Fed: Loans to Poor People Did Not Cause Crisis

In the debate over who caused the financial crash of 2008, some argue that it was poor people. Specifically, as people including Peter Wallison of the conservative think tank American Enterprise Institute argue, government requirements that banks give mortgages to people who couldn’t afford to repay them forced a broad loosening of lending rules, which led to the collapse.

“If the U.S. government had not chosen this policy path—fostering the growth of a bubble of unprecedented size and an equally unprecedented number of weak and high-risk residential mortgages—the great financial crisis of 2008 would never have occurred,” Wallis wrote on page two of his 100-page dissent from the Financial Crisis Inquiry Commission’s final report.

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There’s only one problem with this argument, the Federal Reserve says: It’s wrong. According to research by two top Fed economists, mortgages given to low- and moderate-income homebuyers under the government’s rules actually performed a tad better than other loans through the downturn.

At issue is the Community Reinvestment Act, which broadly requires banks with branches in low-income areas to give loans in those areas. It also applies to Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSE’s) that sell, buy or insure most mortgages made in the U.S.

“We find little evidence that either the CRA or the GSE goals played a significant role in the subprime crisis,” Robert B. Avery and Kenneth P. Brevoort, senior economists with the Fed, wrote in the report, which was published in August. “In fact, the evidence suggests that loan outcomes may have been marginally better.”

In the stuffy world of economics papers, this one amounts to a throwdown, as the Fed essentially argues that those holding the opposing view of the crisis’s origins don’t know what they’re talking about.

“Many of the studies that argue that the CRA and GSE goals played a central role in precipitating the subprime crisis—as well as those papers that have argued against this view—have not relied on hard empirical evidence,” the Fed found. “However a more nuanced look at the data, as conducted in this paper, suggests that this superficial association may be misleading.”

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The Fed looked at two types of data. One part compared loan performance in neighborhoods where CRA loans are required to similar neighborhoods where such loans are not required. The other part compared loans given to borrowers who barely qualified for coverage under the CRA and the Fannie Mae/Freddie Mac requirements to loans to borrowers whose incomes fell barely above the requirements.

In both cases, delinquencies and foreclosures were no more common among people who received government-approved loans than they were for those who didn’t. In fact, the government requirements actually decreased the likelihood of loan failure for both borrowers and lenders.

“Our lender tests indicate that areas disproportionately served by lenders covered by the CRA experienced lower delinquency rates and less risky lending,” the Fed found.

The report does not go a step further to say what actually did cause the crash.

Image: morisius cosmonaut, via Flickr.com