BANKER RACISM WON'T STOP BANKER FRAUD:

In the 1970s, community groups came to Congress to protest the fact that whole neighborhoods were being denied credit by banks. I happened to be working as chief investigator for Sen. William Proxmire, then the chair of the Senate Banking Committee. After several days of hearings and extensive investigation, we wrote and persuaded Congress to enact two laws.

The first, the Home Mortgage Disclosure Act of 1975, required banks to disclose where they were lending. The second, the Community Reinvestment Act of 1977 (CRA), created an affirmative obligation not to redline and to provide credit without regard to location, "consistent with the safe and sound operation of such institutions," which is to say with responsible lending standards.

We made sure to add that phrase so the legislation would neither pressure banks to make bad loans nor be faulted for doing so. Regulators defined that phrase to mean lenders should serve their entire communities, but not water down sound underwriting standards. The banks regularly received CRA scores, which were used to permit or deny mergers and acquisitions. One of the constructive effects of the CRA was the creation of a whole generation of loan officers who took pride in being able to extend credit to low- and moderate-income borrowers without subjecting the bank to undue risk.

It wasn't until the 1980s and 1990s that Wall Street investment bankers and local mortgage originators came up with the scheme that led to the subprime collapse. This was all about inflating profits and passing along risks to someone else. It had nothing whatever to do with the Community Reinvestment Act.

The investment bankers would bankroll local mortgage bankers to make subprime loans with low "teaser" rates. By definition, a subprime loan is a loan to a customer who would not qualify for credit at the usual rates. After a few years, the interest rate on these loans would double or triple. Many borrowers defaulted.

How could lenders make money on a product with a high risk of default? The investment bankers packaged the loans into bonds, known as collateralized debt obligations. These were blessed with Triple-A ratings by private credit rating agencies and bought by unsuspecting investors all over the world.

The investment bankers got the loan originators off the hook, and the bond buyers got the investment bankers off the hook. So local lenders could make unsound loans and investors could underwrite them, making a lot of money and passing along the risk to someone else. The whole process was corrupt, but in an era of deregulation, the regulators looked the other way.

Tweet   @brothersjudd