Bringing the crisis into perspective

According to University of Texas economics professor Stan Liebowitz writing in yesterday’s New York Post, the reason the financial institutions pursued these wildly irresponsible financial practices was not that they were greedy and unregulated, but that they were forced by intrusive government regulators to behave altruistically and irresponsibly in giving mortgages to bad credit risks in order to increase home ownership among blacks and Hispanics, and thus clear the banking industry of the charge of racial discrimination. Liebowitz’s approach is similar to Mark Levin’s in blaming the crisis entirely on the left, with the difference that Liebowitz is explicit about the racial dimension of the bad policies that led to the crisis, while Levin, at least in his radio presentation of September 19, is silent about it.

Liebowitz’s account also brings to mind the many articles that American Renaissance published in the early 1990s about the accusations of “racism” that were being made against lending institutions, because blacks and Hispanics were being turned down for mortgages far more often than whites. As AR repeatedly explained at the time, blacks and Hispanics were rejected at a higher rate not because of their race but because of their poor credit history. With the explosion of the current crisis, and with the informative writings of Liebowitz and others, we can now see those early stories in AR in their full historical context. The accusations of racism in the mortgage industry resulted in new Federal Reserve policies in 1992 and then in radical changes in federal law in 1995 that forced banks to give mortgages to noncreditworthy people, which in turn pushed the banks to create irresponsible investment vehicles in order to mitigate the effect of—and also to make money on—all those bad mortgages. In brief, the campaign of vilification of the early 1990s led directly to the law of 1995 which led directly to the disaster of 2008.

Here is Liebowitz’s article:

HOUSE OF CARDS
LIBERALS FUELED WALL ST. WOES
By STAN LIEBOWITZ
September 24, 2008

HOW did America wind up in its worst financial crisis in decades? Sen. Barack Obama explained it this way last week: “When sub-prime-mortgage lending took a reckless and unsustainable turn, a patchwork of regulators systematically and deliberately eliminated the regulations protecting the American people.”

That’s exactly backward. Mortgage lending took that “reckless and unsustainable turn” because of regulation—regulation driven by liberals and progressives, not free-market “deregulators.”

Pushed hard by politicians and community activists, the regulators systematically and deliberately altered financially sound lending practices.

The mortgage market was humming along just fine when, in the late 1980s, progressives decided that it needed to be “fixed.” Their complaint: Some ethnic groups got approved for mortgages at lower rates than others.

In reality, mortgage lenders were simply being prudent—taking care to provide mortgages to those who could best afford to make the payments.

The shift began in 1989, when Congress amended the Home Mortgage Disclosure Act to force banks to collect racial data on mortgage applicants. By 1991, critics were using that data to paint lenders as racist by showing that minority applicants were approved at far lower rates. Banks were “Shamed By Publicity,” as one 1993 New York Times headline put it.

In fact, they found a racial disparity only by ignoring relevant data on applicants’ ability to make mortgage payments—such as their assets and credit history.

But the political pressure was intense—with few in politics or media eager to speak the truth. And then, in 1992, came a study from four researchers at the Boston Fed, which seemed to bear out the critics’ contentions.

That study was, in fact, based on quite flawed data—but the authors’ political, media and academic protectors stifled most serious criticism, smearing the reputation of one whistleblower and allowing the Boston authors to avoid answering serious academic challenges (mine included) to their work. Other studies with different conclusions were ignored.

The very next year, the Boston Fed announced new requirements for banks—rules that have now turned out to be monumentally catastrophic: Adopt “relaxed lending standards” or risk being labeled as racists, and face serious penalties under the federal Community Reinvestment Act.

Gone (as “arbitrary” and “outdated”) were traditional lending requirements such as requiring a down payment or limiting mortgage payments to 28 percent of income. (Of course, the loosened lending standards weren’t limited to poor and minority applicants—that would be discriminatory.)

The new standards performed as intended: Home- ownership rates, stagnant for 25 years, began a rapid 10-year ascent in 1995, with many new homeowners being lower-income and/or minority families.

The large rise in demand for houses, however, fed a run-up in prices starting in 1997—the infamous housing bubble. And rising prices hid the great vulnerability of these loans to defaults and foreclosures, because refinancing or selling at a profit was the easy alternative.

Soon, these loans began to be sold in the secondary market. Fannie Mae and Freddie Mac were enthusiastic proponents of relaxed lending standards and purchased large swaths of these loans.

Time after time, Fannie and Freddie trumped criticism by pointing to how they were helping broaden homeownership. Because of the subject’s racial overtones, they beat back calls for reform even after financial irregularities were found.

Rating agencies such as Standard & Poor’s had no experience with such loans—and imprudently used the misleading bubble-induced performance to incorrectly judge the likely performance of financial instruments based on such loans.

In 2002, the “reformers” declared victory. In a Fannie report, four academic supporters of relaxed standards crowed how these changes were “fundamentally altering the terms upon which mortgage credit had been offered in the United States from the 1960s through the 1980s … These changes in lending herald what we refer to as mortgage innovation.”

Lucky us.

Now that the popped bubble has left us swimming in foreclosures, the supporters of loosened credit standards seem shy about taking credit for their “mortgage innovations.” Instead, they blame subprime lenders for becoming “predatory”—when they were simply taking the Boston Fed rules to their logical conclusion while broadening the mortgage market.

Investors holding mortgage-based assets now want out. Perhaps they deserve a $700 billion refund—since they were sold a bill of goods by “progressive” politicians, academics and government officials who, in the hope of remaking society, insisted that loans based on relaxed underwriting standards were sound.

Stan Liebowitz is the Ashbel Smith professor of economics at the Business School at the University of Texas at Dallas.

- end of initial entry -

Richard B. writes:

After seeing Bush hand our country over to socialism and McCain jumping in to help him, I realized everything you have been saying about these guys is true! Not a conservative bone in their bodies.

Spencer Warren writes:

Two points:

1. I am always suspicious of explanations of complex matters that give only one cause (as the fool Mark Levin always does). Liebowitz explains the underlying cause, but, given what I know of human nature, I think one can also blame fly-by-night lenders like Countrywide for exploiting the situation as well as the greedy and reckless Wall Street people who borrowed heavily to speculate in this mortgage-based securities. Plus, as Mort Zuckerman said on the McLaughlin Group, the SEC lowered leverage requirements a few years ago, which resulted in more Wall Street speculation in these securities. Further, Dodd, Frank and other Democrats blocked consideration of the bill McCain was pushing in 2005 to clean up Fannie Mae and Freddie Mac.

2. I credit the NY Post for running such a politically incorrect article. Would National Review run such a racially-charged article? (Maybe they rejected it first.)

Also, you noted the other day how abusive Mark Levin is to any caller who disagrees with him. He is the worst I’ve ever heard on radio, and in my opinion should not be on the air. He is an affront to freedom of speech. Also, outside of judicial issues, he generally knows nothing special and tends to rant and rant. He is a vicious, nasty fool most of the time. Anyone who opposes talk radio can use Levin as the poster boy for its worst aspects.

LA replies:

I don’t listen to talk radio and I never heard Levin’s program before the other day. While I was impressed by his opening presentation, I was appalled by his treatment of callers. It’s the worst I’ve ever heard. When Bob Grant treated callers roughly (“GET OFF MY PHONE, YOU JERK!”), it was almost always because they deserved it. and it also had an element of schtick. Levin, in imitatng Grant’s bullying manner but taking it much further, came across as insane, viciously attacking people who had politely raised perfectly reasonable points.

I think there is a strong element of masochism and desire for a “leader type” in contempoary people that causes them to keep listening to such an abusive personality.

While she is not nearly as abusive as Levin, I had the same thought about contemporary radio callers after listening to Dr. Laura some years ago.

Richard Lynn writes from Northern Ireland:

Excellent piece on the mortgage crisis asserting that the mortgage providers were under pressure to provide loans to blacks and Hispanics, although they are known to be poor risks.

The reason blacks and Hispanics are poor risks lies in their high psychopathic personality (which I documented in an article a few years ago) that makes them prefer instant gratification (e.g., impulse purchases, buying alcohol, drugs, or trinkets) over the long term prudence required for the management of mortgage repayments. In the terminology of economics, they have a high time preference, as noted by Michael Levin in his book.

Karen writes from England:

The subprime mortgages alone were not sufficient to cause such massive financial wreckage. The real damage was done by the use of derivatives and leverage. If the banks had never heard of the word “derivative” they would be fine. Derivatives started appearing in the 1980s and were the means of increasing the revenues of the Merchant Banks (now called Investment Banks). The derivative products got ever more complicated and risky asset based securities were packaged with less risky ones and leveraged to conceal the risk and get the ever complaint rating agencies to give them high ratings. They were then sold on as instruments of deception. The Bankers were always hand in glove with the politicians on this one and as mass immigration was promoted, they thought the demand for housing would grow exponentially and keep the prices rising and the profits rolling in. Wall Street and the City of London have a short term perspective (usually the annual bonus) and once the chickens come home to roost, the big guys have made their money and moved on. Some of them are set up for generations. The party is over for the rest, at least for now.

The banks also hired immigrants over local people so they could pay them less, not as any part of a diversity policy. Politicians can only bully small companies. The big companies bully them.

LA replies:

Yes, I’ve emphasized from the start that it was not just the suprime mortgages, but the bundling of the mortgages into securities and bonds that greatly exacerbated the problem.

Posted by Lawrence Auster at September 25, 2008 09:28 AM | Send