainwashed lefty or righty may claim.
The Big Bankers have already got their plans in place to get the money they deliberately over lent back with interest. It gos by the name of CO2=Man Made Global Warming.
Or as my grandfather and father would and did say often.
"Taxing the air you breath if they thought they could get away with it."
They certainly think they can now, because they have been brainwashing our children for the last 25 years or so.
Now if the people wake up to this massively silly, expensive and wasteful scam, then the Big Bankers are in the shit, but only for a while.
We will only be in even bigger shit if this happens. Because the bastards will quickly dream up another plan, or more likely put into action their usual tried and tested plan B.
The sort of plan B that will make us wish for plan A. However clearly unscientific, stupid, counter productive to the interests of mankind, and the poorest parts of it especially, it is.
In the past this usually involved a 4-5 year World War. This time they might even come up with something even more outrageous. So my advice is to keep your heads down whatever happens from here on in.
You and me will be paying it all back one way or another. You can be perfectly assured of that. To say there is no such thing as a free lunch, is an understatement that we will soon all understand.
The good news is that the FACTS I have stated has always been the case all of our lives and that of many past generations. Our forefathers had to deal with far worse and still survived in there millions to tell their tale.
All I ask is that people start to see these lying scum bags for what they really are. Watching and listening to ordinary people having the piss taken out of them every day by the BBC in particular, I find deeply depressing.
I don’t “buy this”. The fact is that there is a memory cycle as well as an economic cycle. Most of the financiers who went through the terrible times of 1989-1993, in this country, have retired long ago. So, there are not very many people who remember the wave of repossessions at that time. A new generation of financiers takes over. They have no experience of recession and believe that property just goes on “up and up” in value. If this is the case then it doesn’t matter who you lend to, because you can always regain your money by repossessing defaulting borrowers property. So the financiers grew careless and lent money to people with appalling credit records. If told that there was a economic cycle and they would have their fingers burnt, they would say that times had changed and things were different this time. In America the extraordinary hubris, which has been sparked by seventeen years of “top dog” status has only added to this. Also, the need to constantly lend to meet targets exacerbated the problem. Now the economic cycle has turned and people will be badly burnt.
Kipling magnificently highlighted this phenomena in his poem “The Gods of the Copybook Headings”. I repeat it below, for it neatly sums up this crisis:-
“AS I PASS through my incarnations in every age and race,
I make my proper prostrations to the Gods of the Market Place.
Peering through reverent fingers I watch them flourish and fall,
And the Gods of the Copybook Headings, I notice, outlast them all.
We were living in trees when they met us. They showed us each in turn
That Water would certainly wet us, as Fire would certainly burn:
But we found them lacking in Uplift, Vision and Breadth of Mind,
So we left them to teach the Gorillas while we followed the March of Mankind.
We moved as the Spirit listed. They never altered their pace,
Being neither cloud nor wind-borne like the Gods of the Market Place,
But they always caught up with our progress, and presently word would come
That a tribe had been wiped off its icefield, or the lights had gone out in Rome.
With the Hopes that our World is built on they were utterly out of touch,
They denied that the Moon was Stilton; they denied she was even Dutch;
They denied that Wishes were Horses; they denied that a Pig had Wings;
So we worshipped the Gods of the Market Who promised these beautiful things.
When the Cambrian measures were forming, They promised perpetual peace.
They swore, if we gave them our weapons, that the wars of the tribes would cease.
But when we disarmed They sold us and delivered us bound to our foe,
And the Gods of the Copybook Headings said: "Stick to the Devil you know."
On the first Feminian Sandstones we were promised the Fuller Life
(Which started by loving our neighbour and ended by loving his wife)
Till our women had no more children and the men lost reason and faith,
And the Gods of the Copybook Headings said: "The Wages of Sin is Death."
In the Carboniferous Epoch we were promised abundance for all,
By robbing selected Peter to pay for collective Paul;
But, though we had plenty of money, there was nothing our money could buy,
And the Gods of the Copybook Headings said: "If you don't work you die."
Then the Gods of the Market tumbled, and their smooth-tongued wizards withdrew
And the hearts of the meanest were humbled and began to believe it was true
That All is not Gold that Glitters, and Two and Two make Four
And the Gods of the Copybook Headings limped up to explain it once more.
As it will be in the future, it was at the birth of Man
There are only four things certain since Social Progress began.
That the Dog returns to his Vomit and the Sow returns to her Mire,
And the burnt Fool's bandaged finger goes wabbling back to the Fire;
And that after this is accomplished, and the brave new world begins
When all men are paid for existing and no man must pay for his sins,
As surely as Water will wet us, as surely as Fire will bum,
The Gods of the Copybook Headings with terror and slaughter return.”
Tapestry
Basel 2 only came into force with effect from 1 January 2008 (and even then not for most US banks) - so just shows how much you know about the subject.
Tory boys never grow up 09:05: You obviously know less about Basle II than you think. The earliest date for Basle II implementation in the UK was 1 Jan 2007 and was optional from then until 1 Jan 2008 when it became compulsory. If you read some of my blog articles you will see why early adoption of Basel II was advantageous to UK banks.
Not a sheep
Not denying what you say - but how many banks adopted it early and of those how many got FSA approval for internal models which is where the real reductions in capital requirements arise. I think you will find the number is pretty miniscule and certainly not enough to be the casue of the credit crunch.
And no I'm not in favour of Basel II - allowing the bank's to decide their own capital requirements based on their internal models is really allowing the lunatics to take over the asylum - and is in effect a further extension of the trend of financial deregulation.
Isn't the New York Post the one controlled by the Moonies? Anyway, totally obviously, the overlending to the poor has nothing whatever to do with the vast commissions and share option deals pocketed by CEOs such as the guy who left Northern Rock having trashed it and half the national savings. Oh dear no. It's all the fault of confused lefties.
amazing post Iain.
certainly goes against the grain of "wall street greed" stories on the credit crunch.
A pretty lame attempt to shift the blame, it really is. Trying to pretend the orgy of global lending and property masturbation over the last decade is all the fault of PC lefties is just going to get bankers laughed at even more. If they're not careful the public will start to get annoyed that the tax-payer is having to foot the bill for all these bailouts of wealthy capitalists...
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