What really caused the mortgage mess?

Some people blame a fair-lending law for the mortgage meltdown and the resulting global financial crisis. Evidence shows otherwise.The Community Reinvestment Act, passed in 1977, requires banks to extend loans where they accept deposits. It was conceived as a way of fighting redlining -- the practice of denying loans to residents of minority neighborhoods. Conservatives have periodically criticized the fair-lending law, saying, for example, that it discourages banks from opening branches in poor districts. The latest salvo from conservatives began via a Sept. 15 editorial in Investors Business Daily, titled "The Real Culprits in This Meltdown.""Tough new regulations forced lenders into high-risk areas where they had no choice but to lower lending standards to make the loans that sound business practices had previously guarded against making," Investors Business Daily said in the editorial.The newspaper didn't get the name of the law right, initially calling the target of its ire the Community Redevelopment Act. Its editorial blamed President Clinton for today's mess because, by encouraging minority homeownership, "he helped create the market for the risky subprime loans that he and Democrats now decry as not only greedy but 'predatory.'"A week later, the Wall Street Journal editorialized that the CRA "compels banks to make loans to poor borrowers who often cannot repay them." On Sept. 25, U.S. Rep. Michele Bachmann, R-Minn., told the House Financial Services Committee that because of the CRA, "loans started being made on the basis of race, and often on little else." The critics are wrong, experts say."It certainly wasn't the CRA," says Kenneth Thomas, author of two books about the law ("Community Reinvestment Performance" and "The CRA Handbook"). Thomas says you could just as easily blame the Sept. 11 terrorists (because the Fed slashed short-term interest rates afterward), or the Chinese (for buying so many bonds during the subprime boom). In other words, he thinks it's a huge stretch to blame the CRA on lenders' bad decisions.There are three reasons to exonerate the Community Reinvestment Act in the mortgage meltdown:- The CRA applies to banks. Most subprime mortgages came from lenders that were not banks -- so the CRA did not cover them.- The non-bank lenders made more reckless lending decisions than banks did.- Regulations didn't drive the subprime lending boom. The pursuit of profits did."How people can think that a law that's been on the books for 30 years somehow precipitated or caused the subprime crisis is beyond me," says Ellen Schloemer, director of research and communications for the Center for Responsible Lending, a nonprofit group that fights predatory lending practices.Of the roughly 300 failed institutions listed on the Mortgage Lender Implode-O-Meter site, the vast majority were not chartered banks. Because they weren't deposit-taking banks, they didn't have to abide by CRA rules. Time after time, lenders closed their doors because they couldn't afford to buy back the bad loans they had originated and quickly sold on the secondary market. (Like a grocer selling spoiled milk, if a lender sells a loan that goes bad right away, they have to buy it back.)In February 2004, Fed Chairman Alan Greenspan endorsed alternative mortgages in a speech at a conference of the National Credit Union Association. "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage," Greenspan said. Soon stated-income loans and subprime piggyback mortgages flooded the market as profit-hungry lenders offered "creative" home financing."When people talk about 'creative' or 'creativity' in credit, it usually means lower credit standards," says Alex Pollock, a resident fellow at the American Enterprise Institute. For his part, Thomas believes he knows where to place some of the blame on the mortgage mess. "The real answer is in two acronyms," he says: TLTL and LTMR.TLTL stands for "too low, too long," and refers to the period when the Federal Reserve kept the federal funds rate so close to the inflation rate that the real interest rate was close to zero. The federal funds rate was 2 percent or lower from November 2001 to December 2004. That roughly coincides with most inflationary period of the housing bubble.LTMR stands for "let the markets regulate." Greenspan used to be an ardent proponent of self-regulated markets, but he told Congress in late October that "this breakdown of the central pillar of competitive markets" in mortgages requires "additional regulatory changes." But he added that any new regulations "will pale in comparison to the change already evident in today's markets."X...X...XVolatility remains the name of the game for mortgage rates, which plunged this week.The average 30-year fixed-rate dropped 33 basis points, to 6.44 percent. A basis point is one-hundredth of a percentage point. Since Oct. 1, mortgage rates have moved at least 20 basis points each week. During that time, they've remained in a pattern of falling sharply one week before rising dramatically the next. The average 15-year fixed -- a popular option for refinancing -- plummeted 25 basis points, to 6.21 percent. The average jumbo 30-year fixed skidded 19 basis points, to 7.76 percent. The one-year adjustable-rate mortgage slid 24 basis points, to 5.85 percent. The popular 5/1 ARM fell 21 basis points, to 6.46 percent. Distributed by Scripps Howard News Service. E-mail Holden Lewis at editors(at)bankrate.com(Distributed by Scripps Howard News Service. E-mail Holden Lewis at hlewis(at)bankrate.com)