Community Reinvestment Act - Part Four

Everybody's happy in 1997. During Jimmy Carter's Democratic administration in 1977, a vague law called the Community Reinvestment Act was passed. It was reworked many times over the years and became very powerful. The CRA became powerful enough to pressure banks of all shapes and sizes into making loans to uncreditworthy people. The CRA was especially adept at pressuring financial institutions into putting "hookers and crack addicts in homes that they couldn't afford," as my friend Mike would say. So the Democratic Government is very happy in 1997.

In October 1997, a couple of investment banks launched the first publicly available securitization of Community Reinvestment Act loans. The securities were guaranteed by Freddie Mac and had an implied "AAA" rating. So now the banks that were pressured into making these risky loans have a way to get rid of them - and they are more relieved than happy.

Moreover, the fly-by-night mortgage-lending companies (who were never subject to the CRA) made millions by "...[saddling] entire neighborhoods with risky, high-priced loans that borrowers could never hope to pay back, sold those loans to Wall Street and then went out of business." Source.

Thanks so much to Mike762, who as always, is so patient in answering my questions. The following is his take on the thread I started at Hunter's Campfire:

"Everybody along the way made money, except the end user. The bank or mortgage broker made their commissions, and since they weren't holding the underlying mortgage to maturity, but were instead passing the risk along, their due diligence on creditworthiness went out the window. Adding fuel to the fire was the Government pushing to put hookers and crack addicts in homes that they couldn't afford, and using various exotic mortgage products, the banks complied. Then the investment banks bought these mortgages from the originators of the loans, packaged them into a "bond", and sold it as a AAA rated risk that paid a few basis points more than Treasuries. Pension funds and other institutional investors bought them because they met the fiduciary requirements of ERISA. So did foreign governments, and foreign investors.

Guess what? All of this bailout money has been going to these foreign banks and investors (primarily China and the oil patch) to make them whole, so they will continue to buy US Treasury debt to finance Government operations. Most pension plans and insurance annuities that have these "investments" are insolvent, because they cannot be sold, except at a huge loss. That is why the requirement of FAS 157 to mark assets to market has been suspended. That's also why AIG was bailed out, and continues to be, because they sold Credit Default Swaps, or insurance against non performance on these "bonds". The sad part is that most of these CDS's are held by parties unrelated to the original CDO. In essence, people were betting that other peoples investments would fail. In some cases, they actively worked to make this happen so they could collect on the CDS.

Bottom line, the financial system in the entire world is broken, and cannot possibly be repaired, There are over $1.4 Quadrillion of these derivatives out there, and $600 Trillion are based on mortgages. There are CDS's covering all of these derivatives from default. In other words, there isn't enough money in the entire universe to cover the paper involved. The Fed and the Treasury are throwing everything that they can think up to cover, but none of it is working, and the market reflects that. Expect it to get worse toward the end of the year. How much worse remains to be seen.

Community Reinvestment Act - Part Three

All of this comes from Wikipedia. I've just changed the words a little and added comment.

There were arguments against the CRA by such people as William A. Niskanen, chair of the Cato Institute. He said there was no assurance that banks would not be expected to operate at a loss, and recommended Congress repeal the Act during March 1995 congressional hearings. In my personal research, I couldn't find where the Government was guaranteeing these CRA loans in any way, shape, or form.

So now we've got the government pressuring banks to make loans to people who will most likely default, and then, in essence, telling the banks they're out of luck if they think the government's gonna help them when these people do default. That's the way I see it anyway.

Of course all the reports from the government side of things were that there'd be (had been no) problems with CRA loans. Significant to me is that now we're talking about mortgages - " ... lower-income neighborhoods...with lower-income borrowers appear to be as profitable as other mortgage-oriented commercial banks".

In my opinion, "CRA-covered lenders" and "CRA-eligible institutions" = banks who were pressured to make bad loans. Having said that:     The Treasury Department said that between 1993 and 1998, $467 billion in mortgage credit flowed from [banks who were pressured to make bad loans] to low- and medium-income borrowers and areas. ...The total number of loans to poorer Americans by [banks who were pressured to make bad loans] rose by 39% while loans to wealthier individuals by [banks who were pressured to make bad loans] rose by 17%. The share of total US lending to low and medium income borrowers rose from 25% in 1993 to 28% in 1998 as a consequence.

In October 1997, First Union Capital Markets and Bear, Stearns & Co launched the first publicly available securitization of Community Reinvestment Act loans, issuing $384.6 million of such securities. The securities were guaranteed by Freddie Mac and had an implied "AAA" rating.

I asked what this meant at Hunter's Campfire. My thanks to Southerntier8 who told me "Securitization means they bundled together the payments coming in from a collection of peoples mortgages and sold them as one security. It is the same idea as a corporate bond except the payments come from the collection of homeowners rather than a corporation. ... Fannie and Freddie would have been the original lenders. Bear Sterns and First Union (investment banks) would have brokered the deal. Probably they were sold on the bond market to large institutions i.e. insurance companies, pension funds, etc."

My thanks also to Mike762 who told me, "Essentially you take a bunch of mortgages made by different banks and mortgage brokers, and bundle them into a "bond". Then you take this "bond" and get one of the ratings agencies such as Standard and Poor's, Fitch, or Moody's to rate the risk of the bond. The lower the risk of default, or failure to perform, the higher the rating. A AAA rated bond is essentially default proof - at least that's how it's supposed to be. Think US Treasury Bonds.

These are then called Collateralized Debt Obligations or CDO's, or Mortgage Backed Securities or MBS's. The kicker is that these bonds are rated on the senior, or most credit worthy tranche (slice), and not on some of the less credit worthy tranches, because the idea was that the senior tranche would always perform, making up for the losses of the more junior or riskier segments, thus paying the dividend, and keeping the risk of default at nil. It obviously didn't work out that way."

Investopedia offers a good definition of "tranche": "Tranche" is actually a French word meaning "slice" or "portion". In the world of investing, it is used to describe a security that can be split up into smaller pieces and subsequently sold to investors. Mortgage-backed securities (MBS), such as a collateralized mortgage obligation (CMO), can often be found in the form of a tranche. These securities can be partitioned based on their MATURITIES and then sold to investors based on their preferences.

For example, an investor might need cash flows in the short term and have no desire to receive cash in the future. Conversely, another investor could have a need for cash flows in the long term but not right now.

To take advantage of this selling situation, an investment bank could split some security or asset, such as a CMO, into different parts so that the first investor receives the early cash flows of a mortgage and the second investor has the right to receive the latter cash flows. With the creation of these tranches, a security or issue that was once unattractive may enjoy some new found marketability."


So finally, in 1997, banks had a way to...get rid of these bad loans. That's what it looks like to me anyway. Everybody's happy now. The government is forcing the banks to make bad loans to bad risks, so the government's happy. I'm assuming the banks, along with Freddie and Fannie, now had a way to get rid of the risky loans, so they're happy. The investment banks who brokered the deals made a bunch of money selling these bad loans on the stock market to unsuspecting suckers; so the investment banks are happy. The unsuspecting suckers? They're not so happy right now.

Community Reinvestment Act - Part Two

For me, unsophisticated and simplistic as I am, it's important to note that the only penalty for not complying with the CRA is being denied the ability to expand through merger, acquisition or branching. Even so, banks are pressured to "...help meet the credit needs of the communities in which they operate" whether they plan to expand or not.

From U.S.News & World Report blogger, James Pethokoukis (March 17, 2009): ... here comes this fantastic story, ...about East Bridgewater Savings in Boston:

Bad or delinquent loans? Zero. Foreclosures? None. Money set aside in 2008 for anticipated loan losses? Nothing. ... The bank even squeaked out a profit of $87,000. And its Tier 1 risk-based capital ratio was 31.6 percent, or more than three times higher than many community banks in Massachusetts. “We’re paranoid about credit quality,” Petrucelli said. The 62-year-old chief executive has run the bank since 1992.

Yet the FDIC has turned up the heat on Petrucelli's bank, giving it an apparently rare "needs to improve rating," for not making more risky loans under the Community Reinvestment Act. Here is how the FDIC puts it: “There are no apparent financial or legal impediments that would limit the bank’s ability to help meet the credit needs of its assessment area.

The FDIC examiners also faulted East Bridgewater "for not advertising and marketing its loan products enough. The bank, which does not have a Web site, offers fixed-rate mortgages."

How many East Bridgewaters are out there that knuckled under to the pressure and started handing out mortgages to whomever? I am not saying that CRA is the only factor here. There is plenty of blame to go around, regulators, Alan Greenspan, derivatives desks on Wall Street. But to let CRA and its enablers off the hook is ridiculous." (End James Pethokoukis article)

Speaking in 2007, the 30th anniversary of the CRA, Ben Bernanke, Chair of the Federal Reserve System since 2006, stated that the high costs of gathering information, "may have created a 'first-mover' problem, in which each financial institution has an incentive to let one of its competitors be the first to enter an underserved market.

Bernanke notes that at least in some instances, "the CRA has served as a catalyst, inducing banks to enter underserved markets that they might otherwise have ignored".

Underserved markets. At first glance I thought this said, "undeserved markets". It's amazing how similar those words look on paper.

In 1989, the first President Bush signed the Financial Institutions Reform Recovery and Enforcement Act (FIRREA) into law. FIRREA established a grading system for the CRA:

• Outstanding


• Satisfactory


• Needs to Improve


• Substantial Noncompliance

FIRREA also mandated that the 'grade' of each financial institution be make public - along with written evaluations using facts and data to support the CRA people's conclusions.

To make the CRA ratings public "... was a defining moment because it put the banks under the scrutiny of the media. It was the first time that any bank exam or rating was made public in the U.S." Source

Community Reinvestment Act - CRA

Referring to the The GLBA, enacted November 12, 1999, The Clinton Administration stressed that it "would veto any legislation that would scale back minority-lending requirements."

This meant that banks would be denied the ability to expand through merger, acquisition or branching unless each party received a good rating from the Community Reinvestment Act ... people.

The CRA 'people' are:
The Federal Reserve
The Federal Deposit Insurance Corporation (FDIC)
The Office of the Comptroller of the Currency (OCC)
The Office of Thrift Supervision (OTS)
and finally The Federal Financial Institutions Examination Council (FFIEC) coordinates the CRA efforts of these four. (The FFIEC's website hasn't been updated since 2007.)

The CRA was originally signed into law by President Jimmy Carter in 1977. It's purpose was to reduce discrimination in the credit and housing markets. You had:

• The Fair Housing Act of 1968 - to prohibit discrimination on the basis of race, sex, or other personal characteristics.


• The Equal Credit Opportunity Act of 1974 - same thing - to prohibit discrimination on the basis of race, sex, or other personal characteristics.


• The Home Mortgage Disclosure Act of 1975 - required that financial institutions publicly disclose mortgage lending and application data.


• The Community Reinvestment Act of 1977 - to ensure the provision of credit to all parts of a community, regardless of the relative wealth or poverty of a neighborhood.

In writing the CRA, Congress apparently didn't say how to ensure that banks and savings associations serve the credit needs of their local communities - the law just said to do it. And little by little, community groups organized to take advantage of their right under the Act to complain about law enforcement of the regulations.

To me, it's kind of like Congress told the banks to make their neighborhood people happy, and the people lined up at the banks, saying "Ok, it's a law now - make us happy." But how? The obvious answer was to make loans to people who otherwise wouldn't have qualified to borrow money - or buy a house. Because the "relative wealth or poverty of a neighborhood", in my opinion, can only be determined by the people who occupy it.

Mandatory Loans ....

A fellow named Barak posted an interesting article at 24hourcampfire.com called The Federal Reserve's Self-Imposed Dilemma - Gary North. (Barak listed the source.)

watch4bear, another member at 24hourcampfire made this comment about the article: "...Mandatory loans to unqualified borrowers, with zero collateral, and waived mortgage insurance, busted the bank. Ours, and other investing countries. Those responsible should be tried before the world court for collusion, and intent to defraud."

It was that phrase, "Mandatory loans" that started me off on this tangent - my quest for National Economic Understanding. Who was responsible for making bank loans mandatory? What an outrageous notion! Watch4bear pointed me in the right direction - the Gramm-Leach-Bliley Act.

The GLBA, enacted November 12, 1999, repealed part of an old law that prohibited a bank from offering investment,commercial banking, and insurance services all under one roof, so to speak. The GLBA made this legal again, and is how conglomerations like Citigroup (Citybank and Traveler's) are able to operate legally.

But the GLBA is beside the point when it comes to "mandatory loans", so I waded through the Wikipedia stuff and found exactly what I was looking for. I posted it on Barak's thread:

"Crucial to the passing of this Act was an amendment made to the GLBA, stating that no merger may go ahead if any of the financial holding institutions, or affiliates thereof, received a "less than satisfactory" rating at its most recent CRA [Community Reinvestment Act] exam", essentially meaning that any merger may only go ahead with the strict approval of the regulatory bodies responsible for the Community Reinvestment Act (CRA).

This was an issue of hot contention, and the Clinton Administration stressed that it "would veto any legislation that would scale back minority-lending requirements."

So this story really has nothing to do with the GLBA, and everything to do with the Community Reinvestment Act.