Three cheers for Sumit Agarwal, Efraim Benmelech, Nattai Bergman, and Amit Seru. Their recent research for the National Bureau of Economic Research comes far too late to have averted our current financial woes, and will likely be little noticed by the people charged with averting future catastrophes, but it’s nice to hear the truth spoken even when only for its own sake.
The quartet of exotically-named economists titled their paper “Did the Community Reinvestment Act (CRA) Lead to Risky Lending?,” and before delving into some very complicated analysis they answer the titular question with a simple “Yes, it did.” This admirably plain-spoken truth isn’t just a matter of academic interest, easily relegated to the pages of obscure economic journals, but rather a matter of importance to anyone hoping to make a living. Simply put, it exposes a widely-believed lie that has done much to bring America to its current sorry state.
Readers with reliable memories will surely recall the sudden bursting of the housing bubble back in ’08, which of course was immediately followed by a recession said to be the worst since he Great Depression, and they might also remember how it was all blamed on the voracious greed of top hat-wearing, moustache-twirling bankers who had tried to get rich by making hundreds of billions of dollars worth of loans to people who would never be able to pay them back. Republicans in general and George W. Bush in particular were also blamed, for it was their superstitious fetish for de-regulation that had removed the rule that previously forbade bankers to make loans to people who would never be able to pay them back. The economic downturn was fortuitously timed for Barack Obama, who stood foursquare against greedy bankers and promised all the regulations that a liberal heart might desire.
It was all utter nonsense, as a moment’s reflection could have revealed. There are no possible circumstances that might occur in a truly free market which would cause a banker, especially a greedy one, to make loans to people who will not be able to pay them back. There had never been a rule against making such futile loans, just as there had never been a rule against bankers giving all their money away to the panhandler on the corner, because there was no need for it. One didn’t even need to know that no financial de-regulation had occurred the Bush administration, and that on the contrary he had signed the Sarbanes-Oxley bill that added far too many new regulations, as simple logic should have sufficed. That panic that followed the crash didn’t allow for a moment’s reflection and overwhelmed logic, though, and the greedy bankers and ideological Republicans made for convenient scapegoats.
The truth, which even the Republican presidential ticket dared not speak, was that the federal government had tempted, cajoled, and at times outright compelled the banks to make the mortgage loans that brought down the financial industry. Although it had gone largely unnoticed, despite the Democrats’ occasional campaign boasts while the housing bubble was being inflated, the sub-prime loan was the culmination of a 30 year effort that began with the usual good intentions. Bankers had refused to make to loans to people who couldn’t pay them back from the dawn of commerce until 1978, but that year Congress and the reliably wrong Jimmy Carter decided to rectify this blatant discrimination with the Community Reinvestment Act to induce loans to law-income borrowers with bad credit scores.
The law was more or less ignored by the Ronald Reagan and George H.W. Bush administrations, an oversight that was little noted at time except in the occasional outraged editorial, but starting in 1993 the Clinton administration began to enforce it with an evangelical zeal. Lawsuits brought by the Justice and Housing Departments forced billions of loans to borrowers who had previously been denied credit, while a concerted effort by activist groups such as ACORN, newspapers such as the Atlanta Journal-Constitution, and leftist lawyers such as Barack Obama increased the pressure. The Clinton administration eventually agreed to a wide range of financial de-regulations intended to minimize the risks of the policy, including the hated “derivatives” for which George W. Bush is usually blamed, and it even ordered the industry-dominating Fannie Mae and Freddy Mac mortgage institutions to fill half their portfolios with sub-prime loans. When a construction boom inevitably followed, Clinton was pleased to take the credit.
As the great French economist Frédéric Bastiat observed, “it almost always happens that when the immediate consequence is favorable, the ultimate consequences are fatal,” but by the time all those loans started going bad Clinton was out of office and basking in his reputation as an economic genius. George W. Bush was the one who was there to deal with the mess, and despite his frequent efforts to convince the congressional Democrats to reform the various sub-prime policies he was the one who would be forever blamed. With no one in the press willing to admit their own culpability in the fiasco, an economic catastrophe caused by well-intentioned governmental meddling led to the election and re-election of the most meddlesome government in American history.
There’s not much that Agarwal, Benmelech, Bergman, and Seru can do about it now, but it’s good to have such highfalutin evidence to back up the obvious truth.
— Bud Norman