In the 1970s, when community groups discovered that lenders and the FHA were engaged in systematic racial discrimination against minority consumers and neighborhoods — a practice called “redlining” — they mobilized and got Congress, led by Wisconsin Senator William Proxmire, to adopt the Community Reinvestment Act and the Home Mortgage Disclosure Act, which together have significantly reduced racial disparities in lending.
But by the early 1980s, the lending industry used its political clout to push back against government regulation. In 1980, Congress adopted the Depository Institutions Deregulatory and Monetary Control Act, which eliminated interest-rate caps and made subprime lending more feasible for lenders. The S&Ls balked at constraints on their ability to compete with conventional banks engaged in commercial lending. They got Congress—Democrats and Republicans alike — to change the rules, allowing S&Ls to begin a decade-long orgy of real-estate speculation, mismanagement, and fraud.
The iconic figure of that era was Charles Keating, who used his political connections and donations to turn a small lender, the Lincoln Savings and Loan Association, into a major real-estate speculator, snaring five senators (the so-called “Keating Five”) into his web of corruption. In 1989, Lincoln Savings collapsed as a result of its risky loans. Edwin Gray, former chief of the Federal Home Loan Bank Board, which regulated S&Ls, told Congress that several U.S. senators, including John McCain, the Arizona Republican now running for president, had approached him and requested that he ease off on the Lincoln investigation. These senators had received $1.3 million in campaign contributions from Keating.
The deregulation of banking led to merger mania, with banks and S&Ls gobbling each other up and making loans to finance shopping malls, golf courses, office buildings, and condo projects that had no financial logic other than a quick-buck profit. When the dust settled in the late 1980s, about a thousand S&Ls and banks had gone under, billions of dollars of commercial loans were useless, and the federal government was left to bail out the depositors whose money the speculators had looted to the tune of about $125 billion.
As a result of industry consolidation, between 1984 and 2004, the number of FDIC-regulated banks declined from 14,392 to 7,511. In 1960, the 10 largest banks held 21 percent of the industry’s assets; by 2005, the 10 largest banks controlled 60 percent of the assets. Meanwhile, a netherworld of non-bank institutions that lend and invest money emerged, offering complex and risky loan products and investment vehicles that defy common understanding and resist government regulation.
The stable neighborhood S&L soon became a thing of the past. Banks, insurance companies, credit-card firms, and other money-lenders became part of a giant financial-services industry, while Washington walked away from its responsibility to protect consumers with rules, regulations, and enforcement. The icing on the cake was the Gramm-Leach-Bliley Act of 1999, which tore down the remaining legal barriers to combining commercial banking, investment banking, and insurance under one corporate roof.
Meanwhile, starting under the Reagan administration, the federal government slashed funding for low-income housing, and allowed the FHA, once a principal force in helping working-class families purchase a home, to drift into irrelevancy.
Into this vacuum stepped banks, mortgage lenders, and scam artists, looking for ways to make big profits from consumers desperate for the American Dream of homeownership. They invented new “loan products” that put borrowers at risk. Thus was born the subprime market.
At the heart of the crisis are the conservative free-market ideologists whose views increasingly influenced American politics since the 1980s, and who still dominate the Bush administration. They believe that government is always the problem, never the solution, and that regulation of private business is always bad. Lenders and brokers who fell outside of federal regulations made most of the subprime and predatory loans.
In 2000, Edward M. Gramlich, a Federal Reserve Board member, repeatedly warned about subprime mortgages and predatory lending, which he said jeopardized the twin American dreams of owning a home and building wealth. He tried to get Fed chairman Alan Greenspan to crack down on irrational subprime lending by increasing oversight, but his warnings fell on deaf ears, including those in Congress. (For more on Gramlich, read “Freedom for the Pike.”)
“The Federal Reserve could have stopped this problem dead in its tracks,” Martin Eakes, chief executive of the Center for Responsive Lending, recently told The New York Times. “If the Fed had done its job, we would not have had the abusive lending and we would not have a foreclosure crisis in virtually every community across America.”
As Rep. Barney Frank wrote recently in The Boston Globe, the surge of subprime lending was a sort of “natural experiment on the role of regulation,” testing the theories of those who favor radical deregulation of financial markets. And the lessons, Frank said, are clear: “Reasonable regulation of mortgages by the bank and credit union regulators allowed the market to function in an efficient and constructive way, while mortgages made and sold in the unregulated sector led to the crisis.”
Some political observers believe that the American mood is shifting, finally recognizing that the frenzy of deregulation that began in the 1980s has triggered economic chaos and declining living standards. If they needed proof, the foreclosure crisis is Exhibit Number One.
Where Do We Go from Here?
Public officials need to distinguish legitimate subprime lenders from the scam artists who engage in predatory lending. Likewise, the people facing foreclosure need to be treated differently depending on whether they failed to exercise personal responsibility or were victims of predatory practices. Banks and other lenders as well as investors who speculated in mortgage-backed debt must shoulder some of the blame for this debacle. Likewise, speculators should live with the consequences of their actions.
Congress should enact legislation to protect victims of predatory loans from foreclosure. The victims should have a right to a nonprofit loan counselor or lawyer who can help them renegotiate the loan or sue banks, including big Wall Street firms, for violations of state and federal consumer protection laws. The federal government should provide more funding to nonprofit groups that help homeowners renegotiate mortgages and require lenders to restructure predatory loans. (For more on this subject, see “Help Now, Not Later.”)
One nonprofit group, ACORN, a national network of community organizations, has been pressuring Citigroup to restructure loans rather than foreclose on low-income consumers. ACORN wants lenders to agree to 30-year, fixed-rate, affordable modifications to existing loans so borrowers can avoid interest-rate increases that come with adjustable-rate mortgages. ACORN has also urged lenders to impose a moratorium on foreclosures, which some Democratic presidential candidates have supported.
The National Community Reinvestment Coalition (NCRC) has a foreclosure-prevention program that has saved thousands of homeowners from losing their homes by pressuring lenders to change adjustable-rate mortgages into fixed-rate loans.
UNITE HERE, the garment and hotel workers union, has launched a campaign against Countrywide Financial, the nation’s largest subprime lender, calling on consumers to boycott the company until it guarantees it won’t foreclose on borrowers who have fallen behind on adjustable-rate loans.
These activist groups have made some headway. But without a federal mandate, they have to rely on protest and other threats to get banks to cooperate. They support a bill sponsored by Rep. Brad Miller, (D-N.C.), and Rep. Loretta Sanchez, (D-Calif.), which would allow bankruptcy judges to amend the terms of home mortgages. Under current law, the terms of a mortgage on a yacht or a vacation home can be adjusted during bankruptcy, but not the terms of a loan on primary residences. Advocates believe that the Miller-Sanchez bill could help as many as 600,000 homeowners avoid foreclosure, but the Mortgage Bankers Association is fighting the legislation.