The anti-redlining law that fed the housing bubble

One of the major points of contentions in the aftermath of the housing debacle was whether the Community Reinvestment Act — an anti-redlining law — contributed to the disaster.

Defenders of the law insisted it did not, but it's harder for backers to support that conclusion now, after the release of a working paper by the National Bureau of Economic Research. Its authors get straight to the point.

"Did the Community Reinvestment Act (CRA) Lead to Risky Lending?" they ask. "Yes, it did. We find that adherence to the act led to riskier lending by banks."

The act required banks to serve depositors from all neighborhoods in their operating areas, including those of low and moderate income. The report's economists found that lending to borrowers in census tracts of modest means increased around the time of a bank's regulatory exam — and more of those loans went bad.

Quoting from the study: "There is a clear pattern of increased defaults for loans made by these banks in quarters around the (CRA) exam. Moreover, the effects are larger for loans made within CRA tracts."

Boiled down, the process was as follows. Banks were required to make affordable-housing loans under the act. Congress then forced Fannie Mae and Freddie Mac to buy up an increasing proportion of those loans, effectively imposing quotas on the two government-sponsored mortgage giants.

Many of the loans were subprime or otherwise dubious. Fan and Fred were required to "affirmatively" support bank CRA lending and to do this, they had to lower their credit standards.

Given the market heft of Fan and Fred, they greatly contributed to the debasement of credit quality in the mortgage market generally.

Wall Street got into the game in a big way, but Fannie and Freddie provided much of the fuel for lousy loans, encouraging subprime factories like Countrywide to crank out even more dubious paper.

Countrywide made the loans and sold them to the government-sponsored mortgage giants — transactions that provided capital for more loans. And of course when Fannie and Freddie bought those mortgages, they attached a taxpayer guarantee against default.

By the end of 2007, as the looming crash was taking shape, the bubble had become enormous. Wall Street had leveraged itself to the hilt, financing much of its effort with short-term money.

When the lousy mortgages started defaulting and the complex bond packages backed by the now-souring loans failed to perform as expected, the shakier firms couldn't renew their short-term credit. In 2008 the unraveling accelerated, first with Bear Stearns and then spectacularly with Lehman, whose failure triggered a global credit panic.

Two years ago, I had an exchange in an editorial board meeting with act supporter Rep. Emanuel Cleaver, who at one point burst out, "There's no evidence that anyone told Fannie and Freddie to make bad loans."

Never mind that Fannie and Freddie don't make direct loans, they buy them — and of course it was Congress itself that ordered the mortgage giants to buy "bad loans." Later, Cleaver sent me a five-page memo defending the act and its role in the debacle.

Cleaver's comment showed that many in Washington were appallingly ignorant of the origins of the crisis and how the well-intentioned drive toward more "affordable housing" helped push mortgage lending into excess. Despite all this, Cleaver said one of his goals was to make the act even more "impactful," which sounded as if he wanted more of what contributed to the problem in the first place.

The study ought to end the debate over whether the act was one of the factors culpable in the housing bubble. It was. It helped debase credit standards and encouraged lending to people with bad or dubious credit, and when those loans were scooped up by Fan or Fred, taxpayers ended up on the hook.

When I wrote about this two years ago, I noted that one result of the crash was that many of the people Cleaver says he wanted to help ended up financially ruined.

One hopes that he can find the time to take a glance at that study.

E. Thomas McClanahan is a member of the Kansas City Star editorial board.