Blaming the Credit Crisis on Poor Minority Homeowners Is Another Conservative Lie

In an excellent commentary posted yesterday Newsweek columnist Daniel Gross debunked the claim by the Wall Street Journal, the National Review, Washington Post columnist Charles Krauthammer and other conservative patrons of financial deregulation, that the current fiscal crisis was caused by bad loans made to the poor. Since this mistaken idea underlies John McCain’s claim in the debate last night that Fannie Mae and Freddie Mac were the culprits that got the crisis going, it’s important to pay a lot of attention to Gross’s analysis. The bulk of it follows.

Let me get this straight. Investment banks and insurance companies run by centimillionaires blow up, and it's the fault of Jimmy Carter, Bill Clinton, and poor minorities?

These arguments are generally made by people who read the editorial page of The Wall Street Journal, and ignore the rest of the paper—economic know-nothings whose opinions are informed mostly by ideology and, occasionally, by prejudice. Let's be honest. Fannie and Freddie, which didn't make subprime loans but did buy subprime loans made by others, were part of the problem. Poor congressional oversight was part of the problem. Banks that sought to meet CRA requirements by indiscriminately doling out loans to minorities may have been part of the problem. But none of these issues is the cause of the problem. Not by a long shot. From the beginning, subprime has been a symptom, not a cause. And the notion that the Community Reinvestment Act is somehow responsible for poor lending decisions is absurd.

Here's why.

The Community Reinvestment Act applies to depository banks. But many of the institutions that spurred the massive growth of the subprime market weren't regulated banks. They were outfits such as Argent and American Home Mortgage, which were generally not regulated by the Federal Reserve or other entities that monitored compliance with CRA. These institutions worked hand in glove with Bear Stearns and Lehman Brothers, entities to which the CRA likewise didn't apply. There's much more. As Barry Ritholtz notes in this fine rant, the CRA didn't force mortgage companies to offer loans for no-money down, or to throw underwriting standards out the window, or to encourage mortgage brokers to aggressively seek out new markets. Nor did the CRA force the credit-rating agencies to slap high-grade ratings on subprime debt.

Second, many of the biggest flameouts in real estate have had nothing to do with subprime lending. WCI Communities, builder of highly amenitized condos in Florida (no subprime purchasers welcome there), filed for bankruptcy in August. Very few of the tens of thousands of now-surplus condominiums in Miami were conceived to be marketed to subprime borrowers, or minorities—unless you count rich Venezuelans and Colombians as minorities. The multi-year plague that has been documented in brilliant detail at IrvineHousingBlog is playing out in one of the least subprime housing markets in the nation.

Third, lending money to poor people and minorities isn't inherently risky. There's plenty of evidence that in fact it's not that risky at all. That's what we've learned from several decades of microlending programs, at home and abroad, with their very high repayment rates. And as The New York Times recently reported, Nehemiah Homes, a long-running initiative to build homes and sell them to the working poor in subprime areas of New York's outer boroughs, has a repayment rate that lenders in Greenwich, Conn., would envy. In 27 years, there have been fewer than 10 defaults on the project's 3,900 homes. That's a rate of 0.25 percent.

On the other hand, lending money recklessly to obscenely rich white guys, such as Richard Fuld of Lehman Brothers, or Jimmy Cayne of Bear Stearns, can be really risky. In fact, it's even more risky, since they have a lot more borrowing capacity. And, here, again, it's difficult to imagine how Jimmy Carter could be responsible for the supremely poor decision-making seen in the financial system. I await the Krauthammer column in which he points out the specific provision of the Community Reinvestment Act that forced Bear Stearns to run with an absurd leverage ratio of 33:1, that instructed Bear Stearns hedge-fund managers to blow up hundreds of millions of their clients money, and that required its septuagenarian CEO to play bridge while his company ran into trouble. Perhaps Neil Cavuto knows which CRA clause required Lehman Brothers to borrow hundreds of billions of dollars in short-term debt in the capital markets and then buy tens of billions of dollars of commercial real estate at the top of the market. I can't find it. Did AIG plunge into the credit-default swaps business with abandon because ACORN members picketed its offices? Please. How about the hundreds of billions of dollars of leveraged loans—loans banks committed to private equity firms that wanted to conduct leveraged buyouts of retailers, restaurant companies, and industrial firms? Many of those are going bad now, too. Is that Bill Clinton's fault?

Look. There was a culture of stupid, reckless lending, of which Fannie Mae and Freddie Mac and the subprime lenders were an integral part. But the dumb lending virus originated in Greenwich, Ct., midtown Manhattan, and Southern California, not Eastchester, Brownsville, and Washington. Investment banks created a demand for subprime loans because they saw it as a new asset class that they could dominate. They made subprime loans for the same reason they made other loans: They could get paid for making the loans, for turning them into securities, and for trading them—frequently using borrowed capital.

At Monday's hearing, Republican Rep. John Mica of Florida gamely tried to pin Lehman's demise on Fannie and Freddie. After comparing Lehman's small political contributions to Fannie and Freddie's much larger ones, Mica asked Fuld what role Fannie and Freddie's failure played in Lehman's demise. Fuld's response: "de minimis."

Lending money to poor people doesn't make you poor. Lending money poorly to rich people does.