ACORN and the Community Reinvestment Act

I wrote a post a few weeks ago about the role that the Community Reinvestment Act played (or, rather, did not play) in causing the current global financial meltdown. I was planning to get out of the issue there, but a really nice article by Devilstower over at Daily Kos sucked me back in. During the time when I wasn't paying any attention to the issue, the right wing noise machine added a new villain to their attempts to blame Wall Street's mess on the left: ACORN.

In 1977 Democratic President Jimmy Carter passed the Community Reinvestment Act to provide housing to poor people. In the 1990s Bill Clinton had Attorney General Janet Reno threaten banks under red lining rules into giving loans to people who could not afford them. Then in the last 8 years, the leftist group ACORN, which has ties to Barack Obama, went to banks and threatened them to relax their rules again. Banks had to give loans to people who had no jobs or no identification.

Devilstower followed up on this with a must-read explanation of what the now-infamous credit default swaps actually are, and why they - and not the CRA - are responsible for the current mess. Along the way, he discussed what the CRA actually entails, what the Clinton-era changes to CRA regulations did, and what the default rates were on mortgages during the early part of this decade. I couldn't help but notice, though, that there was an element missing from his post: the ACORN involvement.

I picked up on the omission because I'd read an article by Eileen Markey on just that topic a couple of weeks ago. In that article, Markey noted that ACORN had actually conducted protests at various banks in an effort to get them to reign in their more predatory subprime lending habits. I resisted the urge to blog the article at the time (and resisted it again when my mother emailed me a link to the same article a week or so later), but after reading Devilstower's post I went back and took another look at it.

The concept of ACORN as a group that tried to head off the current catastrophe is certainly not something that fits in well with the picture that the noise machine is trying to paint. It wouldn't be the first time that the right has promoted an alternate reality, of course, but I figured that it wouldn't do any harm if I did a little fact checking on the Markey piece before blogging it. As it turns out, I was wrong. The "harmless" fact checking cost me some time, and left me much, much angrier at both the loan industry and at the current Administration than I was before.

The quick fact check on the (well-written and accurate) City Limits article quickly turned into a massive, multi-hour geek-out. Looking at ACORN's role lead me to learn more about how the big banks actually pushed people into riskier loans when alternatives were available, about how a little-known federal agency eviscerated state-level attempts to oversee the banks, and about the futile attempts that a number of the very people the right is attempting to vilify made to warn people about the danger posed by predatory subprime lending.

Here's some of what Markey had to say about ACORN's efforts:

In fact - according to a string of 1999 and 2000 reports in American Banker, a 173-year-old publication calling itself "the leading information resource serving the banking and financial services community" - ACORN was an outspoken, consistent advocate for exactly the kinds of regulations that experts across the political spectrum now agree could have prevented the global economic crisis.

On August 4, 2000, American Banker reported on ACORN protests at nationwide offices of Lehman Brothers - the investment bank that went bankrupt last month because of its investment in over-valued mortgage-backed securities:

"Acorn members said they want Lehman and other investment banks to sign a code of ethics, pledging to adhere to 'best practices' in the mortgage lending business. Though the banks are not lenders, the group argues that they provide capital and financial support to abusive lenders by buying and securitizing their loans.

That's right. Eight years ago, ACORN was protesting at Lehman Brothers. They weren't protesting because Lehman Brothers wasn't giving away enough money in low income areas - Lehman Brothers made no direct loans at all at that time. They were protesting because Lehman Brothers was buying up subprime loans and bundling them into the now-infamous mortgage-backed securities. Lehman's demand for subprime loans was providing an incentive for more lenders to make more crappy loans in low income areas - essentially loading those areas under unsustainable debt.

Let me say that one more time, just so we're clear: the demand for more subprime loans did not come from low-income borrowers or ACORN. It came from investment houses like Lehman - firms that did not originate loans, and had absolutely no obligations under CRA whatsoever.

The obvious question here, of course, is this: why would ACORN protest against something that was providing easier credit in low-income areas?

The answer is remarkably simple: the organizers at ACORN are not idiots.

In order to survive, low income areas need access to affordable credit. Many of the loans that Lehman and the other investment firms were buying up (and trading credit default swaps on) were in no way, shape, or form affordable. They were designed to make as much money for the lenders as possible, with little to no attention given to the needs and capabilities of the borrowers.

Unaffordable loans lead to defaults. Defaults lead to foreclosures. Foreclosures frequently result in vacant houses, which depresses home values in already poor areas even more, resulting in poor people who weren't involved in bad mortgages losing some of their home equity. Which places more financial stress on them. When cycles like that go on for too long, you wind up right back in Fort Apache, The Bronx.

ACORN argued that large numbers of subprime loans were essentially predatory, and fought for regulations that would curtail the worst of those loans. Anyone want to guess what the lenders were arguing?

Here's a gem of a quote from a paywall-protected 23 June 2000 article in American Banker:

For example, Mr. Mozilo said, some aspects of an anti-predatory-lending law passed in North Carolina last year harm the very people such laws are supposed to help.

The law limits the number of points a lender can charge the borrower, he said, and if the lender has a subsidiary that provides ancillary services like credit reports or appraisals, fees for these services are counted toward the limit.

The Mr. Mozillo quoted above is, of course, none other than Mr. Angelo Mozilo of Countrywide lending. That's the same Countrywide that collapsed earlier this year, under the weight of people defaulting on the subprime products that Countrywide had sold them, in many cases unethically:

"In terms of being unresponsive to what was happening, to sticking it out the longest, and continuing to justify the garbage they were selling, Countrywide was the worst lender," said Ira Rheingold, executive director of the National Association of Consumer Advocates. "And anytime states tried to pass responsible lending laws, Countrywide was fighting it tooth and nail."

...

The company's incentive system also encouraged brokers and sales representatives to move borrowers into the subprime category, even if their financial position meant that they belonged higher up the loan spectrum. Brokers who peddled subprime loans received commissions of 0.50 percent of the loan's value, versus 0.20 percent on loans one step up the quality ladder, known as Alternate-A, former brokers said. For years, a software system in Countrywide's subprime unit that sales representatives used to calculate the loan type that a borrower qualified for did not allow the input of a borrower's cash reserves, a former employee said.

A borrower who has more assets poses less risk to a lender, and will typically get a better rate on a loan as a result. But, this sales representative said, Countrywide's software prevented the input of cash reserves so borrowers would have to be pitched on pricier loans. It was not until last September that the company changed this practice, as part of what was called in an internal memo the "Do the Right Thing" campaign.

Countrywide might not have done so well, and some of their customers might have gotten royally screwed along the way, but don't worry about Angelo. He's cashed out more than $400 million in stock over the years.

Countrywide wasn't the only one steering people into subprime loans even when they could qualify for prime loans. From a 1999 article in American Banker:

Responding to questions about the protests, a Citigroup spokeswoman said the company "has a wide range of flexible products and services available for customers at all income levels in many communities across the country. We're always looking at innovative ways to reach out to consumers and provide them with financial service products that meet their needs."

But Citigroup's detractors said the disparity in the units' lending practices suggests that the mantra of cross-selling is not being pursued at all levels. While Citibank sends loan applicants who are rejected because of bad credit to CitiFinancial, borrowers with good credit who come to one of those units are not "referred up," the critics say.

"It's simply a one-way street, and those traveling on that street are disproportionately minorities," said Matthew Lee, executive director of Inner City Press/Community on the Move, another activist group. Mr. Lee said he supports Acorn's new campaign.

Basically, if you were Joe Blow borrower, with poor credit, and you walked into Citibank, they'd tell you that you didn't qualify for a loan. Then they'd tell you that there was somewhere else you might qualify, and send you on to CitiFinancial. But if you were a borrower with good credit and walked into CitiFinancial, you'd probably be told that you qualified for the best loan that CitiFinancial offered. What you wouldn't be told is that you also would probably qualify for an even better loan at Citibank.

You might be tempted to shrug this off as nothing more than a case where the buyer needs to beware, and laugh off the ignorance of the folks CitiFinancial screwed over. But before you do, stop and think for a second about what this really means. The more expensive a loan is for the borrower, the riskier it's going to be. This policy means that Citi, as a whole, was doing more than merely shafting their customers. They were voluntarily assuming more risk than they actually needed to, by pushing borrowers into costlier CitiFinancial loans when they could have been easily steered, without any lowering of underwriting standards whatsoever, to Citibank's products.

By now, you might be wondering where the regulators were during all of this. Which brings us to what might be the most amazingly aggravating part of this whole story. (Yes, it really does get worse.)

Between 1999 and 2003, a number of states passed legislation in efforts to curb a number of the more predatory lending practices that the banks and mortgage companies were engaging in. This effort ended after 2003, because a little-known branch of the Federal Government used a little-known Civil-War-era law to curtail the state efforts.

In late 2003, the Office of the Comptroller of the Currency (OCC) announced that it intended to use powers granted to it by the National Banking Act of 1863 to preempt state oversight. They finalized this rule in January, 2004. The OCC undertook this action in the face of opposition from all 50 state Attorneys General. The OCC justified preempting the states by arguing that the preemption would reduce the burdens faced by banks - the same anti-regulation argument that we've seen time and time again over the last 8 years:

"When national banks are unable to operate under uniform, consistent and predictable standards, their business suffers and so does the safety and soundness of the national banking system," said Comptroller of the Currency John D. Hawke, Jr. "The application of multiple and often unpredictable state laws interferes with their ability to plan and manage their business, as well as their ability to serve the people, the communities and the economy of the United States."

Mr. Hawke noted that national banks operate in an environment characterized by rapidly-evolving technology, a highly mobile customer base and credit markets that are national, if not international in scope. In that environment, the proliferation of state and local laws leads to higher costs that banks must either absorb themselves, pass on to their customers, or avoid by dropping products and reducing the availability of credit.

While states are free to pass laws governing the operation of the institutions they supervise and regulate, customers of national banks will continue to benefit from an array of consumer protections available through federal law, OCC regulations and the rigorous supervision of national banks and their subsidiaries by the OCC, the Comptroller added.

In the area of predatory lending, national bank customers would be protected by the comprehensive standard included in today's rulemaking. The standard, which applies to all consumer lending activities, codifies the OCC's pioneering approach to combating unfair and deceptive practices and bars loans that rely upon the foreclosure value of the collateral for repayment, a restriction that will prevent lenders from extending credit with an eye toward seizing a borrower's home.

The standard that the OCC released on predatory lending - 70 F.R. 6329 - is predictably laughable. Let's start with the fact that the standard was released in the form of "guideline", rather than as a "regulation." The difference between the two is explained in the introduction to the "guideline" itself:

Section 39 prescribes different consequences depending on whether the standards it authorizes are issued by regulation or guidelines. Pursuant to Section 39, if a national bank fails to meet a standard prescribed by regulation, the OCC must require it to submit a plan specifying the steps it will take to comply with the standard. If a national bank fails to meet a standard prescribed by guideline, the OCC has the discretion to decide whether to require the submission of such a plan. Issuing these residential mortgage lending practices standards by guideline rather than regulation provides the OCC with the flexibility to pursue the course of action that is most appropriate...

(emphasis in original)

In short, the OCC eviscerated the efforts that the states were making to get banks to reform their lending practices. They replaced these efforts - many of which were backed by actual laws with actual penalties - with a "guideline" that was beyond toothless. With one regulation, we went from class-action lawsuits filed by state AGs to a "guideline" that had no actual penalties, and lets the OCC decide whether or not a bank that violates predatory lending guidelines even needs to submit a written plan detailing the steps they will take to stop breaking the "guideline."

As we all know, the phrases "under the Bush Administration" and "effective Federal oversight" can only be used in the same sentence if the word "no" is included. The OCC's takeover of predatory lending prevention is no different.

I went to the "enforcement" section of their website, and took a look at what the agency has done since they took control away from the states. According to the search results, the OCC has taken a total of 383 "enforcement actions" since January, 2004. Only 58 of those 383 actions involved the banks paying fines (that's an average of just under one per month). No more than four of those fines could have possibly involved predatory lending practices. Thirty nine of the cases involved banks failing to require flood insurance, eight involved money laundering, and most of the rest involved record-keeping violations. There was also one rather spectacular case where a bank paid a total of 16.9 million after getting caught improperly getting HUD to take on their risk by falsifying applications.

The four cases that could involve predatory lending involve two cases where the banks were cited for violating fair lending laws, and two cases where I was unable to determine the reason for the violation, and am giving the government the benefit of the doubt. The banks involved in these four cases paid a total of $57,500 to the OCC to settle these problems. Yes, that figure is in whole dollars, not millions, and yes, that's the combined total.

The OCC publishes annual reports on underwriting standards. In 2003, they reported that the standards for retail underwriting remained "unchanged". In 2004, they reported that the standards "reflected more easing and less tightening". In 2005, they noted "increased easing with easing centered in real estate secured products". In 2006, they reported that demand "from nonbank investors has influenced underwriting terms". In 2007, they saw that "standards eased for a fourth consecutive year". It's entirely possible, of course, that the relationship between the easing of underwriting standards was entirely unrelated to the "easing" of oversight. But I wouldn't personally bet a lot of money on that.

At the end of the day, I'm left looking at this sequence of events:

Banks started making bad loans - not just subprime, but predatory - as a result of demand caused by investment banks that purchased and bundled the loans. Groups, including ACORN, protested, in an effort to bring the practices to a halt. Partly in response to prompting from these groups, several states passed laws in an effort to crack down on predatory lending. Banks and lenders fought against these efforts every step of the way. When they failed to stop the legislation, the Federal Government stepped in to protect the banks from the states. The Federal Government replaced the state efforts with guidelines that are so toothless that they make a jellyfish look like a shark. The banks reduced their underwriting standards even more. Chaos predictably ensued. And the right is trying to blame ACORN for the chaos.

Is it any wonder that I ended the day a lot more pissed off than I started it?

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A big tip of the hat for this article goes to the West Bronx Blog's Gregory Lobo Jost, who linked the City Limits article I used as a jumping-off point in one of two posts he wrote on the CRA back in the last week of October. If you're interested in learning more about some of the unethical banking practices that sparked the passage of the CRA, you might want to take a look at the earlier of his posts.