Tuesday, November 22, 2011

No Really -- CRA and the GSEs Weren't the Reason for the Collapse

For those of us in the economic blogsphere, Barry Ritholtz over at the Big Picture is a bit like a blogfather.  He was one of the first economic bloggers who I read regularly.  We've traded some occasional emails and he's always been very gracious.

His latest Washington Post column illustrates why he has such a great reputation: his research is exhaustive, which appeals to the academic side of me.  His latest column for the Washington Post adds much more intellectual weight to the argument that the CRA and the other government GSEs weren't the cause of the financial mess.

Here are some salient points:
A McKinsey Global Institute report noted “from 2000 through 2007, a remarkable run-up in global home prices occurred.” It is highly unlikely that a simultaneous boom and bust everywhere else in the world was caused by one set of factors (ultra-low rates, securitized AAA-rated subprime, derivatives) but had a different set of causes in the United States. Indeed, this might be the biggest obstacle to pushing the false narrative. How did U.S. regulations against redlining in inner cities also cause a boom in Spain, Ireland and Australia? How can we explain the boom occurring in countries that do not have a tax deduction for mortgage interest or government-sponsored enterprises? And why, after nearly a century of mortgage interest deduction in the United States, did it suddenly cause a crisis?
This is an incredibly good point, and should put the argument to bed for good: did the rest of the world have CRA legislation or GSEs"  If not, why did these economies also experience an economic bubble?

Then there's the question of where the bubble occurred:
For example, if the CRA was to blame, the housing boom would have been in CRA regions; it would have made places such as Harlem and South Philly and Compton and inner Washington the primary locales of the run up and collapse. Further, the default rates in these areas should have been worse than other regions.

What occurred was the exact opposite: The suburbs boomed and busted and went into foreclosure in much greater numbers than inner cities. The tiny suburbs and exurbs of South Florida and California and Las Vegas and Arizona were the big boomtowns, not the low-income regions. The redlined areas the CRA address missed much of the boom; places that busted had nothing to do with the CRA.
So, prices spiked in neighborhoods that weren't the targets of the legislation.  That's one powerful law if it can effect economic areas not intended to be effected.

And then there is this:
•Nonbank mortgage underwriting exploded from 2001 to 2007, along with the private label securitization market, which eclipsed Fannie and Freddie during the boom. Check the mortgage origination data: The vast majority of subprime mortgages — the loans at the heart of the global crisis — were underwritten by unregulated private firms. These were lenders who sold the bulk of their mortgages to Wall Street, not to Fannie or Freddie. Indeed, these firms had no deposits, so they were not under the jurisdiction of the Federal Deposit Insurance Corp or the Office of Thrift Supervision. The relative market share of Fannie Mae and Freddie Mac dropped from a high of 57 percent of all new mortgage originations in 2003, down to 37 percent as the bubble was developing in 2005-06.

•Private lenders not subject to congressional regulations collapsed lending standards. Taking up that extra share were nonbanks selling mortgages elsewhere, not to the GSEs. Conforming mortgages had rules that were less profitable than the newfangled loans. Private securitizers — competitors of Fannie and Freddie — grew from 10 percent of the market in 2002 to nearly 40 percent in 2006. As a percentage of all mortgage-backed securities, private securitization grew from 23 percent in 2003 to 56 percent in 2006
The private market underwrote the vast majority of the sub-prime loans.  These organizations weren't subject to the law.

And that's the buzzer ending the game.

For those of you who still adhere to the CRA/GSE line of argument please do us a favor: don't reproduce. 

And a special thanks to Barry for being intellectually rigorous at a time when our political and economic discourse is incredibly stupid.