Slapped by the facts

Abandoned farm home - Great Depression

Home ownership is typically the largest financial asset of most American families. Equity (the excess value of your home above its mortgage balance) can be tapped to buy a needed new car, finance renovations, or send your kids to college. In retirement, with the mortgage discharged, the home may be sold to finance a nice retirement in Florida, Texas, or some other low tax (and high sun) haven.

Further, home ownership has proved to foster a sense of community far stronger than that of transient rental populations. Neighborhoods with high individual ownership rates tend to be neater and calmer and just nicer to live in. So it’s no wonder that government has fostered the notion that taxpayers’ pockets should be tapped to increase the general overall home ownership rate. What’s not to like about this?

Therefore in bipartisan fashion (meaning both Democrats and Republicans), we passed the Community Reinvestment Act (CRA) in 1977. The CRA was intended to coerce banks to make loans that they would not otherwise make. This is odd in that the language of the CRA also required that banks maintain sound and prudent lending practices. In typical government fashion, the banks were put into a bind that they could not escape. If they declined to make loans to uncreditworthy applicants, they would be punished. But if they made loans to uncreditworthy applicants, they would be punished. What’s a poor banker to do?

Since the punishment for not making loans was far greater, the loans rolled out. In association with other government “affordable housing” initiatives, down payments fell as low as 3.75% and losses were insured by the Federal Housing Authority (FHA). Lenders were incented to lend (protected from losses) and borrowers were incented to borrow, all lubricated by taxpayer largess.

The CRA was amped up in 1995 (Clinton) and again in 2005 (Bush). Politicians of both parties love to give our money away. And what did this largess gain us?

The financial crisis of 2008.

While there has been much argument that the CRA (and related government “affordable housing” programs) had no effect on the economy nor led to the financial crisis, a simple application of common sense might indicate otherwise.

• Would a down payment of 20% result in a sounder applicant than 3.75%? In other words, on a $200,000 loan, would you be more likely to walk away (default) if you had paid $40,000 down versus $7,500?

• As a mortgage originator, would you be more or less likely to grant a loan if you knew that the government would cover your losses?

Well, a recent study published by an independent, nonpartisan economic think tank has given us some answers. The National Bureau of Economic Research (NBER), based in Cambridge Massachusetts, has studied the impact of the Community Reinvestment Act. In their report, the NBER pulls no punches. “Did the Community Reinvestment Act(CRA) lead to Risky Lending? Yes, it did... We find that adherence to the act led to riskier lending by banks."

Read more here: http://voices.kansascity.com/entries/yes-community-reinvestment-act-encouraged-banks-make-risky-loans/#storylink=cpy

Barney Frank, who famously gambled with our money in 2003, had this to say then: “I want to roll the dice a little bit more in this situation towards subsidized housing." But by 2010, Rep. Frank had come to realize the error of his ways: "…it was a great mistake to push lower-income people into housing they couldn't afford and couldn't really handle once they had it." Even Barney was jarred into reality when slapped by the facts.

This sad tale reinforces the damage that the government can inflict when meddling with free markets. Although the intentions were admirable, the outcome was disastrous. Sometimes it’s best to let common sense, and a deep understanding of human nature, reign.