Housing Goals We Can't Afford
THE national wave of home foreclosures, many concentrated in lower-income and minority neighborhoods, has created a strong temptation to find the villains responsible. Among the nominees are the major credit rating agencies like Moody's and Fitch, which certified that the securities backed by subprime loans were a good investment.
There's little doubt that the rating agencies helped inflate the housing bubble. But when we round up all the culprits, we shouldn't ignore the regulators and affordable-housing advocates who pushed lenders to make loans in low-income neighborhoods for reasons other than the only one that makes sense: likely repayment.
The mortgage-securitization system, in which the rating agencies were central, and the bank and housing finance regulatory systems, through community-reinvestment rules and affordable housing goals, shared a common flaw: both provided incentives to make imprudent loans. The American public will be ill served if either is allowed to continue unchanged.
The Community Reinvestment Act was passed in 1977 when bank competition was sharply limited by law and lenders had little incentive to seek out business in lower-income neighborhoods. But in 1995 the Clinton administration added tough new regulations. The federal government required banks that wanted "outstanding" ratings under the act to demonstrate, numerically, that they were lending both in poor neighborhoods and to lower-income households.
Banks were now being judged not on how their loans performed but on how many such loans they made. This undermined the regulatory emphasis on safety and soundness. A compliance officer for a New Jersey bank wrote in a letter last month to American Banker that "loans were originated simply for the purpose of earning C.R.A. recognition and the supporting C.R.A. scoring credit." The officer added, "In effect, a lender placed C.R.A. scoring credit, and irresponsible mortgage lending, ahead of safe and sound underwriting."
Similarly, under the past two administrations the Department of Housing and Urban Development pushed the secondary mortgage market to buy loans based on criteria other than the creditworthiness of borrowers. These affordable-housing goals became more demanding over time. By 2005, HUD required that 45 percent of all the loans bought by Fannie Mae and Freddie Mac be loans to borrowers with low and moderate incomes. HUD required further that Fannie and Freddie buy 32 percent of the loans in their portfolios from people in central cities and other underserved areas and that 22 percent of the loans they buy be to "very low income families or families living in low-income neighborhoods."
One cannot say with any certainty whether the more important cause of the current housing crisis was affordable-housing mandates or the actions of investment banks and ratings agencies. There can be no doubt, however, that both contributed. With that in mind, the best way to make sure that we don;'t repeat our mistakes is to examine—and change—both.
We can be fairly sure that the ratings agencies will, to stay in business, change their approach to evaluating mortgage-backed securities. But we should not continue to push lenders to make loans just to please regulators.
Denying credit to entire neighborhoods based on the race of residents or other factors unrelated to their ability to repay loans on time is clearly wrong. But we no longer need blunt regulatory instruments to draw lenders into low-income neighborhoods.
In contrast to the time when the Community Reinvestment Act was passed, credit scores now make it easier than ever to make loans the old-fashioned way, on the merits of individual households. (The scores provide a clear incentive, too, for borrowers who want better loan terms to adopt better financial habits.) Combined with enforcement of fair housing laws, credit scores offer opportunity to those who deserve mortgages and other loans—and protection from the bad effects of credit going to those who don't deserve it.
If the Community Reinvestment Act must stay in force, then regulators should take loan performance, not just the number of loans made, into account. We have seen the dangers of too much money chasing risky borrowers.
We need not only to fix the system of mortgage securitization but also to repeal unwise lending mandates. Both carry the same terrible risks.
This piece originally appeared in The New York Times
This piece originally appeared in The New York Times