Acorn's a Creature of the CRA
The Acorn scandal, in which amateur journalists posing as a prostitute and a pimp went seeking a mortgage for a house of prostitution and received advice on how to evade the law, is a fitting new chapter in the controversial history of the advocacy group.
Acorn found its way into the mortgage business through the Community Reinvestment Act, the 1977 legislation that community groups have used as a cudgel to force lenders to lower their mortgage underwriting standards in order to make more loans in low-income communities. Often the groups, after making protests under CRA, were then rewarded by banks with contracts to act as mortgage counselors in low-income areas in return for dropping their protests against the banks. In one particularly lucrative deal, 14 major banks eager to put CRA protests behind them in 1993 signed an agreement to have Acorn administer a $55 million, 11-city lending program. It was precisely such agreements that helped turn Acorn from a network of small local groups into a national player. And Acorn hasn’t been alone. A U.S. senate subcommittee once estimated that CRA-related deals between banks and community groups have pumped nearly $10 billion into the nonprofit sector.
Given the economic fallout from the long efforts by advocacy groups to water down mortgage lending standards, as well as the controversy surrounding Acorn’s mortgage counseling methods, you would imagine that politicians in Washington would be eager to narrow the scope of the CRA and reduce the leverage that community groups wield under it. But to the contrary, Washington is actually looking to expand the CRA once again.
On Capitol Hill today the House Committee on Financial Services under Chairman Barney Frank is holding hearings on legislation supported by the Obama administration that would bring insurance companies and credit unions under the umbrella of CRA, placing new lending demands on these groups and opening them up to protests and pressure tactics by organizations like Acorn. As proof that Washington is a looking-glass world where basic values and logic get perverted, proponents of the new legislation claim we need more CRA to rein in the bad practices of the housing bubble, which is sort of like arguing that the cure for alcoholism is another martini. Any review of the history of the affordable mortgage movement in America demonstrates the power that CRA had in helping to shred mortgage underwriting standards throughout the industry and exposing us to the kind of market meltdown we’ve experienced.
Congress passed CRA in 1977 as legislation designed to prompt banks to lend more in lower income areas which advocates claimed were being ignored. Gradually over time community groups learned they could use the law as leverage to negotiate new inner-city lending programs with banks based on lower underwriting standards, which the groups demanded when banks complained that one reason they weren’t doing more lending in some neighborhoods was because few applicants in those areas qualified for loans under traditional criteria.
Acorn led the way in this movement. In 1986, for instance, it protested a potential acquisition by Louisiana Bancshares, a Southern institution, until the bank agreed to new, “flexible credit and underwriting standards” for minority borrowers which included counting public assistance and food stamps as income in mortgage applications.
Acorn also put pressure on the two quasi-government purchasers of mortgages, Fannie Mae and Freddie Mac, to lower their standards, complaining that they were “strictly by-the-book interpreters” who stood in the way of new lending programs. Under pressure both organizations committed to backing billions of dollars in affordable housing loans under so-called “alternative qualifying” programs which approved loans to individuals who didn’t qualify under traditional standards, including those who agreed to go to mortgage counseling classes run by community groups like Acorn.
The threat of CRA proved an effective tool in gathering non-bank lenders into this affordable lending maelstrom, too. In late 1993 President Clinton’s Secretary of Housing and Urban Development, Henry Cisneros, announced a plan to boost homeownership in the U.S. through a series of government initiatives, including having government subsidize mortgages that required no down payments. To produce more of these new, riskier loans Cisneros proposed expanding CRA to cover mortgage lenders and other financial institutions that were not chartered banks. In Congress Rep. Maxine Waters dubbed mortgage companies “egregious redliners” who needed to be corralled by CRA.
Under pressure from these threats, the trade group that represented mortgage bankers announced an agreement with HUD to sharply boost lending in low-income areas. These mortgage bankers, the so-called non-bank lenders, agreed to “voluntarily” help develop new mortgage products with laxer underwriting standards. The first member of the trade group to sign onto the new program was Countrywide Financial, which partnered with Fannie Mae to commit to $2.5 billion in lending in minority communities under new, lower standards.
Other programs soon followed. Sears Mortgage Corp began a massive effort with Freddie Mac’s backing, known as the alternative qualifying initiative, in which low-income borrowers could qualify for a mortgage if their monthly mortgage payment amounted to 45 percent of income, when the industry standard had traditionally been that a mortgage payment should amount to no more than one-third of monthly income. Arbor National Mortgage Inc., a nonbank lender, went further, making loans with monthly payments up to 50 percent of income.
These lending institutions were not only pushed by politicians and advocates into these new programs but were assured by federal institutions that the loans could be safe. In 1992 the Federal Reserve Bank of Boston produced lending guidelines for banks operating in low-income markets which advised them to take into consideration the “economic culture of urban, lower income and nontraditional customers.”
The Fed told lenders, for instance, that applicants with poor credit histories, a problem which plagued many would-be urban borrowers, could still be good loan risks if they agreed to mortgage counseling, even though there was no evidence that counseling programs prevented defaults. The Fed also told banks to consider junking their traditional income requirements in favor of lending with much higher ratios of income to mortgage payments, and to consider nontraditional sources of income as qualifying earnings, including unemployment benefits, even though by definition they are temporary and don’t last nearly as long as the term of a mortgage.
Some of the recommendations by the Boston Fed and other groups led directly to new mortgage products that engendered the greatest abuses during the housing bubble. The Boston Fed, for instance, urged lenders to allow borrowers who didn’t have enough money for down payments and closing costs to accept gifts and grants from charities and nonprofits. That spurred nonprofit groups to solicit donations from builders with houses to sell, which the nonprofits turned around and gave to low-income buyers to use as down payments on homes purchased from the participating builders. Heavily criticized by the IRS as a tax scam and by the Government Accountability Office for their high rates of default, such programs were eventually banned by the Federal Housing Administration, but not until 2007, when the housing bubble was already upon us.
Over time, the mortgage industry not only developed new products based on these lower underwriting standards but eventually allowed many borrowers to qualify for such loans under the reasonable assumption that if they were “safe” for low-income borrowers they were certainly safe for middle and upper income borrowers, too.
Of course, these loans weren’t actually safe, and as far back as the early 1990s it was clear that mortgages made under affordable housing standards had a significantly higher default rate. But the facts weren’t allowed to get in the way of the housing juggernaut, and so the quantity of risky loans increased. By 2005 HUD required that 45 percent of all loans purchased by Fannie Mae and Freddie Mac had to be from low and middle income borrowers, with no sense whatsoever of whether such a quota was advisable or doable.
It wasn’t. Despite all of the talk of how the mortgage crisis has affected all sorts of borrowers across the income spectrum, once the troubles started with the market in 2006 a disproportionate percentage of foreclosures and defaults occurred in low and lower-middle income areas. And some of the pioneers of the affordable mortgage market, like Countrywide, collapsed spectacularly under the weight of their riskier loans, as did Fannie Mae and Freddie Mac.
The subsequent drying up of the mortgage market and failure of many banks has proved an especially great burden to the umbrella of nonprofit groups who were operating programs financed by CRA, which has become big business for nonprofits. So now we have, rather than a diminished CRA, legislation in Washington which would find new sources of funding for community groups in the form of credit unions and insurance companies. And the new legislation takes CRA well beyond the mortgage market and into small business lending, requiring financial institutions to begin keeping records on the race and gender of owners of firms who apply for loans. If form follows, soon banks and other financial institutions operating under CRA will be cudgeled into lending to small businesses based on race and gender, which will be the opening of a new round of lower lending standards in the very risky small business sector.
The effort to save and extend CRA in the face of its role in the mortgage market’s massive meltdown is testament to the unique power of this legislation to nourish an entire industry of nonprofits which, like Acorn, have been reliable supporters of politicians like Barney Frank, Maxine Waters and a former community organizer and associate of Acorn by the name of Barack Obama.
This piece originally appeared in RealClearMarkets
This piece originally appeared in RealClearMarkets