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The Minority Mortgage Meltdown (contd.): How The Community Reinvestment Act Fits In
The mortgage fiasco devastating
I'll demonstrate using the meteoric rise
and fall of Washington Mutual, Inc. (WaMu). Under CEO Kerry
Killinger's direction, WaMu went from being an obscure
So WaMu wasn't quite the biggest
bank—but it may well have been the silliest. When a
mariachi singer in
The bank's slogan was "The Power of Yes". You know, as in "Yes, We Can".
Then, during last year's 1930s-style bank run, the government seized WaMu last September 25 and sold its remnants to JP Morgan Chase for less than $2 billion. The Federal Reserve later outright gave $25 billion to the purchaser, in part for taking this stinker off the government's hands.
Back in the summer of 2008, I pointed out that affirmative action likely had something to do with the horrific default rates on subprime mortgages. That became a modestly popular argument during the recent election campaign. Republicans would attempt to counter Democrats' claim that the mortgage meltdown was caused by "greed" by pointing toward the Community Reinvestment Act.
After being strengthened under the elder
Bush (n.b.!) and Clinton Administrations, the CRB was
"community organizers", like President Barack Obama's
old ally ACORN, to shake down banks wanting government
permission to buy others banks. In return for not protesting
the merger, the racial activists would demand promises of
more loans to minorities with doubtful credit.
The National Community Reinvestment Coalition boasted about the early 1990s change in the CRA from toothless to lucrative:
"Lenders and community organizations have negotiated $1.09 trillion in CRA dollars from 1992 to 2000. [My emphasis!] In contrast, $8.8 billion was negotiated from 1977 through 1991."
"SEATTLE, Dec 21, 2001 … In connection with its merger with Dime [Bank], Washington Mutual recently established a ten-year, $375 billion community commitment which targets funding to low- and moderate-income borrowers, and minority borrowers … One of the largest community commitments of its kind, the ten-year pledge will be implemented with the assistance and support of a variety of non-profit community partners."
On WaMu's still-existent website, the bank explains that $375 billion pledge:
"These funds will provide loans and other financial support to
communities consisting predominantly of people of color, to
residents of low- to moderate-income (LMI) census tracts,
and to people whose income is below 80 percent of median
income. We will strive to create products and programs that
increase our market share in low income and diverse
communities, with a long-term goal of making our market
share in these communities more closely mirror our market
share overall. Using our Year 2000 production as a baseline,
we have set our goal to double the number of loans made to
borrowers of color by the end of the first year of this
commitment. Thereafter, we will increase the number of loans
made in these communities as quickly as possible."
Not surprisingly, WaMu won the 2003 CRA Community Impact Award.
We now know that subprime foreclosures are
centered among exactly the kind of people targeted in WaMu's
CRA agreement with racial activists. During the Housing
Bubble of 2004-2007, minorities accounted for twice as many
subprime dollars borrowed per capita than did whites. And
report by the Boston Fed shows that, at least in
For the GOP, the Community Reinvestment Act (CRA) was a more convenient example of government interference in the mortgage markets than, say, George W. Bush's 2002-2004 holy war on down payments in his effort to boost minority home ownership. That's because the CRA was passed by a Democratic Congress and signed by a Democratic President.
Of course, the GOP's claims about the CRA's centrality in the mortgage meltdown were obviously partisan. And more skepticism about the importance of the CRA seemed plausible, along these lines:
"How could the government hold a gun to the financial institutions' heads and force them to make hundreds of billions in stupid loans? Sure, giving out $375 million in stupid loans to get the government off your back, that would make sense. $3.75 billion, maybe. $37.5 billion, conceivably. But $375 billion, no way. Nobody would promise to give away $375 billion to dubious borrowers unless they thought it was a great idea. They'd leave the industry before they'd promise to hand out $375 billion to people whom they doubted would pay it back."
In general, the government and its associated racket-runners can extort mid-level amounts of affirmative action booty. But when the demands get too great, businesses exit in one way or another. (Often with bad effects on general welfare, of course).
Obviously, it's a massive exaggeration to say the government and the ACORN clones forced WaMu to lend to likely deadbeats. Nobody promises to loan out $375 billion to low and moderate income and minority borrowers unless they actually want to lend out to low and moderate income and minority borrowers something approaching $375 billion.
Moreover, Washington Mutual sure didn't act reluctant. They were positively exuberant about pouring money into the hands of minorities with weak histories of paying off debts. The relatively small number of big financial institutions that did a major fraction of subprime lending really seem to have drunk the same Kool-Aid as ACORN, Congress, Clinton, and Bush. They actually thought they were going to get rich off no-money-down, $400,000 loans to high school dropouts.
And they did, for a few years. CEO Killinger "earned" $88 million from 2001-2007.
WaMu's strategy was lending to deadbeats—the more minority the better. For years, WaMu ran a series of TV commercials where one cool black guy in a blue WaMu shirt, an actor who looked like a cross between Barack Obama and Don Cheadle, would humiliate dozens of old white bankers in suits.
Most advertisers would have put one token minority banker in the crowd of pompous empty suits. But WaMu didn't bother. They wanted to get their message across.
So it would seem that WaMu didn't need the CRA to blows billions.
And yet ... there's a more subtle point that I, and seemingly everybody else, missed in thinking about the impact of the CRA's veto over bank acquisitions: the selection effect on who gets to get big.
Before I explain that, let's back up and think about the big bank-bad bank paradox more generally.
We naturally assume that big banks are safer storehouses for our money than flimsy little banks. It's the basic probability theory of "gambler's ruin"—the more money an institution has, the less likely the chance of running out of money. That's why a casino would still win even if it gave gamblers a fair shake (e.g., no zeros on the roulette wheel): the gamblers would be more likely to run out of money before the casino did.
For this reason, banks have traditionally employed the wiles of architects to make them look as reassuringly massive as possible. When I moved to Chicago in 1982, for instance, I always enjoyed visiting my cousin at work because I had to pass through perhaps the most imposing interior space in the city: the stupendous second floor lobby of the Continental Illinois bank building on La Salle, next to the Board of Trade.
And yet, big banks aren't always as
trustworthy as they might look. An aggressive strategy had
made Continental Illinois the largest commercial and
industrial lender in
Today, the old Continental Illinois
Why do big banks tend to be bad banks?
First, one obvious reason is the "too big to fail" theory that the feds applied to Continental Illinois. The government bailed out bondholders and kept the shell of Continental Illinois limping along for a decade until Bank of America bought it. So, managements and creditors assume there is safety in size, even though the law of diminishing marginal returns says the opposite: the more loans you make, the more likely you'll make bad ones because you'll be less selective.
Second, there's a natural tendency during economic good times for the most recklessly optimistic managements to grow fastest. They borrow the most money and buy the most competitors. (At least until the bad times roll around again, when the skeptics can pick up the wreckage for a song.)
In many industries, however, skill puts a restraint on growth through confidence and luck. For example, Ford Motor Co. became the biggest car company in the world in the first quarter of the 20th Century not because Henry Ford was the biggest risk-taker, but because he was the best car-maker (e.g., he invented the moving assembly line). Similarly, Intel is the top chip maker largely because it's good at making CPU chips.
In finance, in contrast, sheer boldness appears to play a relatively larger role.
Third, the high CEO compensation of recent decades has encouraged a get-rich-quick attitude.
Say a 45-year-old gets appointed CEO of a small bank, with a salary of $1 million per year. He could carefully steward his stockholders' investments, and continue to make roughly $1 million per year until he enters a comfortable but not lavish retirement in 20 years.
Or, he could try to grow the bank fast via risky bets. If he could increase the size radically, he would show the Board that CEOs of banks that big usually get paid $10 million per year. Even if the bank blows up two years later, he'd still have earned $20 million in those two years, as much as he'd earn in 20 years of prudent management of his bank at its current size.
So why not gamble? What's the worst that could happen to his net worth?
Finally, the executives of big banks are,
by necessity, farther removed from what's happening on the
street. In 2006, WaMu moved into the 42-story
skyscraper in downtown
Knowing all the biases favoring risky business, you might expect the government to prudently lean against the tendency of ambitious mortgage lenders to hand out too much money to bad credit risks. Yet, in the name of increasing minority and low-income home ownership, the government did exactly the opposite: since the early 1990s, it has relentlessly pushed for more risky mortgage lending—with the catastrophic results we see all around us.
How did the Community Reinvestment Act worsen imprudent lending to minorities?
It's not a popular question even to ask. "I want to give you my verdict on CRA: NOT guilty", said FDIC Chairman Sheila Bair:
"And 'Let me ask you. Where in
the CRA does it say to make loans to people who can't afford
to repay? Nowhere.' The facts are simple, Bair said. The
lending practices that are causing problems today were
driven by a desire for more market share and revenue growth,
not because the government encouraged certain lending
Bair Sets to Shatter CRA "Myth",
by Kelly Curran, HousingWire.com,
Okay–but how does a bank get more market share and revenue growth?
One major way: by buying other banks. And to do that, you have to pass through the CRA gauntlet. If you aren't willing to lend to people the government wanted you to lend to, then you were out of luck at mergers and acquisitions game.
So, the CRA implicitly selected for Kool-Aid Drinkers, such as WaMu's Killinger. They're the ones whom the government allows to build empires. (Unfortunately, their houses turned out to be built on sand.)
I missed understanding the impact of the
CRA because I kept asking myself:
"How could the CRA
force a banker who thinks lending more to minorities is a bad idea
to lend more to minorities?" I kept trying to imagine
the CRA's effect on the already crazy-stupid WaMu, and how
that couldn't have been all that significant.
But I should have been thinking about the other side of the coin: all the sane-smart banks that didn't get to get big like WaMu did because the government rigged the acquisition process so that crazy-stupid banks were more likely to get merger approval. WaMu got permission from the government to make 29 acquisitions from 1990 onward. A smart-sane bank wouldn't.
That WaMu sincerely believed that it was going to make a fortune handing big mortgages to mariachi singers, illegal immigrants, and Department of Motor Vehicle clerks etc. etc. seems clear. After all, WaMu not only originated about one out of every eight mortgages in the U.S., but it also held on to a fair number of them instead of securitizing them and dumping them on Wall Street.
WaMu explained its minority-oriented strategy over and over again. Robert O'Connor wrote in Mortgage Banking, October 2003:
"Craig Davis, president of Washington Mutual's Home
Loans & Insurance Services Group, says that the high rate of
homeownership in the
"… Porter says that
"Despite the strength of its portfolio operation,
And here's a 2003 WaMu press release that sounds like Dave Barry wrote it:
"Helping to build strong, vibrant communities
Why was WaMu, with its derisible strategy, able to buy out so many big lenders? To understand it, think about it the other way around: why didn't more prudent financial institutions outbid WaMu for acquisitions?
Say there are two banks, WaMu and Scrooge-Potter BanCorp. The latter is owned by Ebenezer Scrooge of Charles Dickens' A Christmas Carol and Mister Potter of Frank Capra's It's a Wonderful Life. While WaMu is beloved for lending to anybody with a pulse, Scrooge-Potter BanCorp is widely loathed for taking a dim view of lending money to likely deadbeats.
They both would like to buy George Bailey's Bailey Building and Loan Association. ACORN and the National Community Reinvestment Coalition announce they will protest vociferously against regulatory approval of the merger unless the winner pledges to make $50 billion in minority and low income loans.
Fearing a debacle of defaults, Scrooge-Potter BanCorp issues a two-word press release: "Bah, humbug". And it drops out of the bidding.
WaMu announces: "Well, heck, we'll promise to lend $55 billion."
In fact, because Scrooge-Potter realized
its quest was hopeless, WaMu got
Lather, rinse, and repeat. The CRA means that WaMu gets big while Scrooge-Potter stays small.
Consider the indirect effects on Scrooge-Potter BanCorp. Who would want to go to work for a bank that can't make acquisitions because it won't play nice with the government on CRA? Scrooge-Potter can't buy anybody, it can only be bought. So, how's your job security at Scrooge-Potter looking? Wouldn't it make more sense to go work for WaMu instead?
The CRA drives the climate of opinion in the entire mortgage industry. If you wanted to be able to buy other banks, you had to play ball.
Practically everybody did. Out of the thousands of banks with federal CRA Performance Evaluations, 496 got the highest rating of Outstanding, while only five dared to be in "Substantial Noncompliance".
biggest noncomplier: First
Bank of Beverly Hills. It had the kind of business
strategy that you'd
expect from a bank with that name: take in deposits from
rich people and make loans to big real estate developers
Over time, the madness infects the entire culture of finance, as the government labels the prudent bankers automatic losers in the great game of acquisitions.
WaMu's 2001 purchase of Dime Bank may have
been its crowning excess. But in the history of the downfall
of the American economy, it wasn't as important as WaMu's
1990s move into
In 1997, WaMu was the second biggest
thrift. When the biggest thrift, Home Savings of America
(owned by H.F. Ahmanson and Co. of Irvine, CA), attempted a
hostile takeover of its Southern California rival, the
number three thrift,
Great Western, WaMu entered as a white knight. This set
off a CRA bidding war. The two competed to see who could
promise the most lending to the politically favored.
Seattle Times headline on
"In the largest inner-city loan program
ever proposed by a U.S. banking institution, Washington
Mutual said today it will lend $75 billion to mostly
lower-income and minority borrowers over 10 years if it
successfully acquires Great Western Financial. Washington
Mutual said the majority of those mortgages, consumer and
small-business loans would be made in
"In the wake of its takeover of H.F. Ahmanson's Home Savings of America, Washington Mutual signed a $120 billion CRA agreement with the California Reinvestment Committee (CRC), the Greenlining Institute, the Washington Reinvestment Alliance, and other community groups."[Community Reinvestment Act—Tool in Action, no date]
Grabbing Home Savings made WaMu the nation's number one lender of adjustable-rate mortgages. Even more ominous, WaMu was now heavily concentrated in California, a state where the combination of nice weather, environmental restrictions on housing development, and a huge influx of immigrants combined to make home prices absurdly volatile in the next decade.
Then, when WaMu bought Dime Bank in 2001, it made a binding promise to lend for Community Reinvestment Act credit $375 billion. Sure, why not?
The only problem is that $375 billion here, $375 billion there, pretty soon you are talking about real money.
The question is, how can Barack Obama, a former community organizer and a charter member of the socialist, interventionist, Big Government Left, get us out of this mess?
Answer—he can't. He can only get us in deeper.
[Steve Sailer (email him) is movie critic for The American Conservative. His website www.iSteve.blogspot.com features his daily blog. His new book, AMERICA'S HALF-BLOOD PRINCE: BARACK OBAMA'S "STORY OF RACE AND INHERITANCE", is available here.]