by Richard J. Grant
To summarize the economic performances of American presidents, a well-known economic adviser once remarked, “I like principled conservatives and unprincipled liberals.” This, by way of introducing former president Bill Clinton who, in his recent convention speech, is widely believed to have boosted the reelection chances of President Barack Obama. But Clinton's greatest gift to Obama was placed under the tree almost 20 years ago.
Clinton recognized the untapped potential in some Carter-era legislation, the Community Reinvestment Act (CRA), which would give his administration leverage over financial institutions to increase loans to members of key voting blocs despite their relatively poor credit ratings. The subprime market had always existed because the higher risks were balanced by higher fees and interest rates, but the CRA pressured banks to increase loans and to hold down fees. From the early 1990s, the dollar amount of CRA loans began a steep decade-long climb.
The Federal Reserve is one of the agencies that oversee CRA compliance. It describes the CRA as “intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound operations.” The theory must be that without the CRA, entrepreneurs wouldn't know what to do. Apparently someone from Washington must tell them that their role is to serve customers.
The real effect of the CRA was to give arbitrary regulatory powers to federal agencies and to give shakedown powers to any community group that could threaten to bring a complaint against a target bank. This alone would be sufficient to tag the legislation as immoral, but it also coerced banks to direct scarce resources into risky uses and away from more productive uses. When combined with Federal Housing Administration guarantees and easy money from the Federal Reserve, mortgage lenders were induced to lower their standards in a moral surrender that spread beyond the subprime market.
As long as real estate prices continued to rise, troubled homeowners could avoid default on their mortgages by selling their properties to cover the loan obligations. The real estate boom was fueled not only by the CRA but also by favorable tax treatment and by the Fed's active lowering of interest rates. The end result of such policy-induced booms is always a bust; the only question is when it will break and how sharply.
The answer in this case came near the end of President George W. Bush's administration. The CRA remained in place throughout the Bush administration, which reaped whatever electoral advantages it offered. But they also reaped the reputational destruction that comes with being in office when a crash breaks.
They were not innocent – they aggressively promoted home ownership – though, in fairness, President Bush did eventually try to restrict the lending of Fannie Mae and Freddie Mac only to be rebuffed by a hostile Congress.
Thus was Clinton’s unintended gift delivered. The timing of the crash was Obama's good luck.
The CRA remains in place and is actively exploited by the Obama administration. The Federal Reserve continues to compensate for Obama's poor fiscal and regulatory performance with repeated rounds of quantitative easing to prop up mortgage and home values. But there is no boom: GDP growth approaches 1 percent, business startups are down, and median income is down, all because our governmental burdens continue to grow.
Richard J. Grant (Lipscomb University and the Beacon Center of Tennessee) appears every other Sunday. E-mail: email@example.com