From who did Obama "inherit" the economic mess?

[scottw]

for the thousandth time Spence, it was not the CRA loans themselves but the culture created and fueled by the pracitces forced by government mandates and requirements....and threats....

There was another major change that has gotten little attention. Back in 1992, a Boston Federal Reserve study claimed to find evidence of racial discrimination -- claiming that minorities got denied mortgages at higher rates than whites even after important factors such as creditworthiness were accounted for. The data used in the study were riddled with typos and other serious errors. For example, of the 3,000 mortgages studied, 50 of the loans supposedly had the banks paying interest to the borrowers, 500 of the mortgages were not even in the data set from which the data was supposedly obtained, and some mortgages were supposedly approved for individuals who had negative net worth in the millions of dollars. When those mistakes were corrected, no evidence of discrimination remained.

Professor Liebowitz noted that Lawrence Lindsey, then a member of the Federal Reserve’s Board of Governors, "was warned about these errors in this study but the Fed ignored them."

The Boston Fed still used the study to produce a manual for mortgage lenders that said: "discrimination may be observed when a lender’s underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower–income minority applicants."

So what were some of the "outdated" criteria?

Credit History: Lack of credit history should not be seen as a negative factor.... In reviewing past credit problems, lenders should be willing to consider extenuating circumstances. For lower–income applicants in particular, unforeseen expenses can have a disproportionate effect on an otherwise positive credit record. In these instances, paying off past bad debts or establishing a regular repayment schedule with creditors may demonstrate a willingness and ability to resolve debts....

Down Payment and Closing Costs: Accumulating enough savings to cover the various costs associated with a mortgage loan is often a significant barrier to homeownership by lower-income applicants. Lenders may wish to allow gifts, grants, or loans from relatives, nonprofit organizations, or municipal agencies to cover part of these costs. . . .

Sources of Income: In addition to primary employment income, Fannie Mae and Freddie Mac will accept the following as valid income sources: overtime and part–time work, second jobs (including seasonal work), retirement and Social Security income, alimony, child support, Veterans Administration (VA) benefits, welfare payments, and unemployment benefits.Accepting these new criteria was hardly voluntary. The Fed warned the banks:

"Did You Know? 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."

And mortgage lenders followed these rules. Liebowitz explained that these changing financial standards "encouraged speculation -- potential homeowners could gamble on the price of homes going up without using any of their own money. Remember, 25 percent of homes being purchased were purchased for speculation."

Others dispute Liebowitz's claim that these changes in rules mattered. For example, James Carr notes that it "may seem on paper that these are a curious thing to count [welfare and unemployment benefits] as income, but they simply didn’t matter."

One lender singled out by Fannie Mae for special praise for following these new criteria was Countrywide:

Countrywide tends to follow the most flexible underwriting criteria permitted under [Government Sponsored Enterprises] and FHA guidelines. Because Fannie Mae and Freddie Mac tend to give their best lenders access to the most flexible underwriting criteria, Countrywide benefits from its status as one of the largest originators of mortgage loans and one of the largest participants in the [Government Sponsored Enterprises] programs. When necessary — in cases where applicants have no established credit history, for example — Countrywide uses nontraditional credit, a practice now accepted by the [Government Sponsored Enterprises].

Or take a 1998 sales pitch from Bear Stearns, which also followed the Boston Fed manual:

Credit scores. While credit scores can be an analytical tool with conforming loans, their effectiveness is limited with [Community Reinvestment Act] loans. Unfortunately, [Community Reinvestment Act] loans do not fit neatly into the standard credit score framework… Do we automatically exclude or severely discount … loans [with poor credit scores]? Absolutely not.

Given these lending practices mandated by the Fed and encouraged by Fannie Mae and Freddie Mac, the resulting financial problems for financial institutions such as Countrywide and Bear Stearns are not too surprising.

Liebowitz said "such reckless behavior by [Fannie Mae and Freddie Mac] has lead to their financial meltdown and to the financial problems for the whole country. During Franklin Raines' chairmanship of Fannie Mae, they were a major proponent of relaxing standards."