I guess I'm tired of reading and hearing banks and their managements cursed, ridiculed and extolled for causing the financial meltdown and economic crisis. It seems that most everyone from Washington to the "Occupy" groups wants a piece of banking's hide for the pain of this recent experience.
Screams of "break up the banks," "never let this happen again," "let them fail" and "get more regulation" ring through my ears everyday. Banking has reached the bottom of public respect somewhere just below the stature of lawyers and terrorists.
There are many to blame for the recent problems and certainly banks and bankers are on that list. But to understand the cause of this troubled period requires a little deeper look into the environment for mortgage lending established in the early 90s. This involves changes made in the law promoting home ownership financing for low to moderate income families. It was certainly a worthy purpose, but these changes created an environment that in hindsight was almost certain to explode.
The best analogy for this situation is that government filled a cookie jar, watched as the jar was emptied and then had to bring the fattened raiders back to health. The question remains as to who was most at fault, those who provided the cookies or those who ate them.
The Housing and Community Development Act was created in 1992 to promote increased home ownership. Its provisions were to be administered by the Department of Housing and Urban Development or HUD. Title XIII of this act set in motion the administrative charge over government sponsored enterprises, primarily Fannie and Freddie. The act authorized the HUD secretary to establish yearly goals for GSEs requiring they purchase loans made to borrowers whose incomes were at or below the community medium income. The initial goal was established at 30% of total loans purchased. This number was increased to 42% in 1995, 50% in 2000 and 56% in 2006. Included was a special sub-goal that mandated that 27% of the loan purchased be borrowers with incomes at or below 80% of the same level.
In order to meet the increasing goals Fannie and Freddie found it necessary to reduce down payment requirements, first to 3% in 1995 and then eliminating any down payment in 2000. Prior to these changes the traditional mortgage required a 15 to 25% down payment depending on the loan size and credit qualifications of the borrower. As these changes were implemented weaker borrowers were attracted to home ownership many with lower credit scores, high debt, uncertain employment and less available cash to meet monthly payments. Because the loans were quickly purchased by Fannie and Freddie, banks and private entities saw little risk in originating these loans.
By 2008, in compliance with these goals, government-sponsored entities had insured and purchased over 20 million nonprime mortgages. Loans made with high leverage and borrower credit weaknesses below what had been the traditional standards. By 2007 it was estimated that one in three mortgage loan originations had a down payment of less than 3%.
Strong debate continues about whether the federal regulators utilized authority over Community Reinvestment Act of 1977 compliance as a lever to gain bank participation in offering similar mortgages. It is argued that it became the practice of regulatory authorities to decline or delay bank requests and applications including mergers and acquisition if the bank was determined out of compliance with CRA. It was reported by the National Community Reinvestment Coalition that in the ten year period up to 2007 banks committed to $4.5 trillion in new CRA lending much of which included nonprime lending in order to receive regulatory approvals.
Of course over this period the expanding growth of lending to less qualified borrowers created excessive demand for housing and a resulting housing price bubble. By 2007 the explosion of the home value bubble reached historic levels. While other factors impacted growing home values the principal cause was more borrowers with easy credit chasing fewer homes.
Banks and other originators knew that in supporting home ownership for low to moderate income families they could reap substantial gains from the origination, servicing and securitization of these loans. Unfortunately they didn’t pause to assess the overall risk and size of the non prime loans and or see the real estate bubble created.
The initial acceptable performance of the nonprime borrowers in strong economic time and increasing home values fooled many including the banks, Fannie, Freddie, mortgage securities investors plus the rating agencies and the plethora of bank and securities regulators. Each seemed to expect the continued growth and performance of nonprime mortgages and that home value would continue to rise. They should have recognized the inherent weaknesses, but they didn't.
In the end, the policy changes increased home ownership from 64% to 69% but also encouraged the practice of ignoring long tested credit principals. The mortgage industry, the banks and the GSEs became fat with success and profits until the bubble burst. They had all eaten too many cookies — or perhaps it was Washington who put too many cookies in the jar and then had to nurse everyone back to health?
Holding banks wholly responsible for all that went wrong doesn't make sense and is damaging our economic future. In the future Washington should work to insure a balanced healthy environment in which banks can be supportive to economic and social growth but not one in which they are encouraged to become the cookie-monster.
Robert H. Smith, the former chairman and chief executive of Security Pacific Corp., is a founder and director of Commerce National Bank in Newport Beach, Calif.