3 Jan

A Primer on the 2007-2009 Financial Mess [Reader Post]

                                       

1.    Politicians had policies which supported bad lending practices.  They believed that not enough loans were being made to minority groups, so they expanded the power and scope of the Community Reinvestment Act, which was designed to get more minorities to buy homes.

2.    There was the problem of minority incomes not being high enough and their credit not being good enough to get home loans.

3.    FNMA and FHLMC are quasi-government institutions (now, fully government institutions) which make the rules for buying mortgages, as mortgage companies do not hold their mortgages; they sell them on the secondary mortgage market, and use that money to make new loans.  In the past, FNMA and FHLMC had strict loan requirements, so that people who met those requirements were highly unlikely to default on a mortgage loan.

4.    At first, some lending institutions did not go along with these practices.

5.    These lending institutions were excoriated by activist groups (like ACORN).  These groups even demonstrated out in front of the private homes of various bank presidents, scaring their families.

6.    At the same time, there was the threat that the government would no longer buy their loans.  Mortgage companies function by making loans, not by holding loans, so this would destroy any mortgage company.

7.    Lending institutions which made a lot of minority loans, taking advantage of the new relaxed standards of FNMA and FHLMC, were rewarded.

8.    All of a sudden, millions of people who previously could not buy a home were now qualified.  This flooded the market with millions of new buyers, who did not have to qualify in terms of income and credit (strong indicators of loan-worthiness).

9.    This flood of new buyers drove housing prices up, which is simple supply and demand economics.  This is the great housing bubble of the early and mid-2000’s where homes increased in value by as much as 100% or more in some communities.

10.    Since loans had become easier to get, millions more people refinanced their homes, with the inflated home value, and pulled cash out of this refinancing.  This meant more people had more money, which meant more spending, which inflated our economy and the market (some of this money was invested, of course).

11.    At the same time, revenues to the state governments kept on going up, because housing values escalated to a tremendous degree.  States had tons of new money
coming in from taxes.

12.    State governments began using this money to buy votes and to incur favor from their various constituencies.  I doubt that many states recognized that this was a lot of new money coming in, and that maybe they ought to bank it or reduce property taxes.

13.    When a huge percentage of these questionable loans went bad, the housing market crashed.

14.    As the home values went down, some people walked away from their loans simply because they were “under water” (the house was no longer worth its inflated value, and, therefore, the loan against the house was greater than the value of the house).

15.    As the value of the houses went down, revenue to state governments suddenly went down causing enormous state-by-state debt.

16.    At one time, investing in the mortgage market was a sure thing, so virtually every pension fund and many investment groups were heavily invested in the housing market (please realize that the amount of money this represents makes ENRON look like a child’s lemonade stand).

17.    So, as the housing market crashed, so did the stock market and every single investment portfolio.  As the stock market began to spiral because the housing market was at an artificially inflated value, this pulled down the rest of the market with it (with automatic buys and sells built into the system, this can happen in just a few hours).

18.    As a result, the exact same politicians who caused this mess blamed predatory lending practices—the same practices which their policies encouraged!  Of course, they quickly blamed the President in charge (President George W. Bush, who attempted to reform FNMA and FHLMC practices, which attempts were shot down by the opposing party).  These same politicians also blamed capitalism and they blamed Wall Street, because the housing market caused the entire market to crash.

19.    Again, the politicians who caused housing bubble, the worthless loans, the inevitable housing bubble bursting, the resultant market crash and our present financial woes then blamed everyone except themselves.

Taken From:

http://kukis.org/Samuel/2Sam_11.htm

About Gary Kukis

A retired math teacher who spends most of his time exegeting the Old Testament and, once a week, puts out an ezeen.
This entry was posted in Economy, Real Estate & Lending, Taxes and tagged , , , , , , , , , , , . Bookmark the permalink. Monday, January 3rd, 2011 at 6:00 am
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21 Responses to A Primer on the 2007-2009 Financial Mess [Reader Post]

  1. JustAl says: 1

    A couple of additional points. First the chronology; the CRA was a Carter brain (dead) child, yes indeed, the failed administration that just keeps on giving. But, note that none of the administrations since did anything to defuse this ticking time bomb, not even draw attention to it in a serious fashion. Clinton’s administration even accelerated it, increasing the percentage of bad loans Fannie and Freddie were required (under threat of government law suite) to take. W. and some GOP senators made a speech and wrote a litter to give themselves cover, but then did nothing. This travesty should have been the leading subject of every speech and memo from the GOP since Regan took office!

    Many will say it was the bundlers of these “toxic assets” who are the blame. Sure, thieves who walked into the treasury are guilty. But the point of the article, one hotly denied by the statests, is that without the government’s social engineering and interference, the back door to the treasury would not have existed in the first place.

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  2. B-Rob says: 2

    What a load of hooey! This is a VERY WEAK attempt to blame the CRA, a civil rights law, for the entire banking crisis. How can you discuss the Crash of 2008 with not a single reference to the impact of collateralized debt obligations, credit default swaps and the securitization of the mortgages?

    If there was no secondary market for the bad mortgages, there would have been far fewer of them because banks and mortgage companies would have had to hang on to mortgage exposure. But with all the new credit and debt instruments, mortgage lenders (a) did not have to hold on to paper and (b) had no financial interest in whether they were lending to credit worthy people. We ended up with a system where (1) the mortgage brokers had no financial interest in their mortgages; (2) the bundlers who put together mortgages for resale had no financial interest in the mortgages; (3) rating agencies said the paper was as good as cash deposits in a bank; (4) foreign and domestic investors bought them assuming they were as good as the rating agencies said they were, and used the “high yields” on this “cash” to goose money market funds, and to artificially shore up their balance sheets; then (5) the insurance companies and investment banking houses sold credit default policies on those same weak securities but did not have any reserves around in case the paper went sour.

    To blame the CRA or Fannie and Freddie for the subsequent implosion of the bond market, the immolation of the money market funds, and the bankruptcy of Merrill, Lehman Bros. and Bear Stearns is akin to blaming a gas station owner for an arsonist’s torching of a house. It wasn’t the fact that many mortgages went to people with shaky credit; it was the fact that a HUGE after-market for shaky credit mortgages spurred further extensions of shaky credit, more exotic mortgage products, and more bundling of regular old “crap” into “crap nicely adorned in heavy wrapping paper.” People in the suburbs, cities and the ‘hood were all targeted for new mortgages because there was so much money to be made packaging and reselling, then betting on those same mortgages. I know this part of the story does not jibe with the revisionist GOPer con talking points, but they are simply the unadulterated facts.

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  3. JustAl says: 3

    I’ve already addressed your circular argument. Without the CRA there wouldn’t have been enough bad mortgages to create the secondary markets you refer to. The only way those secondary markets flourished was because the “word of the federal government” that is to say Fannie and Freddie stood behind them.

    The crooks couldn’t have looted the treasury though the back door if the back door (CRA) had never been cut into the wall.

    Maybe, as Spock said, it is time for more of your “colorful metaphors”?

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  4. drjohn says: 4

    Ahem

    It wasn’t the fact that many mortgages went to people with shaky credit; it was the fact that a HUGE after-market for shaky credit mortgages spurred further extensions of shaky credit,

    That’s not what caused the collapse. Failure to pay the notes caused the dominos to fall. Failure to pay by those who should NEVER have been granted those notes in the first place. Those like who Bawney Fwank who protected the fraud until far too late.

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  5. Nan G says: 5

    Just to show that the goal of Obama and liberals is to get completely away from the very idea of qualifying for a loan is his Equal Employment Opportunity Commission (EEOC) suing the Kaplan Higher Education Corporation for using credit histories to screen applicants.

    See:
    http://www.americanthinker.com/2010/12/how_not_to_help_blacks_find_em.html

    Why prevent a company from looking at whether a job applicant pays his bills?
    Why prevent a company from running background checks to see if a job applicant has already shown that he has ”sticky fingers?”
    ~~~~~~~~~~~~~~~~~~
    I can remember getting out of REITS when the mortgage standards dropped so much that it was alarming to me who was being allowed to say they were buying property.
    If you look they never really bought the property.
    They moved in with no money down and stayed for cheaper than paying rent.
    When they learned that Obama would NOT make them hit the street for stopping payments on their mortgage, they started living for free.
    They have No Stake in their property because they have not paid down their mortgage enough to be paying on their land instead of their interest.

    Walking away is common.
    But even more common is walking away only from the payments while staying put in ”their home.”

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  6. Buffalobob says: 6

    I find this subject interesting and appropriate. I was in my car in Boise ID Saturday listening to the radio, scanning stations. A talk program came up that caught my attention. The show host lady was interviewing a husband and wife who had not paid their mortgage for 2 years. They were afraid the bank would foreclosure. (now you know why this perked my interest) After about 5 min of listening to the interview I determined I had on a PBS station. The man and wife had jobs that were highly dependent on commissions. He was a high end car salesman and she was into real-estate. Bare with me because here comes the kicker. They had a home close to 4000 sq. ft. a BMW + another car in the three car garage. Didn’t mention children.
    His complaint believe it or not was that he was disadvantage because he didn’t have inherited wealth like most people because his ancestors were slaves. Yes he said that and the dipwad lady interviewer chimed in to comment on how unfair that was. I don’t know maybe I missed out on all of this wealth, but my wife have bought our homes through the years with earned and saved money. I had to turn it off, the sun was shinning the day was good. Do you think Barney the Frank and Dodd will ever be held accountable?

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  7. B-Rob says: 7

    Just Al —

    That is just nonsense. The CRA has been around since the 70s. The kinds of derivative financial instruments I am talking about hit their vogue in the 1990s and took off up to 2008. If there was no secondary market, mortgage brokers have nowhere to go. In addition, the credit default swaps are three steps removed from any individual mortgage; so how do you “blamer” the existence of them on the CRA? That makes no sense whatsoever.

    The trillions of dollars in exposure that AIG, Merrill and other finance companies had was NOT a direct result of CRA or consumer mortgages. Indeed, AIG COULD HAVE had decent reserves for their exposure; they simply chose not to. How the heck is the CRA responsible for that? In fact, the CRA has nothing to do with that. So why do cons refuse to address the Wall Street side of the problem.

    Buffalo Bob —

    Time and again, cons focus only on one side of the problems (the borrower side) as if that alone explains what happened. SOMEONE chose to lend that guy and his wife the money for that big house, even though they were over extended. SOMEONE chose to combine that mortgage with others and sell it on the open market. SOMEONE chose to sell a credit default swap on that bond. And SOMEONE chose to rate that bond as if it was as good as cash. The day cons acknowledged this side of the problem without mentioning “Freddie and Fannie” or the CRA is the day I eat my hat.

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  8. B-Rob says: 8

    drjohn —

    You swallowed the bait! Here is where your “logic” implodes:

    1) Any reasonable analysis of the individual mortgages would have predicted default rate would be high. If you want to blame CRA for bad mortgages being written (and I think it is a b.s. argument, given the breadth of the lending in non-CRA areas, and by non-CRA regulated mortgage brokers and state chartered banks) THAT is where the responsibility of CRA would have ended.

    2) But the bond rating agencies looked at the bonds made from bad mortgages, then rated them all AAA+++, even though the underlying mortgages were crappy.

    3) And the investment banking houses combined several thousand crappy mortgages together (even though a review would have shown they were crappy), then sold them as investment grade bonds.

    4) The firms selling credit default swaps chose not to have reserves in case the bonds made from crappy mortgages went bad because the underlying mortgages were crappy to begin with.

    The CRA and Fannie and Freddie had NOTHING to do with anything that happened after origination. And THAT part is why all those firms went under or were crippled. It wasn’t the bad mortgage to Joe Blow that sank AIG; it was the lack of reserves against the bonds AIG guaranteed. It wasn’t the bad mortgage to Joe Blow that made the bonds worthless for banks and mutual funds and money market funds that held them; it was the fact that firms bought them assuming, as the rating agencies said, they were good as gold. You keep concentrating on Joe Blow as if he and other similarly situated people caused the problem. Rather, even if he and millions of others had taken out bad loans, had the banks purchased bonds with caution, had credit rating firms assigned a reasonable rating, and had cdo insurers kept decent reserve levels, NONE of this would have happened. The problem would have been contained because, before the mortgages ever went bad, the Wall Street side would have done a risk analysis of the bad mortgages and planned and acted accordingly. THAT is who the Bush Administration and Congress bailed out with TARP: the Wall Street side that made all the dumb decisions about the mortgages in the first place.

    To use an analogy, the borrowers put three week old egg salad in the refrigerator. It was the bankers and insurance companies who took the rotten egg salad, paired it with four week old caesar salad, rancid meat, oxygenated wine and moldy bread, then served all that at the picnic. Why do you only blame the folks who brought the egg salad, and ignore the other “food” that made the picnickers puke up their guts?

    Lastly, you can blame Chris Dodd and then minority member Barney Frank all you want (as if there were no GOPers in the room when decisions were made regarding Fannie and Freddie . . . ); but that is not why the banking and finance system collapsed. It was the derivative market that magnified and then spread the problem.

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  9. B-Rob says: 9

    Nan G. —

    The use of credit scores in employment decision making has been regulated since 1970s when the Nixon administration’s EEOC wrote the first regulations. When you imply that the Obama administration is making new law here, you are simply flat out wrong.

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  10. JustAl says: 10

    And the fact that the federal government threatened legal action against that “SOMEONE” making the loans had nothing to do with it? Right? Where else would these bad mortgages have gone but into secondary markets? The government forced it’s issuance, it had to go somewhere. Not blaming CRA and government mandated social engineering is like dening the fuse had anything to do with the explosion.

    Please point out where I said the people who took advantage of this situation were blameless.

    Please re-read my note that the Clinton administration increased significantly the number of bad loans it required Fannie and Freddie to buy (as per your astute point about this problem gaining momentum in the 1990’s), thanks for re-enforcing my point.

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  11. Buffalobob says: 11

    A long time ago in a place far away, my wife and I bought our first house. We both had good jobs, I was with a major business machine co. Spent 32+ years with them before I moved on. We had to have a down payment, we had to undergo a financial check, we had to QUALIFY for the loan, with the expectation that we would be able to pay it back. We waited well over a month for a FHA mortgage. Guess what we didn’t get it. There were no Barny Franks/Chris Dodds holding the banks hostage. You had to QUALIFY under the strict guidelines and rules of the lending institutions. We did get a conventional loan, a bit higher in interest, NO Government guarantee to the bank. And guess what ACORN didn’t exist.

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  12. joe doakes says: 12

    The intellectual underpinning of the CRA can be summed up as: “Just because you’re poor is no reason you shouldn’t have a nice house.”

    With that as a fundamental assumption, CRA was enacted (enforcement of which was blocked for a decade by Reagan and Bush I but resurrected by Clinton in the 1990s), attorney Barak Obama sued Citibank to make more loans to poor people, Fannie Mae quietly lowered its “prime” standards to sub-prime levels, Barney Frank and Chris Dodd blocked Republican attempts to reform the system . . . .

    And now those same politicians are saying “Just because you’re poor is no reason you shouldn’t receive top-shelf health care.”

    Would it be rash to predict identical results?

    .

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  13. Nan G says: 13

    We were saving for the 20% down when we realized we didn’t want ”too much house.”
    Suddenly our ”down” was more than enough for a smaller condo.
    So we took a 15-year instead of 30-year mortgage and (with no prepayment penalty through our Credit Union) we were able to pay it off early.
    9 years later (at age 50) we were ”free and clear.”
    I don’t know anyone under 50 in that situation.
    So, for all of the relaxed standards and easy credit, no one is bothering to really ”own” their home.
    Our monthly costs of taxes and dues is less than $200/month.
    But by walking away from payments while living in their places, these deadbeats have that beat!

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  14. Nan G says: 14

    Regulated is one thing.
    Outlawed is quite another.

    The latest is the federal government’s attempt to equalize how black and white job candidates appear to prospective employers even if they differ substantially — just ban employers from checking credit and criminal histories so as not to “unreasonably” disadvantage black job applicants.
    …..
    According to the suit*, since January 2008, Kaplan has examined applicant credit histories, and blacks have been disproportionately rejected.

    The EEOC demands that Kaplan not only cease this harmful practice, but that the corporation also award back wages and benefits to those African-Americans not hired due to credit troubles.

    Kaplan’s defense is that
    1) it already has a diverse workforce and
    2) is an equal-opportunity employer, and
    3) creditworthiness is relevant since Kaplan employees often handle financial matters.

    *Equal Employment Opportunity Commission (EEOC) sued the Kaplan Higher Education Corporation.

    According to the New York Times “The lawsuit [is] an unusual intervention by the federal government on the issue….” In fact “[t]he agency said the Kaplan case was only the third time it has sued over the misuse of credit reports in employment….”
    http://www.nytimes.com/2010/12/22/business/22kaplan.html?_r=3&hpw

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  15. buffalobob says: 15

    We need a troll stamp.

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  16. Greg says: 16

    How odd that we seem to be heaping blame on everyone and everything except for the financial industry. It’s sort of like blaming a robbery on everybody but the robbers–who, after all is said and done, got to keep the loot.

    Bad loans were knowingly made because there were huge profits to be had from making them, and because unacceptable levels of risk could be easily turned into someone else’s problem. Loan officers made money by generating a high volume of loans, not really caring whether they were bad or good. There was no reward for responsible conduct. The companies they worked for also profited from high volume. They unloaded risk by concealing it, much like someone would hide their rotten apples at the bottom of a barrel before taking it to market. The same procedure was followed as the loans worked their way upward through the financial system. Bad and good were calculatingly bundled into ever more complex packages, which at last were given deliberately misleading investment ratings and dumped on unsuspecting investors.

    All of the participants in the scam made money–some, an enormous amount of it–and those who relied on the integrity of the financial industry were left holding the bag. No names were named. No punishment was metted out. Instead, the taxpayers were left to keep the entire financial system from collapsing, and people who probably should have been investigated walked away with bonuses.

    The list covers a lot, but focuses on the environment in which the robbery was committed. What it misses is the fact that there were actually robbers who took full advantage of that environment–robbers who got clean away and are seldom even talked about.

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  17. Missy says: 17

    Oh heck, we don’t have to worry one bit about all that anymore, Dodd and Frank took care of that and fast fingers signed it into law, don’t you remember the euphoria?

    Dodd-Frank, the real threat to the Constitution

    Ooh, I have editing now! Thanks!

    Budget Crunch Threatens Rollout of Wall Street Reform Law

    How……sad. sarc/

    And, it’s rumored that fast fingers is going to appoint William Daley, a WS banker, former Chicago crony as chief of staff. Oh yeah, financial reform here we come.

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  18. Tom in CA says: 18

    Thank you Mr. Doakes.

    Succinct and right on the money.

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  19. Ivan says: 19

    And Bush could have prevented most of this.

    But Free Trade demanded he keep his mouth closed.

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  20. Gary Kukis says: 20

    Of course the financial industry was involved. Many of them were holding worthless loans, that they bundled up and sold (at one time, holding mortgage collateral was like holding gold). I did make mention of this in the primer. Almost everyone holds some kind of mortgage-backed security.

    However, if you take the government out of this equation, there is no sudden housing loan availability made to people who are not qualified to buy a house; there is no housing bubble, there is no sudden injection of money into our economy, and states are not enjoying adjusting to huge increases in revenue.

    Remove the government component, and NONE OF THIS HAPPENS.

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  21. jboogy says: 21

    From Wikipedia;
    Some economists, politicians and other commentators[105][106] have charged that the CRA contributed in part to the 2008 financial crisis by encouraging banks to make unsafe loans. However, every empirical study that has looked at CRA loans has concluded that they were safer than subprime mortgages that were purely profit driven, and CRA loans accounted for a tiny fraction of total subprime mortgages. [107]

    Up to 2007 FDIC has been criticising banks for having “a substantially deficient record of helping to meet the credit and community development needs (…) including low-and moderate-income neighborhoods” and “not making use of innovative and/or flexible lending practices”[108]

    Economists, including those from the Federal Reserve and the FDIC, dispute this contention. The Federal Reserve, having examined the evidence, holds that empirical research has not validated any relationship between the CRA and the 2008 financial crisis.[109] At the FDIC, Chair Sheila Bair delivered remarks noting that the majority of subprime loans originated from lenders not regulated by the CRA, calling it a “scapegoat” and declaring it “NOT guilty.”[110]

    Economist Stan Liebowitz wrote in the New York Post that a strengthening of the CRA in the 1990s encouraged a loosening of lending standards throughout the banking industry. He also charges the Federal Reserve with ignoring the negative impact of the CRA.[100] In a commentary for CNN, Congressman Ron Paul, who serves on the United States House Committee on Financial Services, charged the CRA with “forcing banks to lend to people who normally would be rejected as bad credit risks.”[111] In a Wall Street Journal opinion piece, Austrian school economist Russell Roberts wrote that the CRA subsidized low-income housing by pressuring banks to serve poor borrowers and poor regions of the country.[112]

    However, many others dispute that the CRA was a significant cause of the subprime crisis. Nobel laureate Paul Krugman[113] noted in November 2009 that 55% of commercial real estate loans were currently underwater, despite being completely unaffected by the CRA.[114] According to Federal Reserve Governor Randall Kroszner, the claim that “the law pushed banking institutions to undertake high-risk mortgage lending” was contrary to their experience, and that no empirical evidence had been presented to support the claim.[109] In a Bank for International Settlements (BIS) working paper, economist Luci Ellis concluded that “there is no evidence that the Community Reinvestment Act was responsible for encouraging the subprime lending boom and subsequent housing bust”, relying partly on evidence that the housing bust has been a largely exurban event.[115] Others have also concluded that the CRA did not contribute to the financial crisis, for example, FDIC Chairman Sheila Bair,[110] Comptroller of the Currency John C. Dugan,[116] Tim Westrich of the Center for American Progress,[117] Robert Gordon of the American Prospect,[118] Ellen Seidman of the New America Foundation,[119] Daniel Gross of Slate,[120] and Aaron Pressman from BusinessWeek.[121]

    Legal and financial experts have noted that CRA regulated loans tend to be safe and profitable, and that subprime excesses came mainly from institutions not regulated by the CRA. In the February 2008 House hearing, law professor Michael S. Barr, a Treasury Department official under President Clinton,[63][122] stated that a Federal Reserve survey showed that affected institutions considered CRA loans profitable and not overly risky. He noted that approximately 50% of the subprime loans were made by independent mortgage companies that were not regulated by the CRA, and another 25% to 30% came from only partially CRA regulated bank subsidiaries and affiliates. Barr noted that institutions fully regulated by CRA made “perhaps one in four” sub-prime loans, and that “the worst and most widespread abuses occurred in the institutions with the least federal oversight”.[123] According to Janet L. Yellen, President of the Federal Reserve Bank of San Francisco, independent mortgage companies made risky “high-priced loans” at more than twice the rate of the banks and thrifts; most CRA loans were responsibly made, and were not the higher-priced loans that have contributed to the current crisis.[124] A 2008 study by Traiger & Hinckley LLP, a law firm that counsels financial institutions on CRA compliance, found that CRA regulated institutions were less likely to make subprime loans, and when they did the interest rates were lower. CRA banks were also half as likely to resell the loans.[125] Emre Ergungor of the Federal Reserve Bank of Cleveland found that there was no statistical difference in foreclosure rates between regulated and less-regulated banks, although a local bank presence resulted in fewer foreclosures.[126]

    During a 2008 House Committee on Oversight and Government Reform hearing on the role of Fannie Mae and Freddie Mac in the financial crisis, including in relation to the Community Reinvestment Act, asked if the CRA provided the “fuel” for increasing subprime loans, former Fannie Mae CEO Franklin Raines said it might have been a catalyst encouraging bad behavior, but it was difficult to know. Raines also cited information that only a small percentage of risky loans originated as a result of the CRA.

    Here are the facts, the racists among you will not like them, but…you are all entitled to your opinions, but not your own facts.

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