The Diversity Recession: Political Correctness Makes Lenders Stupid

The American economy is sinking under the weight of trillions in dubious home loans, as exemplified by this month's failure of Pasadena-based mortgage lender IndyMac and the Treasury Department's plan for a taxpayer bailout of the privately-owned but "government sponsored" Fannie Mae and Freddie Mac. Savers are increasingly finding the value of their assets inflated away as the Federal Reserve Board devalues the dollar to spread around the suffering from bad loans.

Traditionally, markets work by balancing greed and fear. Why was greed allowed to outrun fear so badly this time?

One clue comes from looking at the places with the sharpest decline in home prices, such as California, South Florida, Arizona, and Nevada. For example, the median price of homes sold in California last month was $328,000, down 31.5 percent from a ridiculous $484,000 in June 2007. Almost 42 percent of all homes sold in California were in foreclosure.

Why did the housing bubble get out of control in many heavily Hispanic regions?

Because many important people wanted it to.

A widely overlooked reason behind this economic disaster is that the politicians, real estate interests, and financiers told the public that they weren't speculating wildly on the insane hope of home prices rising forever. No, they were actually helping minorities share in the American Dream!

A percipient April 13, 2007 article in the nonprofit San Diego Voice by Kelly Bennett, Foreclosure Wave Said to Hit Latinos Hard, reported:

"This decade, a national push to increase homeownership among Latinos coincided with one of the longest, most dramatic periods of appreciation for home values. Latino mortgage and real estate professionals put forth aggressive outreach campaigns in the community, while lenders reached out to huge, untapped sections of the market by loosening qualifying standards. …

"Because a widened lending gate allowed many more Latinos and other minorities into the housing market than had entered previously, lawmakers and special interest groups championed the lenders' efforts to extend homeownership to those groups."

It's important to understand that practically every politician who comes up through the ranks from state and local government owes favors to real estate interests. (Consider how now-convicted slumlord Tony Rezko sponsored Barack Obama's career.)

 Why? Because developers are more interested in local and state politics than anybody else is. (C'mon, admit it, local politics seem kind of boring.) They're interested because they have financial interests in land use decisions.

Politicians control developers, so developers control politicians.

Thus, politicians, developers, and financial institutions have developed a vast interlocking system of doing subtle favors for each other by leaning on the lending process. It all works smoothly for years at a time with nobody on the outside the wiser … until there's a downturn. Suddenly, the public is left holding the bag, paying off both directly and through enduring stagflation.

Diversity served as the perfect politically correct excuse for rampant irresponsibility. It gave insiders a rationale for putting their thumb on the scales of the vast lending market in the sacred name of anti-discrimination. Who dared be so racist as to argue that blacks and Hispanics should get fewer loans per capita because they were less likely to pay them back? That's "the soft bigotry of low expectations."

In a June 22 article in Taki's Magazine, The Diversity Recession, I recounted a few of the countless examples of politicians from Jimmy Carter to George W. Bush pushing for more lending to "underserved" minorities. The Bush Administration, for instance, raised the quota for Fannie Mae and Freddie Mac to 39 percent for "underserved" regions.

Perhaps worse than quotas, though, was the attack on traditional lending standards in the name of expanding minority homeownership. We've seen repeatedly over the decades that, bad as they obviously are, racial quotas are often less debilitating than eliminating tests altogether due to their "disparate impact." At least with a quota you select the best people from each race (although, by definition, not the best overall). When you junk the standards altogether, however, you end up taking at random from all races.

For example, in January 1981 the outgoing Carter Administration threw out the federal civil service exam, the exquisitely validated PACE, because blacks and Hispanics didn't perform as well on it on average. Since then, federal employees have been hired mostly on the basis of resumes and interviews, which explains a lot about the decline in the competence of the federal government.

Likewise, the mortgage industry once had traditional tests of creditworthiness, such as being able to afford a substantial down payment. Being able to put cash on the barrelhead provided tangible evidence that you weren't just making up the numbers you were putting down on your loan application.

But the politicians encouraged lenders to speculate on dubious borrowers, all in the name of racial equality. For example, MSNBC stated in a March 27, 2004 report subtitled "President wants to add new minority home owners" that Bush was putting the Presidential imprimatur on the no-money-down mortgages that so exacerbated the bubble:

"He also proposes to make zero down-payment loans available to first-time buyers whose mortgages are guaranteed by the Federal Housing Administration."

Similarly, "undocumented workers" and undocumented mortgages (colloquially known as liar loans) tend to go together.

The mortgage brokers were notoriously abusive, putting innumerate clients into teaser mortgages that reset the monthly payment sharply upward after two years. What's seldom mentioned, though, is that Hispanics generally turned to Hispanic mortgage brokers. Bennett observed:

"Among minorities, the pull toward using an agent or a loan broker from the same minority group is strong… 'People tend to go with a loan broker or officer that they know,' said Gabe del Rio, director of homeownership for Community HousingWorks, a nonprofit housing organization in San Diego. 'Everybody's got a cousin or a friend who's in the business. And, especially in ethnic communities, there's a propensity to stay with someone you know.'

"But sometimes, the broker the borrowers know is also the broker who takes advantage of them, abusing the trust of their client by tacking on fees or inadequately explaining the terms of the contract they're signing."

Spanish-language radio stations are now hurting badly because so much of their advertising came from Spanish-speaking mortgage brokers and real estate agents.

An article in today's San Diego Union-Tribune, Busted neighborhoods: Foreclosures ravage parts of county where many used risky loans, by Lori Weisberg and Emmet Pierce confirms Bennett's findings from 15 months ago:

"'Any place where there's a high density of lower-income and less-educated Hispanics and African-Americans you'll see a larger decline in values because many of these families were put into subprime loans they didn't understand and shouldn't have qualified for, more so than in other ZIP codes,' said Clifford Arellano, a real estate broker whose office is in Barrio Logan.

Not surprisingly, illegal immigration has played a big role in bubble and bust:

"A large share of those who took out risky loans were recent immigrants who spoke little English, said Gabe del Rio, vice president of lending and homeownership at Community HousingWorks, a nonprofit developer of affordable housing. Many who have come to his agency for counseling say they didn't understand the terms of their loans."

The homeowners who have been meeting their obligations are suffering collateral damage:

"Residents forced to vacate their homes leave a void in the neighborhood, said Enrique Gandarilla, executive director of the City Heights Business Association…  'It's only getting worse. A lot of loans were made to people who never should have gotten them. The impact on the community is terrible. You have vandalism. You have deterioration in values. You see homes that now are targeted by graffiti.'"

The article sums up what will be the verdict of history on America in this decade:

"Typically, a severe housing slump is preceded by a recession and job losses, but that is not the case this time around, [John Karevoll of DataQuick] said. 'So now all us number crunchers are scratching our heads. This wasn't caused by a recession, but by stupidity.'"

But it's not just the fault of stupid borrowers, although a national policy of importing more of them by not enforcing the immigration laws clearly worsened the problem.

Stupidity extended all the way up the hierarchy—and that was intentional.

Political correctness makes people stupid, so diversity provided the ideal cover story for financial crime of the century.