The Big Short.

If you haven’t heard of the Community Reinvestment Act (CRA) of 1977 it would not come as a surprise to me. You certainly didn’t hear about it in the movie, The Big Short. This movie claims to explain the housing collapse so as to prevent another one. Sadly, they left out the key element leading to the housing collapse and the financial meltdown that followed. Not only was the the CRA left out of the movie but also any responsibility of the federal government and its Government Sponsored Entities, Fannie Mae and Freddie Mac. Worse still, this major cause of the 2008 housing collapse still remains a part of the U.S. Code of Laws.

The problem with progressive/statist/altruists is that they simply cannot conceive that their “do-gooder” schemes are antithetical to their purposes. I decided to repost my thoughts on the 2008 financial crisis. It’s a bit long, but I hope worth your time.

Roy Filly

The Housing Collapse and the Financial Meltdown That Followed.

Democracy … arises out of the notion that those who are equal in any respect are equal in all respects.


A democracy is nothing more than mob rule, where 51 percent of the people may take away the rights of the other 49.

Thomas Jefferson

Democracy never lasts long. It soon wastes, exhausts and murders itself. There was never a democracy that did not commit suicide.

John Adams

Even after mortgage loans started going bad en masse, the confusing mix of federal and state agencies that made up the nation’s regulatory structure had difficulty responding. After regulators finally began to speak up about subprime and the other types of mortgage loans that had spun out of control, such lending was already on its way to extinction. What regulators had to say was all but irrelevant. Yet even the combination of a flawed financial system, cash-flush global investors and lax regulators could not, by itself, have created the subprime financial shock. The essential final ingredient was hubris.

Introduction to Mark Zandi’s Book, Financial Shock (Ah, but whose hubris?)

Fannie and Freddie were the catalysts, the match that started this forest fire.

John McCain

If our Founding Fathers thought so little of democracy as a form of governance, why did they “Found” a democracy? The simple answer is that they didn’t. They founded a Republic. The Aristotelian concept that “Democracy … arises out of the notion that those who are equal in any respect are equal in all respects” is not meant to praise democracy, but to show how those who seek power over the people subvert the basic concept.

If your political party is the friend of “the downtrodden,” then some group must be “downtrodden” or you have no friends. If one wishes to cement the concept that “those who are equal in any respect are equal in all respects” then it is incumbent on the political party to enshrine that “total equality” with lofty notions of “rights.” To be for “minority rights” is not a fundamental concept of Democracy. Majority rule is.

However, those seeking political power cannot simply protect minorities. They must promise “rights” to minorities. The most egregious of these enshrined “rights” is the notion of “an economic bill of rights” (a concept that was only conceived of a little more than 50 short years ago by none other than that great progressive Franklin Delano Roosevelt).

Clearly, our Founding Fathers believed in unalienable rights (i.e., those that belonged to us and could not be changed legitimately by any government). These were “life, liberty, and the pursuit of happiness.” Note that the guarantee is the “pursuit” of happiness, not happiness itself. It is this subtle nuance that led to the current severe recession. What guarantees that “minorities” and the “downtrodden” are happy, ask you? Why, home ownership, answers the Democrat Party! After all, it is the “American Dream!”

I have been concerned of late that the statist/collectivist/progressive media have been beating the drum about the “evil banks and Wall Street” for so long now that the average American believes that the blame for the housing bubble and the financial collapse that followed its bursting lies outside of government and not within it. Nothing could be farther from the truth (at least, as judged by my readings). The cycle that led to the current collapse lies firmly at the door of East Capitol Street, NE and 1st Street, NE, Washington, DC 20002, not Wall Street alone. That “blame” lies with both parties that occupy that address, but the Democrat Party makes the Republican Party look like amateurs in this analysis.

If you hadn’t noticed, our Government has analyzed the financial meltdown and issued a report – the Financial Crisis Inquiry Report. The media stated emphatically that there was no agreement. Republicans said one thing, the Democrats the other. That was not quite true. There were indeed legitimate areas of dispute, but some areas of agreement, as well.

[From Jennifer Taub of the Isenberg School of Management, University of Massachusetts, Amherst – a liberal bastion.] The Report states that: ”It was the collapse of the housing bubble—fueled by low interest rates, easy and available credit, scant regulation, and toxic mortgages— that was the spark that ignited a string of events, which led to a full-blown crisis in the fall of 2008.”

“High-risk, nontraditional mortgage lending by nonbank lenders flourished in the 2000s and did tremendous damage in an ineffectively regulated environment, contributing to the financial crisis.”

“Virtually everyone who testified before the Commission agreed that the financial crisis was initiated by the mortgage meltdown that began when the housing bubble began to deflate in 2007.”

Thus, it is time to begin our story. Interestingly, our story does not begin with a history of “derivatives” – those evil Wall Street constructs that supposedly resulted in the financial collapse. Indeed, credit derivatives are scary financial devices that few understand – I do not count myself among the informed. In their hay day their sum was $12 trillion – another one of those big numbers that is difficult to comprehend. However, to give you an idea of scale, $12 trillion is the approximate size of the entire US economy ($14 trillion in 2008) or approximately four times the entire value of the London Stock Exchange.

“Derivatives” were invented a short decade ago by a small group of financial Whiz Kids known as the “Morgan Mafia,” for JP Morgan Bank, the company that employed them and, indeed, made them very rich. Of course, now they are the ex-Morgan Mafia. To be sure, Wall Street played with fire and we all got burned. Wall Street lit the match to the kindling but what was the kindling?

For that information we must go all the way back to the 1970s and perhaps earlier still. Importantly, I wish to completely credit Professor Thomas Sowell and Steven Malanga, the Manhattan Institute Scholar, with the information I am about to regurgitate – and “regurgitation” is such an appropriate word to describe this particular culmination of the “law of unintended consequences.” The key words in our story’s history are “redlining,” and the Community Reinvestment Act (CRA). [From Wikipedia: The Community Reinvestment Act is a United States Federal law designed to encourage commercial banks and savings associations to help meet the needs of borrowers in all segments of their communities, including low- and moderate-income neighborhoods. Congress passed the Act in 1977 to reduce discriminatory credit practices against low-income neighborhoods, a practice known as redlining.] Now, what could be nobler than that?

Why was this law necessary and what the hell is redlining? Let’s begin with the latter. Redlining is the name given to the practice when banks were reluctant to give mortgages to some individuals living in particularly lawless areas of inner cities (i.e., banks drew a red line around these areas where they were reluctant to make loans. If you are old enough you will remember these areas going up in flames during the 60s riots – Viet Nam, Rodney King, etc. Those bastard banks! That is so undemocratic! After all, banks should follow yours and my example. We eat dinner in restaurants in those same lawless areas of the inner city every other day and we would never “discriminate” against such areas in our choices of where to dine. Damn those banks!

OK, say you. Filly is being “flip” again. True. But, sometimes the truth hurts and the only way to face it is to be “flip.” Neither you nor I would dine in those neighborhoods or would we likely make a personal loan to someone wishing to purchase a home in such a neighborhood. However, the need to exonerate banks for redlining doesn’t exist. Why? Because the whole notion of “redlining” was a near complete falsehood and “data proving” the existence of redlining was manipulated for political purposes.

The data that caused the furor was that non-white loan applicants were 60% more likely to be denied a loan than white loan applicants with “similar income levels.” The facts were as follows: 83% of non-white applicants were approved while 89% of white applicants were approved (i.e., approximately a 60% greater likelihood of being “declined”). Clearly, the overwhelming majority of both white and non-white applicants were approved. However, one cannot make a political argument by stating that 6% fewer non-white applicants were approved than white applicants. The sound bite doesn’t work. Quoting “denial” rates works. Quoting approval rates doesn’t. Further, 91% of Asians were approved for loans. Thus, whites were “denied” loans more commonly than the Asian minority. To make the political argument that “minority rights” were being violated it would be counterproductive to mention that whites were treated less well than Asian minority borrowers.

The second fallacy of the political arguments regarding “redlining” and thus leading to the Community Reinvestment Act was that they compared white and non-white borrowers of “similar income levels.” Now, that seems eminently fair as a comparison and would tend to make the political point that “discrimination” was at work and the government needed to step in to protect the underserved. However, if you have ever filled out a loan application you realize that “income” is only one line in a very long document. Employment history, net worth, assets, other loan responsibilities, credit history, your monthly payments for other expenses, the amount of planned “down payment,” etc all are factored by banks prior to issuing a loan. “Similar income levels” do not define the totality of the playing field.

These mitigating factors must be considered by any responsible bank, but apparently not by irresponsible politicians. Thus, despite plenty of evidence to the contrary, our leaders in Washington determined that non-whites must be protected from those evil banks and they passed the Community Reinvestment Act. This started a chain of events that, at least by my interpretation, led to the current financial crisis. Virtually every link in that chain was government initiated.

It was not just the Federal government, although they were the dominant force. States and municipalities didn’t want to be left out of the party. So they lent assistance whenever possible to cause the debacle. Banks and Wall Street investment firms entered the game very late. To be sure, they nailed the coffin shut, but the corpse (you or me) was placed in the coffin by our government sticking its nose into areas that were never meant to be “governed.” And so begins a house of cards.

The second link in the chain was an acorn. Not the acorn that grows the mighty oak, but ACORN. (Association of Community Organizations for Reform Now). Groups like ACORN began to monitor the lending practices of banks (this was allowed by the CRA). They began to file lawsuits based on perceived deviations from the intentions of the law. In 1986, for instance, ACORN protested a potential acquisition by Louisiana Bancshares, a Southern institution, until the bank agreed to new, “flexible credit and underwriting standards” for minority borrowers that included counting public assistance and food stamps as income in mortgage applications.

Acorn found its way into the mortgage business by using the CRA as a cudgel to force lenders to lower their mortgage underwriting standards in order to make more loans in low-income communities. Often, after making protests under CRA, ACORN was rewarded by banks with contracts to act as “mortgage counselors” in low-income areas in return for dropping their protests against the banks.

These “infractions” by banks caused government overseers to deny them the opportunity to open new branches or to merge with or purchase other banks. In one particularly lucrative deal, 14 major banks, eager to put CRA protests behind them, signed an agreement (in 1993) to have Acorn administer a $55 million, 11-city lending program. It was this very agreement that helped ACORN evolve from a network of small local groups into a national player. It was under this very banner that ACORN was eventually shattered as a national force when, acting as “mortgage counselors,” they counseled a pimp on how to get a loan to set up a brothel for underage prostitutes.

ACORN wasn’t alone in these efforts. Other agencies with different acronyms participated. A U.S. Senate subcommittee once estimated that CRA-related deals between banks and community groups had provided nearly $10 billion of funding to the nonprofit sector. Indeed, government regulators at this point in the story relied heavily on groups like ACORN to monitor compliance with the CRA – not their own analysis. The foundational cards in a growing house of cards were laid down.

Now, let us look at the evil banks. They are being sued and severely penalized for not making loans to individuals who are at risk for not being able to repay the loans. They are further being pilloried for not lowering their mortgage underwriting standards. So, surprise, surprise, they lowered their mortgage underwriting standards. The house needs more cards added!

At approximately this time the Reagan miracle had begun – the longest and greatest expansion of any economy ever on planet Earth. So, times were good! By the mid 1990s thing were very good. We were well into the upswing of the first of the recent bubbles – the “dot com” bubble. Housing prices began to rise and rise and rise. There seemed to be no end in sight.

No self-respecting statist/collectivist/ progressive could let this go by without some plan to expand the economic rights of the less fortunate. William Jefferson Clinton decided that he was going to single-handedly expand the dream of home ownership to every American. Any review of the history of the affordable mortgage movement in America demonstrates the power that CRA had in helping to shred mortgage-underwriting standards throughout the industry and expose us to the kind of market meltdown we’ve experienced. President Clinton sought to expand the CRA exponentially.

Clinton’s Secretary of Housing and Urban Development, Henry Cisneros, announced a plan in 1993 to boost homeownership in the U.S. through a series of government initiatives, including having government subsidize mortgages that required no down payments. How did Secretary Cisneros propose to accomplish this? He vastly expanded CRA to include mortgage lenders and financial institutions other than banks under the CRA umbrella.

The Democrat Congress saw the wisdom of the President’s plan and smoothed the way to expand the CRA program. Rep. Maxine Waters dubbed mortgage companies “egregious redliners” who needed to be corralled by CRA. Representative Barney Frank and Senator Christopher Dodd became … well, let us be kind and call them “advocates.” Under pressure from these Congressional and White House threats, the trade group that represented mortgage bankers announced an agreement with HUD to sharply boost lending in low-income areas. These mortgage bankers, the so-called nonbank lenders, agreed to “voluntarily” help develop new mortgage products with less stringent underwriting standards.

For my readers who are not familiar with the term “nonbank lenders,” these institutions are not banks, but either extend loans, securitize bank loans or otherwise play roles in the extension of credit, long-term or short-term. Didn’t you ever wonder why there were, all of a sudden, 10 commercials per hour for Countrywide and Lending Place two more cards on the growing house of cards.

By now banks and non-bank lenders were doing their part under the watchful eye of ACORN and friends. But banks couldn’t make the dream of home ownership for every American come true by their efforts alone. A really big, powerful entity was required – the Federal Government. Viola! ACORN began to put pressure on the two quasi-government purchasers of mortgages, Fannie Mae and Freddie Mac. These Government Sponsored Entities (GSEs) were “forced” to lower their mortgage underwriting standards.

ACORN complained that Fannie and Freddie were “strictly by-the-book interpreters” who stood in the way of new lending programs. Under relentless pressure, both organizations committed to backing billions of dollars in affordable housing loans under so-called “alternative qualifying” programs that approved loans to individuals who didn’t qualify under traditional standards. However, the wise bastions of rational lending insisted on some provisions to these risky loans. The recipients were required to go to mortgage counseling classes. Who ran those programs, ask you? Why ACORN, answer I. Add another card or two to our growing house of cards!

The problem began to grow at a rapid rate. Nonbank players in this drama began to lend, lend, lend. Independent mortgage companies like Ameriquest and New Century were among the most prolific subprime lenders. Since they were not banks, they could not accept deposits, which limited their access to funds. When the hammer came down, these organizations were the first to collapse. At least 169 independent mortgage companies that reported lending data in 2006 ceased operations in 2007, according to the Federal Reserve.

[From “The Roots of the Financial Crisis: Who is to Blame? By John Dunbar and David Donald.] Again, big banks are not to be exonerated. “Some of the nation’s largest banks have subprime lending units, including Wells Fargo & Co., which ranked No. 8, JPMorgan Chase & Co. at No. 12, and Citigroup Inc. at No. 15. The big banks’ mortgage business was less reliant on subprime lending than that of the non-bank lenders. But most of the big investment banks also purchased subprime loans made by other lenders and sold them as securities” (more on this later). Lehman Brothers (No. 11) was in for a massive surprise when the dike finally broke.

“The government seized two of the top subprime lenders (when the bubble finally burst). IndyMac Bank (No. 14) and Washington Mutual (owner of Long Beach Mortgage Co., No. 5) were each taken over by federal banking regulators after big losses on their portfolios of subprime loans. American International Group (AIG), better known for insurance and complex trades in financial derivatives, made the list at No. 18. (Lucky us, we, the American taxpayers, own AIG now).”

Did you ever buy a derivative? Probably not. If you did, you probably weren’t aware of it. These sophisticated instruments were sold in bulk between major investment firms and bank-to-bank transfers. Oh, to be sure, there was an enormous desire among investors to earn greater dividends on their bond purchases. What investor wants less, not more? However, to say that these huge investment firms were duped into buying derivatives loaded with subprime loans is insane. They knew exactly what they were buying. They wanted them. Why? Because they could resell them easily. Why? Because they were Mortgage-Backed Securities. What the hell are those? The process of securitization is complicated. However, these mortgages are securitized by trusts. Securitization trusts include government sponsored entities. In the USA, the most common securitization trusts are Fannie Mae and Freddie Mac. Add a whole bunch of cards to the growing house of cards.

It appears that I am exonerating financial institutions in this report. If that is how it sounds, then I am doing a poor job. The banks and nonbank lenders dove in when they realized profits from lending to non-credit worthy borrowers were astronomical. [From the Financial Crisis Inquiry Report] “Across the mortgage industry, with the bubble at its peak, standards had declined, documentation was no longer verified, and warnings from internal audit departments and concerned employees were ignored. These conditions created an environment ripe for fraud. William Black, a former banking regulator who analyzed criminal patterns during the savings and loan crisis, told the Commission that by one estimate, in the mid-2000′s, at least 1.5 million loans annually contained ‘some sort of fraud,’ in part because of the large percentage of [so-called] no-doc loans originated then.” The report reveals that: “between 2000 and 2007, at least 10,500 people with criminal records entered the [mortgage loan] field in Florida, for example, including 4,065 who had previously been convicted of such crimes as fraud, bank robbery, racketeering, and extortion.” Add at least 5 cards to the top of the rapidly growing house of cards!

Therefore, one must wonder, how did they get away with this? It is my conclusion that one must go directly to the CRA. It was not that the CRA was “the” cause. Rather, the CRA began a process that had an inevitable conclusion – do-gooders, politicians, less than savory people and very sophisticated investors would find their way into this multi-trillion dollar bonanza created by a burning collectivist desire. What desire, ask you? Why the old “home ownership for all” (“chicken in every pot”, etc) collectivist desire, answer I. So, greedy lenders and Wall Street investment houses indeed struck the match. But the Federal government laid out the kindling nicely. Had there been no kindling – no fire.

Now, take your right index finger, make a circle with your thumb, and flick at the base of the house of cards.

Roy Filly


About Roy Filly

Please read my first blog in which I describe myself and my goals.
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