You would think that regulating Wall Street after what bankers just put our country through would be the one thing that Republicans in Congress would join Democrats in doing. But as financial reform comes up for a vote in the Senate, Republican support is largely MIA. The party's leadership is ducking its responsibility by fabricating a different narrative as to what caused the financial crisis. It's time to take on those myths.
Republicans and conservative commentators lay blame for the financial meltdown almost entirely on a push by do-gooders in government (read Democrats) to help lower-income people buy homes. Their prime culprits are Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSEs) with a mission to expand home ownership, as well as the Community Reinvestment Act, a 1977 law intended to get banks to lend in underserved areas.
Now I won't quibble that Fannie and Freddie were seriously mismanaged entities, possibly even corrupt. But the loans that Fannie and Freddie were willing to buy on the secondary mortgage market (GSEs don't originate loans) did not precipitate the crisis. Neither did the CRA.
Fannie and Freddie bought home loans that met certain underwriting standards to free up credit so banks could lend to other borrowers. Many of these loans were packaged into bonds (known as agency mortgage-backed securities) and then sold. But Fannie and Freddie kept much of the risk on its own books by guaranteeing the underlying mortgages against default.
Since about 1995 Wall Street started encroaching on this business, but with a key difference. After Wall Street bought the mortgages, securitized and sold them, it did not guarantee them against default. Wall Street banks had no skin in the game and not surprisingly had less interest in making sure they were buying sound mortgages.
That is why the inflated market for really bad subprime lending was due to Wall Street's insatiable appetite, not Fannie and Freddie's. In fact, the GSEs wouldn't buy subprime loans until the mid 2000s, and even then Fannie and Freddie refused to purchase the worst junk out there, the so-called 2/28s and 3/27s, that would adjust upward quickly so they had to be regularly refinanced or the borrower would likely default.
Why then did we have to take over Fannie and Freddie, and why are they still in serious financial trouble today? Largely because they are on the hook for the mortgages that did go bad — and with the depths of the foreclosure crisis even some prime mortgages are now failing. But the mortgages in the GSEs' securities were far less likely to default than the ones in securities Wall Street was peddling, according to Kathleen Day of the nonpartisan Center for Responsible Lending.
Now let's talk about the other Republican scapegoat, the Community Reinvestment Act. The Republican line is that the CRA forced banks to lend to people in inner city and minority neighborhoods who couldn't afford a home. The facts tell a different story. The CRA specifically requires banks to seek credit-worthy borrowers, individuals and businesses. Just look at the subprime loans that caused the crisis — 94 out of 100 were not CRA loans, Day says.
Financial expert and author of Bailout Nation Barry Ritholtz puts it another way. He writes that if the CRA caused the crisis, then foreclosures in CRA regions should be the highest in the country, but in fact it's the "sand states" — non-CRA regions such as Southern California, Las Vegas, Arizona and South Florida — that have the worst rates. Ritholtz says the banks making CRA mortgages should be disproportionately failing. But again, Ritholtz notes, that's not what has happened. CRA banks have been relatively healthy. Compared with other factors, Ritholtz says, "the CRA impact is all but irrelevant."
There are three reasons that Republicans in Congress won't support financial reform: They want to deny President Barack Obama any legislative victories, they fundamentally object to regulations that protect borrowers and investors from being preyed upon, and they want to encourage rich campaign contributions from Wall Street. Any other story is full of holes.