How Crackpot Egalitarianism Caused the Sub-Prime Mortgage Crisis

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"In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing credit requirements on loans that it will purchase . . . [to] encourage . . . banks to extend home mortgages to individuals whose credit is generally not good . . . . Fannie Mae is taking on significantly more risk."

~ New York Times, September 30, 1999

The main cause of the current economic crisis is the boom-and-bust cycle that was caused by the Greenspan Fed. Years of artificially-lowered interest rates caused trillions of dollars in mal-investment in real estate and other industries, and now we must endure the bust. But crackpot egalitarianism within the Fed and, indeed, in the entire Washington establishment, has made the crisis infinitely worse.

In the early 1990s the Boston Fed did all that it could to fabricate "evidence" of widespread lending discrimination against racial minorities. But when Peter Brimelow and Leslie Spencer of Forbes magazine asked Boston Fed official Alicia Munnel what evidence of discrimination she really had, she was forced to admit that she had none.

Fighting discrimination was not the Fed’s real goal. The real goal was to achieve a more "egalitarian distribution" of housing, period. So under the phony guise of "fighting discrimination" the Fed, the Congress, Fannie Mae, Freddie Mac, and myriad other federal government agencies forced, bribed, and extorted mortgage lenders of all kinds into making literally trillions of dollars in bad loans to unqualified borrowers. Countrywide Bank alone was praised by the Fed for making $600 billion in such loans (shortly before it went bankrupt).

The Fed’s "smoking gun" in this entire charade is a Boston Fed publication entitled "Closing the Gap: A Guide to Equal Opportunity Lending." There is a gap, you see, between the value of real estate owned by middle- and upper-income Americans on the one hand, and lower-income Americans on the other. (There is also a luxury automobile gap, a two-week European vacation gap, a luxury boat gap, an expensive suit gap, and many others). The federal government has used all of its powers of threats, force, and intimidation over the past two decades to try to close the housing "gap." "The Federal Reserve Bank of Boston wants to be helpful to lenders as they work to close the mortgage gap," the publication states.

In addition to closing the "mortgage gap," the Fed also pressured lenders to adopt a more vigorous racial hiring quota system, presumably under the theory that minority loan officers would be more likely to acquiesce in the Fed’s dictates to make more mortgage loans to its political mascots, sub-prime borrowers.

The Boston Fed report claims that it is only offering lenders "guidelines," and "suggestions," but it is very clear that failure to obey the Fed’s "guidelines" can lead to serious financial problems for any mortgage lender. The report states in bold type that "Failure to comply with the Equal Credit Opportunity Act or Regulation B can subject a financial institution to civil liability for actual and punitive damages in individual or class actions. Liability for punitive damages can be as much as $10,000 in individual actions and the lesser of $500,000 or 1 percent of the creditor’s net worth in class actions."

All lenders — banks, independent mortgage companies, etc. — were told that they needed to pay close attention to "such laws and regulations as the Equal Credit Opportunity Act (Regulation B), the Fair Housing Act, the Home Mortgage Disclosure Act (Regulation C), and the Community Reinvestment Act." A "conscientious [bank] Board will recognize the potential liability associated with noncompliance . . ." Ah, the subtle power of suggestion.

The Fed instructed lenders to ignore traditional measures of creditworthiness when it came to "minority and low-income consumers." Traditional underwriting standards were said to contain "arbitrary or unreasonable measures of creditworthiness." "Special standards" that "are appropriate to the economic culture of urban, lower-income, and non-traditional consumers" were urged. For example, traditional underwriting standards take into consideration such things as age, location, and condition of a house, but these should be abandoned when it comes to sub-prime borrowers, said the Fed.

Traditional ratios of mortgage payments to monthly income can also be ignored, said the Fed. And besides, "the secondary market [i.e., Fannie Mae and Freddie Mac] is willing to consider ratios above the standard" ones for other borrowers. "Lack of credit history" should not be a factor either. "Successful participation in credit counseling" was said to be an adequate substitute.

Lenders were repeatedly urged to "work with special secondary mortgage market programs" such as those administered by Fannie and Freddie. Lenders were told to "be aware that Fannie Mae and Freddie Mac have issued statements to the effect that they understand urban areas require different appraisal methods." If a sub-prime borrower has a property appraisal problem, then the Fed or Fannie Mae could help to find "another experienced appraiser" who would presumably see to it that the property was "correctly" reappraised so that the sub-prime loan could be made. Yours truly was always under the impression that shopping around for "the right" appraiser who would give you the number you wanted (for a fee) was fraudulent and illegal. Silly me.

In sum, the Fed’s policy of housing market socialism (endorsed and supplemented by numerous federal laws and regulations), combined with the boom-and-bust cycle that it created, has been an unmitigated economic catastrophe for the entire world. Naturally, the Fed’s response has been to grant itself even more powers, while the executive branch and Congress are busy nationalizing the capital markets, a move that will kill American capitalism. Abolishing the Fed would be a very modest first step in dismantling our rotten Leviathan state so that the next generation can at least have some hope of living in a reasonably free and prosperous society.

Thomas J. DiLorenzo [send him mail] is professor of economics at Loyola College in Maryland and the author of The Real Lincoln; Lincoln Unmasked: What You’re Not Supposed To Know about Dishonest Abe and How Capitalism Saved America. His latest book, Hamilton’s Curse: How Jefferson’s Archenemy Betrayed the American Revolution — And What It Means for America Today, will be published on October 21.

Thomas DiLorenzo Archives at LRC

Thomas DiLorenzo Archives at Mises.org

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