CRE and the CRA

Zombies, zombies, everywhere. One of the enduring myths of the financial crisis has been the claim that it was the result of (a) Fannie and Freddie (b) the Community Reinvestment Act, which forced poor, helpless bankers to make loans to you-know-who. It’s a myth that won’t go away — I get asked about it almost every time I give a public lecture — even though it has been extensively debunked. (See, e.g., here.)

But reading this scary piece about commercial real estate, I realized that CRE offers yet another debunking. After all, there was no federal act driving banks to lend money for office parks and shopping malls; Fannie and Freddie weren’t in the CRE loan business; yet 55 percent — 55 percent! — of commercial mortgages that will come due before 2014 are underwater.

The lenders didn’t need government urging to dive deep into a property bubble, and drown.

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Judd Cramer November 2, 2009 · 5:52 pm

Professor Krugman has slain more zombies than a dozen cheap indy films!

scientella November 2, 2009 · 6:07 pm

You cant blame

1. Freddie and Fanny,
2, CR Act
3. or the lenders as they were only doing their job and their jobs and risk WAS so successfully distributed so that the buck stopped nowhere.
4. Or the poor suckers with the mortgages, because the schools dont teach finance and the advertisers preach consumption.

So who do you blame?

I blame the pension funds, the endowments, the educated supposedly financially savvy purchasers of this worthless paper.

If these guys had been doing there jobs the market for these mortgage derivatives would have been a tiny fraction of the size that it is. The whole pack of cards would have been a whole lot smaller. And no one would have been too big to fail.

Why are these guys being left to stay in their jobs???? They were NOT doing their jobs. Everyone else was.

robob18 November 2, 2009 · 6:10 pm

Right you are professor ! Come to think of it, it wasn’t even the bankers who first made the argument – seems like it was the Wash. pols trying to justify why they weren’t regulating things.

Your lectures are victims of the CRA canard because the talking point has been repeated so often that Goebbels is proved right.

This whole modus operandi is part of what Hillary famously named, and it is characterized by the attempts from Jan. 20 1993 forward to discredit and de-legitimize Clinton, beginning with the deployment of troops to Somalia by G.H.W. Bush after he had lost the ’92 election but before he left office.

Just a little parting complication for the next president to throw him off his 1st year game plan.

Daniel November 2, 2009 · 6:29 pm

Thanks, Paul. More much-needed ammunition to fight back in the age of the pundit-economists.

Steve Strahan November 2, 2009 · 6:31 pm

And one wonders why the regulators are allowing the banks to kick the can a bit further down the road.

Maybe if enough time passes the assets will end up back in the plus column.

But what if they don’t?

Zombies indeed…

Konstantin November 2, 2009 · 6:35 pm

I don’t think it’s a myth that the CRA contributed (but NOT caused) the meltdown.

Economist Thomas E. Woods explains it in a language even non-economists can understand in his book “Meltdown”
//www.amazon.com/Meltdown-Free-Market-Collapsed-Government-Bailouts/dp/1596985879

Nylund November 2, 2009 · 6:40 pm

The financial world was more than happy to give money to people that couldn’t repay it because they thought they were smart enough to be able to rearrange all that debt into new fancy packages and pass on the risk to the next sucker down the line, while skimming some profit off the top. They needed no government urging to do this.

Its just like any other issue the GOP opines on, evolution, climate change, abstinence only education, etc. – make the facts fit the myth rather than use the facts to understand reality.

Its a systematic problem that has corrupted every aspect of the GOP and it is the single biggest reason why they should never be in charge. One must understand and acknowledge the facts, no matter the topic, before one can make an informed decision.

Omega Centauri November 2, 2009 · 6:45 pm

I think you are experiencing the unfortunate fact that politics (in the USA at least), is mainly about the care and feeding of convenient myths. And candidate selection is about finding the candidate whose set of “myths” best agree with our own guts. Any myth that seems likely to get traction, and which has a partisan effect will do. As in a shooting war, in politics truth is the first casualty.

Don the libertarian Democrat November 2, 2009 · 6:53 pm

What they needed was an implicit guarantee from the govt to help them in a crisis. They thought they had one.

JuanBobsDad November 2, 2009 · 6:59 pm

But we will hear about CRE being due to Obama administration policies anyway, now won’t we?

bill d November 2, 2009 · 7:03 pm

The data used in your cited source is far too outdated. More recent data suggests much higher default rates for CRA and GSE-guaranteed loans.

Bogwood November 2, 2009 · 7:27 pm

There was a podcast on Econtalk, basically in agreement about Fannie/Freddie but noted they labeled themselves out of sub-prime. The actual performance of many of their mortgages was sub-prime. They did not set a conservative model. So congressional enablers of Fannie/Freddie do not deserve to be drawn and quartered. Just drawn or just quartered.

Smooth Sailing November 2, 2009 · 7:39 pm

That puts it into perspective Speaking of all things Clinton, what are your thoughts of Brooksley Born and her ability to see into the future? She had an understanding of something much bigger than she was capable of getting her arms around. She understood the size and scope of the problem and still gave it her best shot regardless. It is sad to see that the same people that played a large part in looking the other way, are the same people we are being sold a bill of goods from today. Is there no shame?

Frank Restly November 2, 2009 · 7:53 pm

On Fannie Mae and Freddie Mac. If memory serves the problem wasn’t that these entities were part of the large underwriting problem for mortgages. The problem was they were being pressured to accept lower quality loans and they refused. I will give you one guess where that pressure was coming from.

If you accept that the primary culprit for the housing boom and bust was over relaxed lending standards and Wall Street financial wizardry – then Fannie Mae and Freddie Mac were fairly innocent in the matter. Now I won’t say who or where the pressure was coming from to originate these loans but it was more than Wall Street that was playing this game.

Matt November 2, 2009 · 8:02 pm

For that matter, most of the subprime lenders weren’t banks, and therefore weren’t covered by the CRA in any case. It’s the same tired Republican racism code – just like Nixon and co. talking about the need for “law and order”. The base knew what the dog whistle meant, and they know now – it’s all “those people”s fault.

The self-employed realtors in OC taking out NINJA loans for $700k+ to buy rental houses that couldn’t cash flow – nothing to see there, they are white people, it’s OK. :)

JM November 2, 2009 · 8:07 pm

Your EXACTLY right, there was no Federal Act driving the CRE loan market…There was however a private bank that caused the bubble. It’s called…drumroll please…the Federal Reserve. You remember, during the 2001 recession when they knocked down interest rates to 1% and left them there, kind of like they are doing today. Look into it Paul, you might learn a thing or 2.

Mike November 2, 2009 · 8:15 pm

I agree that CRA did not itself create the mortgage problems, but isn’t it possible that CRA provided the instigation for financial wizards to dream up exotic mortgage in order to allow easier compliance with CRA? It could also be argued that CRA inflated the numbers of players in the housing market and indirectly helped to blow up the housing bubble a bit. Once the bubble was kickstarted, CRA was irrelevant, but I’m not sure the bubble would have been blown as large without some CRA support.

Gregory Sokoloff November 2, 2009 · 9:15 pm

I hate to mention another zombie to add to your list, but Niall Ferguson has popped up again, this time as the authoritative “economist” in a feature segment by Neil MacDonald on the Canadian Broadcasting Corporation national television news. His claim, as usual, was that the most important problem facing the US was the growth of the deficit. You just can’t keep a good zombie down!

John November 2, 2009 · 9:53 pm

If only. Clearly government subsidized a housing bubble that destroyed the whole economy, taking commercial real estate market with it.

beth k November 2, 2009 · 10:05 pm

By CRE, you are referring back to Commercial Real Estate, rather than Counselors of Real Estate, right? I find the world of acronyms very confusing, especially when there are multiple possibilities within the same topic.

Okay. enough whining by me. On to content. The thing about commercial mortgages is that they are underwater due to the way that commercial mortgages are structured — they require the credit markets to be stable and property values to continue rising because refinancing every 5 or 10 years is built into the contract — you’ve gotta make a bubble payment or renegotiate the loan. This has always seemed pretty dumb to me, but TALF was supposed to be the bailout for that structure. I suppose, though, that what this suggests is that we weren’t dealing with a housing bubble, per se, but a property bubble. And it might be worth it for MSM to start referring to it as such, as you have. It is always worth it, though, to understand how the different loan types make the commercial scene even more risky at the moment — if the credit markets are dysfunctional, it basically makes the collapse of the commercial real estate market inevitable.

Gary Henscheid November 2, 2009 · 10:23 pm

Well that is some interesting stuff. You know, they had me going with that CRA excuse, or at least I believed it was a major factor behind reckless lending. Looking at the very poor prospects for commercial real estate, the rather sinister thought occurred to me that defaults on such loans might be a sign of some economic justice happening in America. I mean, surely investment in commercial real estate comes largely from higher income, risk taking sorts, and certainly nothing makes my heart glow warmer than seeing such people lose. I like winners as much as the next guy, but for a long time, it’s appeared to me that far too many people were gambling beyond their means, and that far too much money has been accumulating to wealthy people for business ventures in which most of them provided nothing but capital, and all too often, inherited capital. That’s why seeing the government rescue the largest banks and brokerages bothers so many people – they are truly not allowed to fail or to suffer the consequences of their bad judgment.
The rest of my family made their money in building material sales or in contract-building homes, and we were fortunate to grow up in north Texas, where the economy has been on a nearly straight and upward trajectory for at around 40 years or more. Regardless of my own family’s good luck, I’m sorry to admit it, but I have as little sympathy for anyone who defaulted on their home mortgages as I do for the bankers or for those who’ll probably be defaulting on commercial loans. What about all the first time buyers waiting to buy homes that they can afford? Sure, we got a tax credit for first time buyers, but is that anything like renegotiating mortgages or other government initiatives to keep people in their homes? Still, I’d rather see relief for the little guy than bailing out wealthy bankers, anyday. It’s absolutely sickening, and I agree completely that the largest banks – the ones deemed to big to fail – should have been nationalized rather than assisted in carrying on as usual.

Claremont November 2, 2009 · 11:05 pm

A) So you acknowledge that Fannie and Freddie were driving loans in the commercial real estate, and that the government was at least partly responsible for the real estate bubble? That is what your logic implies. It’s good to see that you are out of denial (the first stage).

B) “The lenders didn’t need government urging to dive deep into a property bubble, and drown.”

No, they just need the artificially low interest rates provided by Bernanke and Greenspan. Which are all part and parcel of having a currency controlled by the government and enforced by legislative fiat.

Steve Breeze November 2, 2009 · 11:28 pm

It seems to me if Freddie and Fannie, and affordable housing were the cause of the mortgage problems we would be overwhelmed by affordable housing. Not so much.

JimF November 2, 2009 · 11:29 pm

The impact of the two Fs and CRA are willfully exaggerated by conservatives.

Nonetheless, your attempt to acquit them of all responsibility is also self-defeating.

If “only” a fraction of the LIAR loans were CRA that makes it OK? Not so much.

Conservatives do enough misrepresentation. When you try to equal them (as with CRA and previously by claiming that people who defend Medicare don’t know it’s a gov’t program) you merely undermine your own arguments IMHO.

>> > CRA assessment-area lending
accounted for only nine percent of higher-priced loans to lower-income borrowers.

tew November 3, 2009 · 1:25 am

There’s no single source of trouble. The CRA as well as many examples of arm twisting, prodding, and legislation at the local, state, and federal levels did contribute to this mess. It’s not an either-or. The CRE example is useful in demonstrating that government sponsored entities and legislation alone did not cause the crisis.

However, the ‘argument’ above is an example of:
Hypothesis: A = X
Observation: B = X
Thus, A <> X

This is a logical fallacy unless one can show that X can have one and only one corresponding value.

where
A is CRA & Freddie/Fannie
B is CRE loans
X is a cause of banking insolvency
The “=” sign here could mean “causes” or “contributes to” and the “<>” would mean “does not cause or contribute to”