What Barney Frank Doesn't Grasp: Lending Mandates Hurt The Poor

House Financial Services Chairman Barney Frank has suggested that linking the banking crisis to the high-risk bank lending mandates of the Community Reinvestment Act and the "affordable" housing goals set by Congress for Fannie Mae and Freddie Mac constitutes a Republican effort to scapegoat poor, minority households that took out such mortgages.

Frank says such people are the victims, not the cause.

He not only fails to acknowledge the role the government-sponsored mortgage giants played in the flight to unsafe lending. He also doesn't understand the wrongheadedness of government lending mandates for low-income neighborhoods: They tend to harm the prospects of the households and areas they purport to help.

That's why it's crucial, once markets begin to right themselves and Congress turns to the work of crafting a post-crisis regulatory regime, that such lending mandates end.

The unanticipated consequences of the CRA, which pushes banks to make loans they'd otherwise not originate, and the HUD "affordable housing goals," which forced Fannie Mae and Freddie Mac to buy such loans, stem from the same fundamental mistake: the misguided belief that it is enlightened public policy to mandate lending for reasons other than the capacity of households to make their payments.

I first encountered the fallout from this on a visit to Barack Obama's home turf, the near South Side neighborhood of Chicago known as the Back of the Yards. It's the place where the original community organizer, Saul Alinsky, plied his trade.

There, in 2003, I was taken on a tour of a street where the leading edge of what turned out to be our foreclosure crisis was just emerging. Of perhaps 20 bungalows on a block, four were in foreclosure, one already taken over by a local gang. A community organizer (yes, really) from Neighborhood Housing Services of Chicago had gone so far as to identify the lenders whose loans had led to defaults — both on that street and in an emerging "default belt" for blocks around. They were not local institutions, but rather a who's who of major banks from around the country.

All had good reason to make such loans in low-income neighborhoods such as this or buy them from banks that advertised in banking industry publications — to fulfill the goals that Treasury Department officials had set for compliance with the Community Reinvestment Act.

If banks hoped to branch, or to merge, an "outstanding" CRA rating was paramount. The law provided no incentive for the loans to perform — only to be granted.

The implicit operative philosophy: Our financial system is inherently unfair, and the "disenfranchised" should, by mandate, be dealt in on whatever terms.

It was left for the leader of the neighborhood block association — the wife of a local plumber who herself worked at the local school — to try to pick up the pieces. "That hurts values right there," she said, referring to a boarded-up house. "You try to show people that there's hope for the block, and then you get slapped right back down again."

One can say that banks should not have made the loan. But the fact is the law gave them the incentive to do so — all the more so because such loans in low-income ZIP codes were easily sold to Fannie Mae under pressure from Congress and HUD to meet its "affordable housing goals and subgoals."

These included a mandate that no less than 32% of the loans that Fannie Mae purchased come from "central cities, rural areas and other underserved areas."

As one major regional banker told me, "Fannie Mae would come in and scoop up all our CRA loans."

The point here is not that the combination of CRA and the secondary mortgage giants caused our meltdown by themselves — although Fannie Mae and Freddie Mac's climbing stated profits during the first half of the decade certainly did put pressure on all financial institutions to show results that were comparable or better.

No, the key point is a rejoinder to the Barney Frank view that those now criticizing the CRA are indifferent, at best, to the situation of poor and minority households.

Congress can mandate that credit be allocated to select areas — but it won't create healthy neighborhoods that way. It turns out that it's the discipline of well-functioning markets that helps create neighborhood social fabric.

When households work hard and play by the rules — saving a down payment, improving their credit rating over time — they are far less likely to default and far less likely to leave their credit-worthy neighbor left holding the bag as a street declines.

When lending is charity, foreclosure is invited — and it's the good borrowers and frugal families who are hurt.

It's worth noting that the only consistent voice in Congress to express concern about the fallout from "community reinvestment" requirements, as they expanded during the 1990s, was the senator now judged to be especially indifferent to the plight of those of modest means — Phil Gramm.

There was, to be sure, a time when many urban neighborhoods could not easily get access to credit. That, however, was merely a side effect of a heavily regulated banking system, one that provided little reason for banks to take risks or try markets where values might be falling.

Today, instead of politically allocated credit dished out because of where people live rather than their ability to repay, we must look to a revived banking system that will set interest rates commensurate with credit histories and reward those who work hard and save. Otherwise, the very people in whose name Barney Frank operates will again be victims.