Think Sub-prime Lending Came From Greed – Think Again

I was there. I met with the Chicago Chapter of ACORN when I was employed as part of First Chicago’s Community Reinvestment Act (CRA) team as they threatened us with public protests if we didn’t change our ways. In 1993, when we had our CRA audit by the Comptroller of the Currency we were roundly criticized for our lack of lending in minority neighborhoods. We had actively been advertising and trying to find more credit worthy borrowers in those neighborhoods at the time and we had several “partnerships” going with various community groups. We even set up a special fund to keep sub-standard credit risks in the portfolio – since we couldn’t, at the time, sell the risk to the secondary market.

In 1995 my unit, Small Business Banking, was one of the first four lenders in the country to use automated credit scoring for small business loans. It was a highly contentious practice in the industry, not because it was discriminatory, but because old school lenders were certain that we couldn’t use predictive models that didn’t have a human element of discretion. I was interviewed by the New York Times that year to defend the practice, but not against the old credit curmudgeons of banking, but because ACORN was calling it discriminatory. So much pressure was put on the practice that I was forced to set up another special risk pool to make loans to minority borrowers that didn’t show the empirical history to be credit worthy.

W ell, finally, someone is telling the story the way it was.

Yet a “landmark” 1992 study from the Boston Fed concluded that mortgage-lending discrimination was systemic.

That study was tremendously flawed – a colleague and I later showed that the data it had used contained thousands of egregious typos, such as loans with negative interest rates. Our study found no evidence of discrimination.

Yet the political agenda triumphed – with the president of the Boston Fed saying no new studies were needed, and the US comptroller of the currency seconding the motion.

No sooner had the ink dried on its discrimination study than the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: “discrimination may be observed when a lender’s underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants.”

Some of these “outdated” criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification. Instead, the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant’s ability to manage debt.

Sound crazy? You bet. Those “outdated” standards existed to limit defaults. But bank regulators required the loosened underwriting standards, with approval by politicians and the chattering class. A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities. It also let community activists intervene at yearly bank reviews, shaking the banks down for large pots of money.

Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department.

Flexible lending programs expanded even though they had higher default rates than loans with traditional standards. On the Web, you can still find CRA loans available via ACORN with “100 percent financing . . . no credit scores . . . undocumented income . . . even if you don’t report it on your tax returns.” Credit counseling is required, of course.

Then, in order for banks not to be charged with reverse discrimination the flood gates had to continue to open.

Ironically, an enthusiastic Fannie Mae Foundation report singled out one paragon of nondiscriminatory lending, which worked with community activists and followed “the most flexible underwriting criteria permitted.” That lender’s $1 billion commitment to low-income loans in 1992 had grown to $80 billion by 1999 and $600 billion by early 2003.

Who was that virtuous lender? Why – Countrywide, the nation’s largest mortgage lender, recently in the headlines as it hurtled toward bankruptcy.

Read the whole thing. From my experience it is dead-on true. So, as we’re floundering through this mess let’s keep this in mind as pandering politicians look for a “cure”. It was a cure for a false problem that set it off but now we’re told that it’s the “greedy” bankers who sent us down this road to perdition. Don’t believe it for a minute.

This entry was posted on Tuesday, February 5th, 2008 at 11:20 am and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed.