Pundits and market fundamentalists often cite the Community Reinvestment Act (CRA) and other government initiatives as the cause of the Sub-Prime Mortgage Crisis. But is this accurate? A report from the Federal Reserve says no. Here is the abstract, and a link to the report:
Abstract:
A growing literature suggests that housing policy, embodied by the
Community Reinvestment Act (CRA) and the affordable housing goals of the
government sponsored enterprises, may have caused the subprime crisis.
The conclusions drawn in this literature, for the most part, have been
based on
associations between aggregated national trends. In this paper we
examine more directly whether these programs were associated with worse
outcomes in the mortgage market, including delinquency rates and
measures of loan quality. We rely on two empirical approaches. In the first approach, which
focuses on the CRA, we conjecture that historical legacies create
significant variations in the lenders that serve otherwise comparable
neighborhoods. Because not all lenders are subject to the CRA, this
creates a quasi-natural
experiment of the CRA's effect. We test this conjecture by examining
whether neighborhoods that have been disproportionally served by
CRA-covered institutions historically experienced worse outcomes. The
second approach takes advantage of the fact that both the CRA and GSE
goals rely on clearly
defined geographic areas to determine which loans are favored by the
regulations. Using a regression discontinuity approach, our tests
compare the marginal areas just above and below the thresholds that
define eligibility, where any effect of the CRA or GSE goals should be
clearest. We find little evidence that either the CRA or the GSE goals played a
significant role in the subprime crisis. Our lender tests indicate that
areas disproportionately served by lenders covered by the CRA
experienced lower delinquency rates and less risky lending. Similarly,
the threshold tests
show no evidence that either program had a significantly negative effect
on outcomes.
The Financial Collapse of 2007-08 affected everyone- globally. It has exposed inherent flaws in our globalized world- our banking and monetary systems are interconnected today to a degree that never existed before. Economists since the 1990s have been talking of "contagion;" financial turmoil in one part of the world can now easily spread throughout the entire global financial system and crush economies, bankrupt entire nations, or merely cause recessions. The scale of the disaster is not yet known. As of right now, the US seems to believe the emergency has passed, at least if you ask officials publicly-- but high-level officials are still scrambling to fight the spread of the turmoil. That is why Europe's problems are still front-and-center in the news, and partly why it would be disastrous if any country in the Eurozone defaulted on its debt- it would begin a domino effect in Europe which could easily spread to other parts of the world. Many economists and news sources compare the financial meltdown of 2007-08 to the Great Depression. Indeed, there are many similarities. However, the response has differed on many levels, and the result is that "the biggest economic downturn since the Great Depression" still doesn't quite match the scale of the devastation wrought in those years. Yet, there still is danger on the horizon, and the experience is not quite finished. Causes of the Collapse Beginning in the United States and then spreading to the rest of the world due to our globalized finance system, the financial meltdown was a case of reckless investing, fraud, and
regulatory neglect. What a lot of Americans don't realize is that it was a
direct result of the 1999 removal of vital legislation (the Glass-Steagal Act)
that was enacted in the United States following the 1929 Crash that led to the
Great Depression. The Glass-Steagal Act of 1933 was designed to prevent the
very type of incident that wound up happening in 2008.
In a nutshell, Glass-Steagal
prevented commercial banks (banks that make loans and hold your money) from
being the same institutions that buy/sell/make investments. This basically kept
the banks that hold your money and loans from gambling in the stock market or reinvesting their assets and liabilities in risky financial instruments.
Among several other pieces of Depression Era legislation, Federal Deposit
Insurance agencies were set up to ensure that the deposits of customers at
these banking institutions were protected in the case that their money was
somehow lost (due to robbery, physical destruction of bank notes, bank failure,
etc.).
The repeal of these laws led to a dangerous entanglement of financial
institutions- commercial banks, investment banks, securities handlers/private
investment insurers and hedge funds were hopelessly interrelated with no
firewall in place in case of calamity or market failure. Worse yet, in some
cases they were insured by both private and federal agencies. Even more troubling, in a bid to make big profits even bigger, major banking institutions began leveraging their assets as high as 40:1 and investing in securities, derivatives and hedge funds to distribute the risk. American institutions were the inventors of these practices during the 1990s, but banking instituions in the rest of the world were so impressed with the profits being made, they soon began engaging in these same risky practices. What had been created was an illusion. There was a promise of well-distributed risk, but in reality the risks were mounting higher and higher while infecting every corner of the global financial system.
When the bottom
dropped out of the Mortgage-backed Securities market and CDOs, banks and insurers
both began to fail at an alarming rate. These institutions had just gone
through a rapid merger and consolidation process throughout the 1990s and
2000s, leading to the creation of institutions that were so large their failures were a
systemic risk to the economy of the entire world-- not just the US economy.
This 11-minute video explains what
happened with the CDOs and Mortgage-backed Securities rather succinctly:
"The Crisis of Credit Visualized" by Jonathan Jarvis
Since the scale of the collapse was
so immense, the government of the United States was faced with a rather
ludicrous paradox to its capitalist system: we now had to resort to a form of
socialism in order to prevent the collapse of capitalism. The banks got bailed
out, through several means.
Flawed Responses
Overtly, TARP (Troubled Assets Relief Program) was
administered by the Bush and Obama administrations, followed by several
economic stimulus programs at an ever-increasing price tag of over $3 trillion
(subsidized, of course, by the American taxpayer).
Covertly-- mainly to secure
confidence in the system-- the Federal Reserve also implemented "secret"
loans to some of the largest banking institutions in the world (not just
American banks). These loans were delivered as
short-term loans at what is known at the Fed as the "discount window"
in which interest rates are at or close to zero.
Page 131 of the GAO's Report. Dollar amounts are in billions.
The main idea behind this was to
save these institutions from total collapse while encouraging lending between
banks and (hopefully) to consumers in general. The Federal Reserve handed out loans to major banks worldwide (but mainly US & European banks) valuing a total of $16 trillion. It worked- but only halfway. The
institutions stayed open, but credit was not freed up. This prevented a total
economic collapse, but failed to stop the global Great Recession. Aside from this arrangement, the Fed also secured a currency-swap with the Central Banks of the EU, the United Kingdom, South Korea, Switzerland, Norway, Sweden, Denmark, Canada, Australia, Brazil, Mexico, Singapore, and Japan, in which the Fed lent $10 trillion USD in exchange for the currencies of these countries (secured at the cost of dollars/unit of currency of the day, with no appreciation or
depreciation).
Page 131 again, with emphasis added. These loans wereadministered without the knowledgeor consent of the USCongress.
This information only came to light due to the first-and-only audit of the US Federal Reserve since its creation. The audit was administered by the Government Accountability Office and only investigated the activity surrounding the financial collapse and emergency relief funds extended to banks during the aftermath. As it turns out, the loans were largely repaid. Only about $1 trillion remained outstanding at the time of the audit. Banks mostly were able to afford this because of two things: they didn't extend credit like they were supposed to, and they levied interest and fee increases on their customers.
So in other words, the people paid
for this crisis twice (or three times, depending on how you count): Once in lost assets, once in tax money administered by the government bailouts in all forms, and then once again in fee increases imposed upon banks' customers.
No wonder
the economy was in such a shambles! The money at the Federal Reserve is
"printed" at our expense; the banks financed their repayment of the
debt to the Fed on fees imposed on you & me, and the banks still refused to
resume lending. You may remember that at the time during & following the
bailout, credit card companies began charging ridiculous interest rates on new
and at-risk customers-- rates far beyond what used to be called
"usury" -- up to 75%.
Meanwhile, homeowners- even ones in
good standing- began to experience the loss of their biggest investment. House
prices fell so rapidly that many homeowners suddenly realized they
were paying on mortgages that far outmatched the present value of their homes
(we call these "underwater mortgages").
Foreclosure rates not seen since the
Great Depression ensued, and unemployment skyrocketed (While it's important to be sure the scale of today's problems aren't understated, it's worthwhile noting that the home foreclosure and unemployment rates never really came close to the rates of foreclosures and unemployment during the Great Depression). We had entered the Great Recession.
Socialism For the Rich, Capitalism for Everyone Else
What followed these events led
to the eruption of populist uprisings like Occupy Wall Street
(OWS). The average American was outraged that, not only had the government
bailed-out these irresponsible banks, but they refused to institute effective
regulation of these institutions. The OWS battle cry became, "Banks got
bailed out; we got sold out!" the core concepts of capitalism seemed to be
torn asunder. Bernie Sanders (I-Vermont) said of the bailouts, "This is a clear case of socialism for the rich and rugged, you're-on-your-own individualism for everyone else."
For the banks, this
institutionalized a concept called "moral hazard" in which the banks
know they are too big to fail, and that if they are on their way down, the
government must step in to save them, or risk the collapse of the entire system
and contagion to the rest of the Global Economy, thus incentivizing systemic risk if the potential short-term gains are high.
Countries in the European Union are
still reeling from this disaster, and while it cannot be said that it was the
only cause of their woes, the financial collapse was the catalyst that caused
countries like Spain, Greece, Ireland and Italy to slip toward bankruptcy.
The Federal Reserve Bank continues
to treat the problem by "Quantitative Easing" (inflating the money
supply domestically) and by sending trillions of dollars to the EU, to prop up
their Central Bank. Normally, this would cause inflation rates to soar, but the
problem we could be facing in absence of this tactic would be massive
deflation.
To be clear: there are many
details and inner workings of the real economy that complicate and exacerbate
the situation of frozen credit markets; large corporations often borrow money
to cover R&D, new acquisitions and, yes, even employee payroll. Thus, the
reason for rampant unemployment: if companies can't get easy credit, they can't
expand as easily, nor can they afford to hire American workers.
My opinion is that the bailouts,
while repugnant to the core principles of capitalism, were utterly necessary to
prevent a second Great Depression. Where the US government's response failed was at
three points:
1. The bailouts weren't big enough
to solve the credit crisis, and banks remained leery of loaning money, even to
each other.
2. U.S. banking institutions should
have been dismantled to pre-1999 sizes, separating commercial banks from
investment banks, and should have been led through government-managed bankruptcy proceedings as a condition of accepting federal funds.
3. Homeowners whose mortgages were
threatened by falling home prices and frozen credit should have had their debts
forgiven by failing banks. At least then there would have been an equitable extension of
"socialism" for all and a suitable punishment for the banks and
financial institutions that caused the crisis, while freeing up what little
liquidity there still was in the private economy.
The real betrayal happened in more
recent days, however. While the US is still facing high unemployment, the stock
market has regained almost all of its losses, the GDP of the US is higher than
ever (albeit at a slightly reduced rate of growth) and corporate profits after
taxes are at record highs. While many common folk seemed to (bafflingly) blame
the government for this predicament, the onus falls squarely on bankers and the
directors of large corporations.
Yet, the "solutions"
proposed by this group of the richest people in the world are the same exact
reckless philosophies that led to the crisis in the first place. They are
demanding reduced regulations in banking and lower corporate, individual and
Capital Gains taxes.
The question at the root of all of
this is whether or not to support what some economists call "Market
Fundamentalism" in which a free, unregulated market allegedly functions
perfectly and makes "natural" corrections, or to return to what is
known as Keynesian Economics, in which the government allows a certain amount
of economic freedom in a pre-determined market, while controlling liquidity and
interest rates through a government-supervised Central Bank.
I personally think the
concept of "Market Fundamentalism" (an extreme view of neo-liberal economic policies) is more akin to "Economic
Anarchy." Think of it on a social scale: if there were no laws, there
would be no police and no judicial system. Would that eliminate crime? Would
society "correct itself" and regulate itself? I'd hate to see the
brutal Darwinist world that would emerge from such a policy, just as I'd like
to avoid the emergence of a Darwinist economic anarchy of a "truly free" market as these fundamentalists envision. What would inevitably emerge
would be giant corporations and megalithic monopolies that would steamroll over
small business and crush workers. We may as well submit to feudalism.
We've already seen the consequences of loosening regulations. I don't need any more proof. Do you?
Are we just cogs in a social machine? Are we just independent particles floating in an endless ocean? Are we each insignificant specks of dust in an emotionless Universe? Or are we fundamentally connected?
Science now knows our bodies are made of trillions of separate organisms- viruses, bacteria, as well as your own body cells- and we cannot live without this interspecies collaboration that exists within our skin. Each of us is our own biosphere. Nature is made of the same type of interdependence, and the boundary of our Earthling biosphere is a fuzzy border. Where does "Nature" end? Not at the highest layer of our atmosphere-- not at the edge of the Moon's orbit, not beyond our Sun.
Western culture loves to apply a Cartesian dualism to each of its studies-- but we're quickly learning this is not accurate. We are not separate. Want empirical proof? You can study the interdependence of beings in any ecosystem, you can look to the smallest pieces of observable matter in quantum physics, or you can study the effects of gravitation on the Earth's tide, Solar winds and cosmic rays emanating from space and their affect on life on Earth. Everything is connected and interdependent.
