Reversing the Damage

We have committed more than $8 trillion to bailing out banks, but one common lament, from many business owners and prospective homeowners, is that the very same banks are reluctant to make loans. We need to modernize existing laws and enact some new ones in order to restore flows of credit.

One immediate remedy is the CRA Modernization Act of 2009. This proposed law would strengthen the existing Community Reinvestment Act to make it more effective and expand CRA's purview to financial institutions other than banks.

Had the existing CRA covered independent mortgage companies, most of the unsavory lending practices that led to millions of foreclosures and brought down the nation's economy would not have occurred. Top economic researchers from the Federal Reserve have found that less than 7 percent of the high-cost, high-risk loans that are at the source of our economic and foreclosure calamity were made by CRA?regulated institutions.

As it turns out, regulatory oversight matters. A CRA?regulated bank would have CRA examiners looking over their loan portfolios and practices to prevent unethical, unsafe, unsound, and discriminatory lending practices. The regulatory oversight for non-bank mortgage institutions was all but nonexistent. The CRA Modernization Act of 2009 would level the playing field by treating banks and non-banks alike, while increasing average Americans' access to credit and capital.

    Here's a list of lenders not currently covered by CRA:
  • Independent Mortgage Companies (to name a few that have disappeared: Countrywide, Ameriquest, New Century Financial Corporation, Option One, Golden West)
  • Mainstream Credit Unions (not predatory lenders but they lag behind banks in most areas in serving minorities and low-wealth borrowers)
  • n Insurance Companies (try being a business and getting a loan where insurance companies refuse to issue property or casualty insurance in your community)
  • Securities Firms (Morgan Stanley, Bear Stearns, Charles Schwab, and others)

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With the expansion of CRA to other financial institutions, we not only decrease unsafe lending practices but exponentially expand the responsible credit available to low-, moderate-, and middle-income neighborhoods for small businesses, homeowners, investors, and others. Literally trillions of additional private-sector dollars would be available for reinvestment in cities and towns, and all this without government subsidies (such as the $11 trillion welfare payment already appropriated for our financial-services system).

The new legislation would also improve the system for evaluating banks, so that predatory lending and racial discrimination would be explicitly penalized. It would provide far more detailed data on lending practices. Lending to small cities and towns as well as to rural areas would also be explicitly covered.

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But expanding CRA regulation is not sufficient. The legacy of the sub-prime collapse is also an epidemic of foreclosures. Thus far, the administration's response has been far too feeble.

President Barack Obama's $75 billion program, Making Home Affordable, creates financial incentives to loan servicers, banks, and investors who modify loans. Yet the program is entirely voluntary for the banks. The one possible stick, proposed authority for bankruptcy judges to order modification of loan terms, was rejected by the Senate after the administration failed to press for it.

Unfortunately, the new foreclosure filings continue to escalate. New foreclosures are occurring at about 300,000 per month, with foreclosures at this level projected through all of 2009 and most of 2010. This will produce a continuing downward spiral in property values, stripping additional equity and wealth from property owners who did not get predatory or sub-prime loans.

One strategy, as proposed by the National Community Reinvestment Coalition in January 2008, would have government brake this collapse by forcing the sale of toxic mortgages, as well as mortgages that have been converted to securities, by directly purchasing them from Wall Street firms and banks. This involves using the power given Treasury under the Emergency Economic Stabilization Act of 2008 (which gave us TARP) or government's powers of eminent domain. We take homes to make room for highways, airports, city centers, and schools; why not purchase securities to actually keep people in their homes?

This proposed new Homeowners Emergency Loan Program (HELP Now) would allow government purchase of these loans at a deep discount, since these mortgages have already lost substantial value. Under current market conditions, this discount would be steep enough (between 30 percent and 50 percent) so that private-sector banks would be able to immediately refinance these mortgages at terms that matched the borrower's ability to pay.

Millions of these toxic loans could be refinanced through this mechanism without government guarantees or subsidies. Instead, the loss the investors and banks have already suffered on paper would be converted into a gain for homeowners. The government could then use its guarantee and subsidy programs and perhaps direct lending, as it did in the 1930s, to assist homeowners in deeper trouble.

The overriding goal is to keep people in their homes. Once a home becomes vacant, it is likely to lose even more value, dragging down the value of homes in surrounding neighborhoods.

There is some talk now within the Obama administration of creating a direct-purchasing program, although administration officials remain hopeful that their financial-incentive program will work. But the deepening collapse of our economy exacerbates the challenge. Whereas most of the foreclosures that occurred when the economy first collapsed in 2007 resulted from these exploding sub-prime loans, increasing numbers of Americans can't pay their mortgages because of job loss. These homeowners also need mortgage relief.

Creating a direct-purchasing program now would allow millions of homeowners, who are still working, to avoid defaulting on their loans. This could help lessen the foreclosure crisis and contribute to stabilizing home prices. The challenge of creating jobs, stabilizing communities, and getting banks back into the business of lending will be further undermined if the foreclosure filings continue to escalate.

So let's tell Congress: You've taken care of the banks. It's time to assure that those who elected you at least have the chance to start or expand businesses or to become homeowners the old-fashioned way, borrowing money from a lender that is not predatory, usurious, or disengaged.

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