The mortgage fiasco devastating
many causes, but perhaps the least understood is the complex
impact of the 1977 Community Reinvestment Act (CRA). There
has been some hoopla over the CRA in recent months, but
nobody seems to have noticed the subtle way the CRA actually
exacerbated the disaster.
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
claimed a six-figure income on his mortgage application, for
example, WaMu accepted
a picture of him in his mariachi outfit as the
sole documentation of his income.
The bank`s slogan was
“The Power of Yes”.
You know, as in “Yes,
Then, during last year`s 1930s-style bank
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
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
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
boasted about the early 1990s change in the CRA from
toothless to lucrative:
“Lenders and community organizations have
trillion in CRA dollars from 1992 to 2000.
In contrast, $8.8 billion was negotiated from 1977 through
“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
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
on subprime loans at twice the white rate. All this suggests
that minorities accounted for approaching two-thirds of
subprime mortgage dollars lost.
For the GOP, the Community Reinvestment
Act (CRA) was a more convenient example of government
interference in the mortgage markets than, say,
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
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
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
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
$88 million from 2001-2007.
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
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
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
We naturally assume that big banks are
safer storehouses for our money than flimsy little banks.
It`s the basic probability theory of
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
in May 1984, requiring the biggest FDIC bailout of
depositors in American history…up to that point, of course.
Today, the old Continental Illinois
America, one of the new
four Red Ink Supergiants of American banking along with
Citigroup, JP Morgan Chase, and Wells Fargo. Nonetheless, B
of A—and perhaps some of its colossal colleagues—may follow
Continental Illinois into nonexistence if the federal
government ever tires of bailouts. The problem, of course,
is countless (at present, literally)bad mortgages made
during the late
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
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
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
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
were making so many fraudulent loans.
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
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
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
percent–can mask very low rates among immigrants and
minorities. He argues that encouraging ownership among these
groups is both good for
good for the country. `Affordable housing and lending is
front and center in terms of our strategy,`
“… Porter says that
Mutual takes the CRA very seriously. But he adds the bank
regards the CRA as a floor rather than a ceiling. He says
the company, and its employees, want to surpass the
regulatory standard for institutions to meet the credit
needs of their communities. Porter points out, for instance,
that the bank`s $375-billion, 10-year lending commitment was
not necessarily dictated by the CRA. `It was good from the
company`s perspective,` he says. `It was good from the
community perspective, and it actually gives us a higher bar
that we want to achieve.` …
“Despite the strength of its portfolio operation,
Mutual is also committed to the secondary market. Early this
year, it entered into a five-year strategic alliance with
Fannie Mae Fannie Mae: to encourage home-buying among a
number of groups, including immigrants, minorities,
first-time buyers first-time buyer first-time
buyer and people with low and moderate incomes.
The goal is to generate $85 billion in mortgage lending.”
And here`s a 2003 WaMu press release that
Dave Barry wrote it:
“Helping to build strong, vibrant communities
Mutual does business is integral to the company`s long-term
strategy. The Community and External Affairs Division
oversees all community investment and development activities
to ensure that
Mutual fulfills its community goals in the most strategic
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`
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
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:
And it drops out of the bidding.
“Well, heck, we`ll
promise to lend $55 billion.”
In fact, because Scrooge-Potter realized
its quest was hopeless, WaMu got
and Loan for less than it would have paid if the government
wasn`t biased in favor of imprudent bankers. This gives WaMu
more money to pursue more targets.
Lather, rinse, and repeat. The CRA
means that WaMu gets big while Scrooge-Potter stays small.
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
CRA Performance Evaluations, 496 got the highest rating
of Outstanding, while only five dared to be in
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
popping of the Housing Bubble coming, it was pulling it its
horns when the government evaluated it. The feds didn`t like
that. (You can read the government`s
report and see if you can find anything shameful about
how FBBH did business. I can`t.)
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
together like a match and dynamite.
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
Loan Plan Trumps Rival—$75 Billion Inner-City Proposal
Eclipses Ahmanson Bid.”
Reporter Don Lee wrote:
“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
billion community reinvestment commitment made three weeks
ago by Home Savings of America.”
“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
Reinvestment Act—Tool in Action,
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
environmental restrictions on housing development, and a
influx of immigrants combined to make home prices
absurdly volatile in the next decade.
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.
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.