Regulation and the sub prime mortgage crisis. Or how America got itself in a mess.

I’m going to take a wider view this week and not write about Australian property laws. By the time you read this the dust will be settling on the American Presidential election- which I’m told cost about a billion dollars (which is the same as Americans spend on potato crisps each year). But the problems of the world economy remain.

Some of the commentators such as Piers Ackerman in the Newcastle Herald last month have been trying to blame the American subprime mortgage crisis-which they say started it all- on laws which made USA banks lend to minorities and poor people. Ackerman was vague, he didn’t name the laws but other commentators have: they say the Community Reinvestment Act is to blame. Now that is in fact the only law that made banks lend to minorities and poor people so I guess that’s the one Ackerman is talking about. Ackerman and those like him go on to argue that its regulation that got us into this mess and the only way out is to remove regulation and have what they call a free market.

That this is utter garbage can be seen by comparing America and Australia. America has a far less regulated system then we do, and our banks are (because they are regulated by government agencies) far safer, indeed our four big banks are among the 20 safest and most secure in the world (there are only 20 banks in the world that have an AA credit rating –which each of our big 4 does). And that’s one reason why there is so few problems here. All lenders here are regulated for capital adequacy for the type and size of loans and for many other things- talk to your bank or building society if you want more details.

But what I want to focus on is the Community Reinvestment Act. This was started because American lenders wouldn’t lend to poor people. This wasn’t nearly so much a problem in Australia (partly because the government helped finance lenders through community terminating building societies- one my older readers may remember was the Telarah Community Advancement Association). So in 1977 the US Congress enacted this law. Now its this law that after 30 years of trouble free progress is now blamed for causing the problem. The people like Ackerman who say that this law interfered with the market also say that this interference is responsible for the problems.

The evidence is against them. The Bank for International Settlements economist’s 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," Ellis goes on to say that the failed subprime loans have been mainly what he calls ‘exurban’ –which includes what we would call rural residential and that loans under the Act were made to poor urban dwellers. Again f the Federal Reserve Bank of San Francisco says that independent mortgage companies (which I think are lenders like Aussi home loans) made "high-priced loans" at more than twice the rate of the banks and thrifts;(which are like building societies and credit unions) most CRA loans were responsibly made, and were not the higher-priced loans that have contributed to the current crisis.

Aussi and lenders like it are regulated here and are not in any responsible for Australian problems nor do they make higher priced loans. Even so the problems that RAMS suffered seem to show that foreign wholesale lenders thought that our non bank lenders had the same sort of problems.

The answer is not the free market that Ackerman goes on about. Its not the answer -if only because its not a free market- my university lecturers told me that free markets were ones in which every person was effectively equal, that no buyer or seller could by itself influence the market and that’s certainly not true here – I am not my bank’s equal, and the banks are big enough to influence the market.

Rather the answer is better regulation, that’s why we can be thankful for the bipartisan approach of our successive federal governments.


Some links: some of the leading deregulationist commentators * http://www.lewrockwell.com/dilorenzo/dilorenzo125.html (don’t believe what you read by this man without checking reviews of his biography of Abraham Lincoln-which he advertises on his site (he believes the slaveowning Southern states were right to succede and keep on owning slaves. " "Consider this inflammatory assertion: "Eliminating every last black person from American soil, Lincoln proclaimed, would be 'a glorious consummation.'" Compare the nuances and qualifications in what Lincoln actually said: "If as the friends of colonization hope, the present and coming generations of our countrymen shall by any means, succeed in freeing our land from the dangerous presence of slavery; and, at the same time, in restoring a captive people to their long-lost father-land, with bright prospects for the future; and this too, so gradually, that neither races nor individuals shall have suffered by the change, it will indeed be a glorious consummation." One need not be a Lincoln admirer to recognize that DiLorenzo is making an unfair characterization." http://www.claremont.org/publications/pubid.226/pub_detail.asp)

An article from the Wall St Journal http://online.wsj.com/article/SB122298982558700341.html

J A Millon on CNN http://www.cnn.com/2008/POLITICS/09/29/miron.bailout/index.html
(but note these people don’t provide any detailed analysis)

Luci Ellis (warning a long and technical paper ) http://www.bis.org/publ/work259.pdf?noframes=1

The US Federal Reserve analysis http://www.frbsf.org/news/speeches/2008/0331.html

Traiger & Hinckley LLP. (2008). The Community Reinvestment Act: A Welcome Anomaly in the Foreclosure Crisis (also long and technical) http://www.traigerlaw.com/publications/traiger_hinckley_llp_cra_foreclosure_study_1-7-08.pdf