The Wall Street Journal reports tonight on its website, and presumably tomorrow in its print edition, that
Federal Reserve Chairman Ben Bernanke said Friday that ongoing issues in the subprime mortgage market could force bank regulators to rethink their enforcement of a 30-year-old law that requires banks to serve the credit needs in their communities….
“Recent problems in mortgage markets illustrate that an underlying assumption of the CRA — that more lending equals better outcomes for local communities — may not always hold,” he said, according to prepared remarks. “Whether, and if so, how to differentiate “good” from “bad” lending in the CRA context is an issue that is likely to challenge us for some time.” (See the full text of Bernanke’s speech.)…
The 30-year-old law was passed as a way to require banks to lend and reinvest in communities where they take deposits. Financial-services companies often complain that compliance with the law is costly and that regulators examine banks for their compliance with the rule and not the actual results of community investment.
Banks are given credit for lending to low and moderate income areas, as well as rural areas where financial services may not be readily available.
This year, rising default rates and foreclosure rates among subprime loan borrowers have shaken the mortgage and real estate markets. Subprime loans are made to people with weak credit histories, and these are the types of borrowers a bank could get credit for serving under the law.
Mr. Bernanke’s statements suggest a warning to banks that lenders should make these loans carefully, and not simply for the sake of complying with the CRA.
Now why does this sound, as the Australians would put it, a bit sus? This is the first time I’ve seen CRA invoked as a reason for the explosion in subprime lending. It was entirely profit driven, or now what we recognize as “fantasy of profit driven,” unless you were a mortgage originator and didn’t have to care much about what happened on the back end (it turns out agreements that the final buyers of subprime paper had with the mortgage originators to recoup losses if defaults exceeded certain levels proved to be worthless. Duh. An agreement is only as good as the party making it, and these originators had puny balance sheets relative to the volume of mortgages they were placing. Nevertheless, firms such as Credit Suisse and Bear Stearns are suing bankrupt and soon to be bankrupt subprime mortgage lenders like ResMae, to recoup whatever they can).
We also noted last week that, Roger Cole, the Federal Reserve’s director of supervision and regulation, was given a very hard time by both Republican and Democratic members of the Senate Banking Committee for the Fed’s failure to forestall the subprime mess. Cole didn’t muster much of a defense, even though we think the Fed actually isn’t to blame (customer protection isn’t part of the Fed’s charter, and the majority of subprime lending was performed by institutions out of the Fed’s reach). But it will still be hard for the Fed to escape criticism, particularly since it appears that the Office of the Comptroller of the Currency took a stronger stand than the Fed in trying to rein in subprime lending.
So this spurious invoking of the CRA may be a way to shunt blame from the Fed, by making it sound as if the primary aim of subprime lending was to meet regulatory requirements, and hence there was no reason for the Fed to intervene. Worse, this may be a warning: “Don’t expect banks to be able to meet their CRA obligations if you restrict their offerings.” That’s a terrible message, for it guts CRA. Yet that seems to be precisely what Bernanke is hinting at.