Capitol Ideas

Crediting the Uncreditworthy

By From the November 2008 issue

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I bought my condo in Washington, D.C., 25 years ago, for a little over $100,000; two bedrooms, two baths, in a “good” part of the city (meaning safe, about a mile north of Georgetown). As a freelance writer I had no salary, but I qualified for a mortgage all the same. How come? Well, when I went to see the money lenders I brought along some letters, including one I had received from Ronald Reagan (written before he was president) and from one or two other political notables as well. I debated whether to include my Nixon letters (written after he was president!) and can’t right now recall whether I decided they would impress these gentlemen more than they would frighten them.

I was deemed qualified. But rest assured, Reagan or Nixon had little to do with it. By far the most important consideration was that I had put up 50 percent of the purchase price. In cash. That no doubt persuaded the moneylenders that I had every intention of repaying the loan. Which I have done (well, almost).

I have been thinking about this in light of our credit woes today. It amazes me to read that, until recently, people have been allowed to borrow the full purchase price of a house without showing they could repay it. By 2006, the median down payment for first-time home buyers, once 20 percent, had sunk to a mere 3 percent, probably with a variable-rate mortgage. I wonder how many of these borrowers even knew what that meant. Some thought of the loan as something that they wouldn’t ever have to repay. They would just walk away if the value of the house declined.

How could supposedly intelligent people have believed that house prices would keep climbing forever? That’s just one of the mysteries. The then Fed chairman, Alan Greenspan, contributed to the problem by holding interest rates too low for too long. He forgot that maintaining a stable dollar was by far the most important part of his job. It will permanently stain his reputation for wisdom.

But I would like to bring up one of the least discussed roots of the crisis. The idea somehow took hold that poor neighborhoods in inner cities were deteriorating because they were being denied credit. Bankers should “affirmatively help” meet “community credit needs.” So Congress enacted a new law, the Community Reinvestment Act (1977). It was dreamed up by Sen. William Proxmire, massaged by Walter Mondale, and signed into law by Jimmy Carter. It declared “redlining” to be illegal.

Redlining means denying a mortgage because the applicant lives in a particular geographic area. An insinuation of the law, unstated, is that lenders are inclined to be racist.

When “redlining” came over the political horizon, I was living in a communal house on Embassy Row. Our most famous tenant was Judy Miller, who was then with the Progressive magazine. Soon she joined the New York Times. I do have Judy Miller  stories, along with Nixon correspondence stories, but I guess they will all have to wait. As Times newcomers must, Judy went to the metro desk—this was many years before she became a famous foreign correspondent for the paper, with (it turned out) some influence over how our Iraq Misadventure was to be interpreted.

In an early redlining story for the Times, Judy wrote that the new law “has been creating some tough problems for the nation’s bank regulators.”

She got that right. The regulation of mortgage loans was about to be undermined by the insistence that banks and S&L s could no longer be too fussy about borrowers’ credit-worthiness. I particularly liked the following paragraph in Judy’s story:

The Savings Bank Association of New York contended at the hearing last week that the law’s goal of encouraging lenders to meet credit needs of the entire community “is entirely at variance with the business of banking in a free enterprise system.” The association said: “Our institutions are not social service organizations…”

Try telling that to Rep. Barney Frank.

The New York Times, which was then (30 years ago) a more balanced newspaper than it is today, editorialized that “measures that would weaken standards are dangerous. New York’s savings banks already hold large numbers of defaulted mortgages, including many inner city properties.…We raise a strong word of caution against the expectation that bank credit is a substitute for the wages, salaries and other income that are needed to keep a community alive economically.”

By 1993, with the advent of the Clinton administration, the Washington Post began publishing articles about racial disparities in mortgage loans in the Washington area. The following year the Chevy Chase Federal Savings Bank (the largest such bank in Maryland) was accused of racial bias by Janet Reno and the Clinton administration. Without admitting any wrongdoing, the bank settled, agreeing to open branches in poor neighborhoods and by making $140 million in concessionary loans available to the alleged victims of “discrimination.” The Times, by now sounding a more familiar note, warned in 1994 that the Community Reinvestment Act “requires banks to meet the credit needs of all neighborhoods in a bank’s service area.”

Credit needs? How long before needs would become rights?

THE CHEVY CHASE BANK has survived, but recently posted a quarterly loss of $5 million on assets of $15 billion.

Of course, if race and financial assets are correlate (as they are), then insisting on assets as a precondition for a loan could look a lot like racism; the variables are confounded. The response was predictable. Why be so “rigid” about assets? These communities “need” these loans. And so the unraveling continued.

Going along with the political pressure, as the Chevy Chase Bank had done, would “buy them friends in high places,” according to the American Banker. New York Times financial columnist Peter Passell, who is now with the Milken Institute, said that banks would find “that the path of least political resistance is simply to shovel enough money into minority projects to make the regulators go away.” Congressional Democrats increased the pressure for politically subsidized loans.

Mortgage risks could be passed on to the secondary mortgage market by Fannie Mae and Freddie Mac in Washington, D.C., backed by an implicit federal guarantee. They would buy up these mortgages, call them “assets,” and sell them to investment bankers who believed that they were worth a lot more than they turned out to be. Like a Ponzi scheme, it seemed to work for a while, but when house prices began to decline everything fell apart.

In recent years, the great political promoter of the Ponzi scheme has been the chairman of the House Financial Services Committee, Barney Frank. Fannie and Freddie showered Democrats, and to a lesser extent Republicans, with campaign contributions. They have invested in politicians. Since 1989, Connecticut’s Sen. Chris Dodd has been the top recipient; more recently, one Barack Obama.

The truth is that the nation’s financial system has been run for many years with a great deal of irresponsibility. There is far too much reliance on credit, for one thing. People should be encouraged to save money, not to rely on loans at every turn. But what

happens to savers? The government allows the dollar to fall, year after year, thereby repudiating its debts. Prices rise, and savings buy less and less. The Republicans have sometimes been worse than the Democrats in this regard. GOP treasury secretaries are inclined to think it is their job to help business, and so they imagine that a sinking dollar will encourage exports. Bad policy.

Meanwhile, the puny interest we may receive on savings accounts will be taxed away as unearned income (one more opportunity to punish “the rich”). But if we go into debt with a mortgage, inflation will erode the value of what we owe and we get a tax break into the bargain. When are they going to reverse this, with savings encouraged and debt discouraged? It’s high time.

Tom Bethell is a senior editor of The American Spectator.

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About the Author

Tom Bethell is a senior editor of The American Spectator and author of The Politically Incorrect Guide to Science, The Noblest Triumph: Property and Prosperity Through the Ages, and most recently Questioning Einstein: Is Relativity Necessary? (2009).