I had an interesting conversation with a friend of mine, a Wall Street veteran in the mortgage business and a very conservative Republican. While he acknowledged excesses in the mortgage market, and conceded that certain kinds of derivatives while profitable in the short term, were a very bad idea for the overall health of the marketplace, he insisted that the government, and in particular Democrats, deserved a large share of the blame for the implosion. In particular, that the policy of encouraging low-income home ownership was the primary culprit. He pointed out that the Community Reinvestment Act created tremendous incentives for lending institutions to originate loans in support of low-income home ownership. His view was that many people ended up owning homes, and taking on debt that was unsustainable because the government pushed the lending institutions to demonstrate how much they were doing to support low-income housing, and so the institutions extended credit beyond what was economically prudent. Or, somewhat uncharitably, that the wrong people got loans.
I was somewhat aware of this argument, and pointed out to him that loans issued by institutions covered by the CRA were a very small part of the overall sub-prime business. He countered that non CRA institutions still wanted to show Congress how much they were doing for low-income home ownership, as part of their lobbying efforts, and that Fannie and Freddie in response to Congressional pressure, both started buying up the highly rated portions of the securitized packages of loans, thereby in effect, enabling the more questionable originations.
It occurred to me that this discussion reflected the classic differences in the world views between so called liberals and so called conservatives. Conservatives often look towards an individual attribution. The circumstances a person finds themselves in are due to the choices they made and the skills they have. Liberals often look to a situational attribution. The circumstances a person finds themselves in are due to a gamed system, culture stunted by class or other hegemony and social structure.
The resolution of these antitheses in a particular situation, for a thinking person, requires an honest analysis of data and of course one of the more distressing aspects of much of today's Republican leadership is their adherence to positions wholly unmoored from data and intellectually honest analysis. For example: The public option is too expensive. Except that it actually saves money.
But the individualistic perspective is not without merit, people should be accountable for their actions, and so the truth lies somewhere in the middle. As I have aged, I find myself crediting things like luck, tribalism, unrecognized bigotry, and rationalized group self-interest, as drivers with power equal to effort, skill, and meritocracy in explaining the ups and downs of a life and/or career.
So what does this say about the sub-prime crisis? Did government pressure provide some/much of the fuel that led to an overheated mortgage market? The data, and I think, fair analysis, suggests that it made little difference. (Hat tip to Prof. Krugman for some of what follows.)
My natural inclination is to believe in the innate depravity of mankind, meaning that if people can legally do something, and it is profitable in the short term, they will do it, regardless of the longer term consequences. This premise, and admittedly it is a premise, leads me to two fundamental conclusions, one high level, the other more specific to the sub-prime crisis.
- While free markets are in general a good thing, a little regulation to prevent excess is in everyone’s interest; and,
- That the absence of relevant regulation in the mortgage market, and the available short term profits, would have led us to the "frothy" situation we found ourselves in, regardless of the incentives provided by the CRA or others.
This speechfrom Federal Reserve Gov. Kroszner is instructive. It cites research which supports the notion that lending institutions jumped into these markets because they thought they were profitable, and indeed, until it came tumbling down, they were. The fact that non-CRA covered institutions started pursuing business that was typically the domain of CRA-covered intuitions is, of course, not dispositive. As noted earlier, being able to show a Congressman or other governmental official how active you were in supporting low income home ownership was a valuable political chit. Still, the analysis that this business was as profitable as other more traditional businesses, coupled with the entry of non-CRA institutions, strongly suggests that regardless of the political incentives, profit motive alone would have likely led to the frothy market we ended up having. If they can... they will.
This conclusion is supported by the state of the commercial real estate market, which had no CRA like incentives, but which become so frothy that according to the Wall St. Journal 50% of the deals are now under water.
Kroszner also notes that a high percentage (60%) of the sub-prime originations went to middle and upper income individuals, which weren’t related to the CRA, nor were they originations that would support the political goal of growing low income home ownership. The data also suggests (but is not specific enough to prove conclusively) that delinquency rates were high for these loans regardless of income level and that foreclosures were higher in the middle and upper income levels.
The research Kroszner cites is consistent with a Harvard economist’s analysisas well. One of the interesting points of his brief paper is that the percentage of CRA loans in CRA areas had been steadily declining from 1993 to 2006, when they made a small rise. This would seem to support the notion that profits were to be had in these markets, and non-regulated institutions were jumping in to get them.
It would seem that the mess we are in is not mainly driven by misguided social policy, or irresponsible debtors, but rather from good old fashion free market excess. It is very hard for conservatives to believe that, perhaps because they are often the beneficiaries of this excess -- at least in the early stages.