Friday, September 26, 2008

Where The Mortgage Crisis Began (Updated)

Columnist Mike Masterson of the Arkansas Democrat-Gazette wrote a great article about the current mortgage crisis and its roots. Below are a few excerpts. You can read the full story here.

Excerpt 1
I believe a former investigative reporter for Atlanta’s daily newspaper likely pitched the snowball that grew into the avalanche and buried our leading mortgage institutions. Bill Dedman in 1989 produced a series called "The Color of Money" that exposed the practice of redlining by banks that routinely declined risky home loans in low-income neighborhoods. Dedman wound up with a Pulitzer Prize and supporters for his cause within the federal bureaucracy.

Excerpt 2
“At the crisis’ core,” he wrote, “are loans that were made with virtually nonexistent underwriting—no verification of income or assets; little consideration of the applicant’s ability to make payments, no down payment....

Excerpt 3
...while head of Fannie Mae, “Clinton crony” Franklin Delano Raines was accused of “overstating earnings and shifting losses so he and other senior executives could earn big bonuses.... At the same time, the Clinton administration was pushing Fannie and her brother Freddie Mac to buy more mortgages from low-income households.”

Bill Dedman, the reporter who wrote "The Color Of Money" series of articles has posted a comment below. Mr. Dedman says his report was mischaracterized in the article that was referenced here. He offers a link where you can read the report for yourself.


Bill Dedman said...

In his opinion article accusing me of starting the mortgage credit crisis, Mike Masterson makes a fundamental misunderstanding.

My 1988 series of articles in the Atlanta Journal-Constitution dealt with the failure of banks and savings and loans to make mortgage loans in middle-income black neighborhoods.

Middle-income black neighborhoods.

But all Mr. Masterson remembered from these articles was "black," so he made an assumption. He writes, "Bill Dedman in 1989 produced a series called 'The Color of Money' that exposed the practice of redlining by banks that routinely declined risky home loans in low-income neighborhoods."

See what he did? Hearing "black," Mr. Masterson decided that meant "low-income." He thought "black" meant "risky."

Mr. Masterson's assumption is precisely the same one that many bankers in Atlanta and elsewhere applied at that time. For years they had made loans in even the poorest white neighborhoods, while avoiding Atlanta's middle-class and more affluent black areas. Some might call his assumption racist. Let's charitably chalk it up, not to a racist intent, but to ignorance. Either way, the effect is the same.

For the record, all low-income areas (and high-income ones, too) were left out of our study entirely. We compared white middle-income areas with black middle-class areas.

Your readers can do what Mr. Masterson did not: You can read "The Color of Money" for yourself at The article "How study of home loans in metro Atlanta was carried out" explains the methodology. (You'll also see that that the articles were published in 1988, not 1989. Mr. Masterson seems to have written this article without access to reference books or a computer.)

A loosening of credit standards in recent years, as loans (mostly to white borrowers) were packaged and sold to Wall Street investors, may or may not be tied to the anti-discrimination efforts of the 1980s. Mr. Masterson is entitled to his opinion, but not to his own facts. My article pointed out how banks were avoiding good money to be made in middle-income neighborhoods.


Bill Dedman

DiStefano said...

Bill Dedham shouldn't have to explain himself. His work speaks for itself, and it does Not encourage boneheaded lending.

The federal Community Reinvestment Act, passed in 1977, requires banks to offer loans in poor neighborhoods if they also lend to rich people in the same market. It does Not require that they make stupid loans to people who can't pay. That's bad underwriting and gets bankers in trouble with their examiners, always.

Dedham's achievement, in those pre-Excel Spreadsheet days, was in showing how federal loan data could be analyzed to see which banks were complying with the law by attempting to lend in poor neighborhoods. The data was abused by people who equated loan refusals with racism. The data doesn't prove intent.

Successful banks in the 1990s (like PNC, Mellon, Fidelity in Philadelphia) found ways to make responsible loans to responsible borrowers, make money on the loans, and comply with CRA.

The problem came late in the late 1990s when the big banks sold their mortgage businesses, just as specialized mortgage companies that were Not subject to CRA began aggressive campaigns to make high-cost, high-risk mortgages, often in inner-city neighborhoods. That was made possible (and profitable) by the fast-growing market for high-rate subprime loans as a vehicle to fund all kinds of bond finance, separating loan originators from loan investors and giving originators all kinds of incentives to make bad loans.

Bad money drives out good. The mortgage companies -- even those owned by banks -- were Not directly subject to CRA. These are the companies that made most of the bad loans that so many financial companies, solvent banks (via the FDIC), and taxpayers (via the various Bush administration bailouts) are now being asked to pay for.

Joe DiStefano, Philadelphia Inquirer, business news.