OK so who is responsible for the Subprime mess?

This afternoon I had a lunch with an old friend and the discussion eventually went to the current election. We discussed the problems of the subprime situation. There are a couple of possible culprits. The first might be the people who lied on their applications, inflating their income to get a larger loan. At the same time there were those mortgage brokers who induced people to borrow more than they should have. Clinton and Obama seem to think that the people who took out the mortgages are without blame.

Perhaps more important than any of that was the Community Reinvestment Act. (or CRA, Pub.L. 95-128, title VIII, 91 Stat. 1147, 12 U.S.C. § 2901 et seq.) Like many congressional enactments, the intentions were noble. The authors thought that Congress should encourage more loans in low income areas. So they mandated some new statistics which looked at loan volume by area. Supposedly the act would induce more "affordable" housing. Part of the push for affordable housing was a new set of criteria that judged lenders on how well they served communities. Bank regulators began loosening down payment and other credit standards and surprisingly enough as those standards were loosened more and more mortgages were let with mortgagees who had no skin in the game.

So who should society go after? Obviously, the mortgage brokers who created the frauds. No one disagrees with that. But in my opinion, the people who signed the fraudulent applications also have some responsibility. People like Barney Frank seem to think they were innocent of any involvement. That is nonsense. But no one thinks that part of the responsibility for the problem comes from Congress, who changed the law in a way that would get the fast buck players into the game.

The linkage of the CRA to the subprime mess closely parallels the scandals for the S&Ls in the 1970s. Savings and Loans institutions began with a very limited purpose. They had low federal guarantees, but they also had significant restrictions on the investments they could pursue. So Congress simultaneously increased federal guarantees and loosened investment guidelines. Jake Garn and Fernand St. Germain got a bill passed (the Depository Institutions Act) which did all that. One commentator at the time suggested that the Act had successfully "privatized gains while socializing risk." The net cost of the congressional changes was something in excess of $120 billion. The stakes in the subprime mess are a bit higher. But the source is about the same.