part4
Clinton Administration Reforms – CRA and the National Homeownership strategy
1995 was a pivotal year in the politicization of mortgage lending. In that year, the
Clinton Administration implemented a major reform of the Community Reinvestment
Act (“CRA”) and issued its National Homeownership Strategy (“the Clinton Strategy”),
both of which increased pressure on Fannie and Freddie to loosen their lending standards. The CRA was originally passed in 1977 to prevent banks from engaging in “redlining” –refusing to lend to otherwise credit-worthy borrowers in lower-income neighborhoods. Until 1995, the legislation was largely ineffective because it was very broad in its directives to both banks and regulators. For example, while the legislation called for federally-regulated banks to meet “the credit needs of [their] entire community, including low- and moderate-income neighborhoods,” it also directed the regulators to “encourage” banks to achieve this goal. It went on to require regulators to “consider” any failure when banks seek approval from the government for actions such as mergers and acquisitions.17 It was not surprising that this expansive language was not effective in achieving compliance, as demonstrated by the relative infrequency of CRA enforcement actions against banks. However, in 1995, the Clinton Administration implemented a major regulatory reform of CRA which emphasized “performance-based evaluation.” The impact of this reform was that regulators would no longer rate banks based on their efforts to lend to customers
using equitable procedures but rather on the volume of their lending. According to one academic study of CRA, this regulatory change marked “a shift of emphasis from
procedural equity to equity in outcome.” Furthermore, the “lending test” component of the regulatory review process, which was the “most heavily weighted component of CRA examination,” included criteria for the “use of innovative or flexible lending practices.” As demonstrated time and again by congressional advocates of affordable mortgage lending, “innovative and flexible” means reduced down payments and riskier, unsustainable lending.18 This shift of regulatory emphasis from ensuring equitable lending procedures to ensuring equitable lending outcomes regardless of borrowers’ ability to repay was subtle but significant. When combined with the endorsement of “flexible and innovative” mortgage underwriting, this change in the CRA represented a troubling move away from prudent and sustainable mortgage lending towards government endorsement of lower quality lending to those of modest means. Although the annual value of CRA home mortgage lending increased some 250 percent between 1996 and 2008, CRA lending never exceeded about 3 percent of total originations.19 While CRA cannot be directly blamed for the huge volumes of risky nonprime mortgages that were eventually purchased by Fannie, Freddie and Wall Street investment houses, CRA continued a pattern of behavior of lowering mortgage underwriting standards in order to drive up the national homeownership rate. The other important event of 1995 was the release of the Clinton Administration’s National Homeownership Strategy. The document’s foreword, penned by HUD Secretary Henry Cisneros, cited President Clinton’s directive to “lift America’s homeownership rate to an all-time high by the end of the century.” Among the methods the Strategy proposed to achieve this bump in the homeownership rate was lower down payments. It observed that, “low- and moderate-income families often cannot become homeowners because they are unable to come up with the required downpayment.” It goes on to direct that, “lending institutions, secondary market investors [Fannie Mae and Freddie Mac are the dominant players in the secondary market], and other[s]…should work collaboratively to reduce homebuyer downpayment requirements.” The Clinton
Strategy also called for increased use of “flexible underwriting criteria,” which it said
could be achieved in concert with “liberalized affordable housing underwriting criteria established by…Fannie Mae and Freddie Mac.” It also called for “financing strategies, fueled by the creativity and resources of the private and public sectors to help homeowners that lack cash to buy a home or to make the payments.” 20
The Clinton National Homeownership Strategy made only a passing acknowledgement of the risks associated with reducing borrowers’ equity in their mortgages and instituting “flexible underwriting standards:”
The amount of borrower equity is an important factor in assessing mortgage loan
quality. However, many low-income families do not have access to sufficient
funds for a down payment. Instead it praised lenders for their efforts thus far toward reducing this “barrier to home purchase” but urged that “more must be done.” The report noted that in 1989 only 7 percent of mortgages had less than a 10 percent down payment but that by 1994 this had increased to 29 percent. The Strategy praised lenders for developing “innovative low-down payment programs” and applauded Fannie Mae for announcing 3 percent-down payment mortgages. HUD also issued new rules that allowed the GSEs to count subprime mortgages made to low-income borrowers toward their affordable housing goals.
In retrospect, President Clinton’s rebranding of prudent down payments of 10 to 20
percent as “barrier[s] to home purchase” takes on great significance. As with the 1995
CRA reform and the Clinton Administration’s decision to allow the GSEs to count
subprime loans toward their affordable housing goals, this represented a shift in
government policy from one that emphasized equity of procedure to equity of outcome. This emphasis on equity of outcome inevitably created tremendous pressure on regulated institutions to make more loans to low-income borrowers. It also created pressure for secondary market investors such as Fannie Mae and Freddie Mac to buy these loans. The correspondingly lower emphasis on how the loans were being made inevitably meant less attention would be paid to their quality and sustainability.
A Freddie Mac spokeswoman later acknowledged that the Clinton HUD’s decision on
subprime loans “forced us to go into that market to serve the targeted populations that HUD wanted us to serve.” Clinton’s HUD Assistant Secretary William C. Apgar, Jr. has since called the decision a “mistake,” while his former advisor Allen Fishbein called the loans that the GSEs started buying to meet their affordable housing goals “contrary to good lending practices,” and examples of “dangerous lending.”21 President Clinton himself acknowledged his role in efforts to loosen mortgage lending standards when he admitted that “there was possible danger in his administration’s policy of pressuring Fannie Mae…to lower its credit standards for lower- and middle-income families seeking homes.”22 These accumulated government affordable housing policies, including the Clinton Strategy, trapped millions of Americans in mortgages they could not afford.
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