Diagnosis for Democracy
Insights into the State of Our Union
A Blog by Rob Tenery, MD


August 10, 2011: Maybe This Wasn't George W. Bush's Recession?

By Rob Tenery, MD on August 10, 2011

COMMENTARY: This is a departure from the subjects I usually discuss in my blogs. With everybody pointing fingers and my prior lack of knowledge on this subject, I chose to venture out of my comfort zone and undertake a study into the causes of the current recession that began in 2008 and, still today, continues to threaten to take this country into an even more uncertain future. We, the public, get such ‘media bias’ on both sides that the truth is more what they want us to believe, than reality.

What is real is that we live globally. What happens with the earthquake in Japan, the potential financial collapse of several European countries, the continuing wars in Iraq, Afghanistan and Libya do have effects worldwide. Just look at the August 4 plunge in stock markets around the world.

There is an alarming social divide in this country. Supporters on both sides are vying for their own solutions, often without taking the time to understand the facts or the consequences of their positions. The future of health care delivery is only a part of this debate.

Although this article was put together almost a year ago, the information has not changed and the debate in Washington has only become more divisive.

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The Community Reinvestment Act (CRA) is a federal law designed to encourage commercial banks and savings associations to meet the needs of borrowers in all segments of the communities. Passed in 1977, during the Carter Administration, it was designed to reduce discriminatory credit practices against low-income neighborhoods, a practice known as redlining.

The Act mandated that all banking institutions that receive FDIC insurance be evaluated by Federal banking agencies to determine if the bank offers credit in all sectors of the community in which they do business. The law does emphasize that these activities be undertaken in a safe and sound manner and does not require any institution to make high-risk loans that might bring losses to the institution.

The Act was passed as a result of pressure to address the deteriorating conditions of American cities---particularly lower-income and minority neighborhoods. In contrast to previous acts that addressed discrimination in the credit and housing markets, the CRA sought to ensure the provision of credit to all parts of a community, regardless of wealth or poverty of a neighborhood.

Two other bills were put into law that have contributed to our current lending practices. In 1980, the first, again during the Carter administration, was labeled the Depository Institutions Deregulation and Monetary Control Act. It gave the Federal Reserve greater control over non-member banks. The other was the Alternative Mortgage Transaction Parity Act of 1982 and was passed during Reagan’s tenure. This legislation allowed the borrower to only pay the interest on their principle balance for the first years of their loan.

In 1989, and signed into law by President George H. Bush, Congress passed the Financial Institutions Reform, Recovery and Enforcement Act which required the appropriate Federal regulatory agency to prepare a written evaluation of an institution’s record in meeting the credit needs of its entire community. Then in 1991, through an amendment to the CRA, the Resolution Trust Corporation (RCT) would make available to any branch of any savings association located in any predominately minority neighborhood the amount of the contribution or the amount of the loss incurred in connection with donated, sold with favorable terms, or made available on a rent-free basis, which would go toward meeting the credit needs of the institution’s community and would be taken into consideration when CRA examinations were evaluated.

The Federal Housing Enterprises Financial Safety and Soundness Act passed in 1992, also under George H. Bush, required Fannie Mae and Freddie Mac, the two government agencies that purchased and securitized mortgages, to devote a percentage of their lending to support affordable housing. In October 1997, First Union Capital Markets and Bear, Stearns & Co launched the first publically available securitization of CRA loans, issuing $384 million in such securities. These securities were guaranteed by Freddie Mac and had a ‘AAA’ rating.

During the early part of the Clinton administration, his representatives pushed for changes in the CRA by cutbacks in paperwork and the costs on small business loans. The Office of the Currency moved to allow lenders, subject to the CRA, to claim community development loan credits for loans made to help finance the environmental cleanup or redevelopment of industrial sites when it was part of an effort to revitalize low and moderate-income community where the site was located.

In 1999, President Clinton signed into law the Financial Services Modernization Act that allowed banks to offer a full range of investment, commercial banking and insurance services. One of the bills’ major supporters was Senator Phil Gramm. President Clinton stated, “The Act establishes the principles that, as we expand the powers of banks, we will expand the reach of the Community Reinvestment Act.”

CRA regulations gave community groups the right to comment on or protest about banks’ non-compliance with CRA guidelines. Regulatory changes during the Clinton administration allowed these groups better access to CRA information and enabled them to increase their influence.

In the fall of 1999, Senators Dodd and Schumer secured a compromise in the Federal Deposit Insurance Act that any bank holding institution wishing to be re-designated as a financial holding institution by the Board of Governors of the Federal Reserve System would also have to follow CRA compliance guidelines before any merger or expansion could take effect.

In October 2000, to expand the secondary market for affordable community-based mortgages and to increase liquidity for CRA-eligible loans, Fannie Mae committed to purchase and securitize $2 billion of ‘My Community Mortgage’ loans. In November of that same year, Fannie Mae announced that HUD would require it to dedicate 50% of its business to low and moderate-income families. In 2001, Fannie Mae announced that it had acquired $10 billion in specially-targeted CRA loans more than one and a half years ahead of schedule, and announced its goal to finance over $500 billion in CRA business by 2010.

In 2002, a study by Kathleen C. Engel, a professor of law at Suffolk University, and Patricia A. McCoy, a professor of law at the University of Connecticut law school, noted that banks could receive CRA credit by lending and brokering loans in lower-income areas that would be considered a risk for ordinary lending practices. They also noted that CRA regulations, as then administered and carried out by Fannie Mae and Freddie MAC, did not penalize banks that engaged in these lending practices. They recommended that the federal agencies use the CRA to sanction behavior that either directly or indirectly increased predatory lending practices by lowering these banks’ CRA rating.

In early 2005, during the administration of George W. Bush, the office of Thrift Supervision (OTS) implemented new rules to ‘tweak’ the CRA ratings thresholds by allowing thrifts with over $1 billion on assets to make optional 50% of their services and investments as they wanted. Thus, freeing those funds from CRA guidelines. In April of 2005, a contingent of Democratic Congressman issued a letter protesting these changes, saying they undercut the ability of the CRA to ‘meet the needs of low and moderate-income persons and communities.’

In 2007, Ben Bernanke, Chairman of the Federal Reserve System since 2006, stated, “the CRA has served as a catalyst, including banks to enter the underserved markets.” He also stated, “the loans usually did not involve disproportionally higher levels of default.”

On September 11, 2003, the New York Times reported: The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago. It was supposedly an attempt to reign in the current practices of Fannie May and Freddie Mac. In 2005, Senator John McCain, as a contender for the presidency advocated, “if Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie May and Freddie Mac pose to the housing market, the overall financial system and the economy as a whole.”

Representative Barney Frank, the then ranking Democrat on the Financial Services Committee, said, “these two entities---Fannie Mae and Freddie Mac---are not facing any kind of financial crisis. The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.”

There are arguments on both sides as to whether the establishment of and strengthening of the CRA contributed to the 2008 financial crisis by encouraging lending institutions to make unsafe loans. The Federal Reserve, having examined the evidence, contends that research has not validated any relationship between the CRA and the 2008 financial crisis. Economist Stan Liebowitz published in the New York Post that a strengthening of the CRA in the 1990s encouraged a loosening of lending standards throughout the banking industry. He also charged the Federal Reserve with ignoring the negative impact of the CRA.

A summary that seems most appropriate is found at: http://www.investopedia.com/articles/07/subprime-blame.asp. It is as follows: ‘The economy was at risk of a deep recession after the dotcom bubble burst in 2000; this situation was compounded by the September 11 terrorist attacks that followed in 2001. In response, central banks around the world tried to stimulate the economy. They created capital liquidity through a reduction in interest rates. In turn, investors sought higher returns through riskier investments. Lenders took greater risks too, and approved subprime mortgage loans to borrowers with poor credit. Consumer demand drove the housing bubble to all-time highs in the summer of 2005, which ultimately collapsed in August of 2006. The end result of these key events was increased activity, large lenders and hedge funds declaring bankruptcy, and fears regarding further decreases in economic growth and consumer spending.

Although there seems to be no universal agreement as to the factors and to what extent each played in the recession of 2008, there are three that are most often mentioned. They are the wars in Iraq and Afghanistan, the tax cuts passed in the early part of the George W. Bush presidency and the collapse of the lending market.

With respect to the two the wars that began during the George W. Bush presidency, although there were a few in Congress who were against them, our current president being one, both wars were supported by both houses. Since no weapons of mass destruction were discovered after the invasion of Iraq, there are many who regret their decision. At the time, however, most of the elected leadership in Washington, including former President Clinton, felt Iraq was a threat to stability in the Middle East.

The Bush tax cuts of 2001 and 2003, which are set to expire in 2011, have been controversial since their inception, and arguments for and against them fall along party lines. Some argue that the loss of revenue has added to the federal deficit. Most, at least on the conservative side, feel they were important in growing the economy until the onset of the 2008 recession.

The consensus is that the collapse of the lending markets was the leading cause of the recession. Although blame can be placed on both sides of the aisle, it seems clear that the start of looser lending practices and the impetus for the Community Reinvestment Act in 1977 and its strengthening in the 1990s, came from the Democrats. It only makes sense, since their base constituency centers around the inner-city and underprivileged. It appears the George W. Bush administration made attempts to reign in the out-of-control lending practices, but those efforts were rebuffed by the Democratically controlled Congress since 1995. Despite all the finger pointing, Barack Obama inherited the recession after it was well underway.

The focus should now be on solutions. How can the current recession be brought to a conclusion? The differences between the Democratic leadership, under Obama, Pelosi and Reid and the Republican recommendations are like night versus day. In the pure sense, President Obama and his fellow leadership in Congress have advocated for an approach of ‘spending our way’ out of the recession through the federal stimulus plans by borrowing on our national debt and allowing the Bush tax cuts to expire in 2011. The Republican plan is to let the existing tax breaks continue for now, hoping to move private sector revenue from the sidelines back in order to grow the economy. They argue against more stimulus money controlled by federal dictums and letting the private sector sort out some of these problems.

There is a growing divide in this country. The ‘progressives’ on the far left, who currently seem to have control of the Democratic party, appear to advocate for almost a socialist system. The ‘tea party’ on the far right is pushing the moderate Republicans to go back to the basic principles upon which their party was founded---the less government intervention the better.

On one thing there seems to be almost universal agreement: To continue to print more money and back it up by borrowing against the federal deficit will only lead to a further collapse of our monetary system resulting in a long-term shift to bigger government. The choice seems to be either ‘distribute the wealth’ by taxation and more government control or increased private sector participation.

As I recall, this country was founded and has prospered, until recently, on the latter.

September, 2010




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