Many of life’s lessons are capable of imparting more than one pearl of wisdom. The brightest and best among us are capable of learning not only from their own mistakes, but from those so thoughtfully provided by others as well. Enron provides one such example of this in action. Two years before Enron exploded, the company fired her accountants, Arthur Anderson, and hired a rival firm, Anderson Little. The reason given to Arthur Anderson and the shareholders of Enron was that the accounting giant, “did not possess the creative thinking and vision that management was seeking to push their company to the next level.” This red flag, which was the response to Arthur Anderson’s refusal to publish the corporate report produced by Enron without the disclaimer’s Arthur Anderson demanded as an accompaniment to their signature was ignored by Anderson Little, who signed off without demanding a similar disclosure. Anderson Little won that particular piece of accounting business, and now there are 7 major accounting firms instead of 8. The other lesson Enron provided, as most of their employees had 90% or more of their 401k’s in Enron Stock, was that your financial advisers are probably right when they jump up and down and scream about diversification. (As a side note, if anybody reading this has more than 5% of their 401k in their company’s stock, change it immediately, you are playing Russian roulette with your retirement.) Another pearl of wisdom provided by the Enron example is that governments will misidentify the reasons for a problem developing, and then propose and implement solutions that will do almost the exact opposite of what they promise as the over reaching solutions. We got Sarbanes Oxley as a result of Enron, a broad reaching law that made committing a crime extra double illegal and created a new level of compliance for publicly traded companies designed to prevent nothing. It costs U.S. consumers Billions though, each and every year.
As the Berenstain Bears would say, the Community Reinvestment Act provides several great examples of what not to do. One day in 1977, the weekly long CBS propaganda broadcast, 60 Minutes, aired a piece detailing how Black and White patrons seeking home loans were treated differently and shown houses of differing values and in different neighborhoods. While the network news team came up woefully short in presenting actual evidence to back up their claims, they were able to provide ample snippets of situations designed to invoke an emotional response. it did not take long for Congress or our President to react either. This is where our current economic crisis was born.
The original act passed in 1977 gave the government permission to intrude itself upon the risk committees of companies who made their living by lending money to people who wished to purchase houses. That intrusion manifested itself as a panel of politically appointed bureaucrats with zero real world experience in lending money or analyzing risk telling people facing actual consequences what aspects to risk taking that they must legally now ignore and what they were now allowed to consider.
In 1989, the law was amended to now dictate that special interest advocacy groups could demand non public records from financial institutions in order to perform their own quantitative analysis which would compete with the banks existing risk committees. Those special interest advocacy groups were then allowed to publish their opinions in a very broad manner as to how they rated the performance of the institutions based on what ever their particular interests may be.
In 1991, the law was amended, as per the schedule established with the 1989 amendment to now have a government agency rate an institution’s performance as well, based on the data collected not by themselves, but by the special interest groups mentioned before. It also introduced monetary incentives to banks for approved behaviors in the form of tax credits for meeting the criteria of the concerned advocacy groups.
The 1992 Amendment saw the introduction of special tax rebates going to banks with a qualified percentage of minority and or female ownership. It also introduced Fannie Mae and Freddie Mac being directed to purchase mortgages from banks made to low income households and in qualified neighborhoods, presumably in areas considered to be decaying urban areas.
In 1994, we decided that the prohibition against banks being allowed to cross state lines was in order, but only for those institutions that were approved by the CRA board. Advocacy groups were solicited for their input into this activity, and thus even more pressure was brought to bear on activity which further disregarded internal risk committees.
The 1995 changes saw the functional end to any internal risk assessment. This was the year that welfare receipts including the housing and food allotment became legal to use as proof of income. It was also the year that the government exerted pressure to decrease down payment standards. Regulators were also given the ability to use ethnic standards and comparisons of the number of total loans written in order to grade compliance with the act. In other words, a bank was now forced to write so many loans to Black customers and so many to Asian customers, etc. These numbers were considered irrespective of the number of applications taken.
1999 saw the end of the Glass Steagall Act. Banks were now fully capable of acting as broker dealers fully participating in selling securities. This is where mortgages were first pooled together, bundled and then sold as an investment product.
The 2005 changes to the law merely served to re clarify the special interest standards imposed by the 1995 changes. As the demographics of our nation changed, so did the quotas for the numbers of loans made to specific ethnic groups, whether a borrower would have existed or not.
The 2007 change to the law may be perhaps the most insane of all. Ethnic barriers were removed and replaced with the phrase low income. That’s right, banks were now being forced to loan large sums of money to people identified as not capable of paying it back, and were now legally obligated to make a specific number of such loans as dictated by their total asset value.
To add the cherry to the top of idiocy, in 2008 we decided that it would be a good idea to tie the number of student loans allowed to the CRA compliance.
For those of you keeping score at home, every addition to the act from 1995 onward legally mandated banks to loan money in a, “predatory,” manner.
So now you may ask, what does all of this mean?
The broader lessons we can take from this act are numerous. Social engineering of our capital markets do not work out well at all. Social engineering does not benefit our society. Equality of the rules governing our society as they apply to every citizen is a good thing, forcing an equality of results will end ultimately in disaster. More importantly, even the least talked about aspect of a President’s 4 year term in office can have a far reaching impact upon American life, and indeed world living standards 31 years after that President enacted his vision. Prior to the financial crisis, Jimmy Carter’s name invoked discussions on the energy crisis, Iran, stagflation, the Misery Index, rampant unemployment experienced during the 70’s, but almost no one saw this one act as the disaster that it would become. Republicans talked of a need to reign in Fannie and Freddie during the earliest part of the Bush 43 years, but this particular act was not only left alone, but actually bolstered during that time frame.
One of the other lessons here is how hard it is to repeal a bad law. Even after the crisis became the crisis it is, and even after its causes became well known to anyone paying attention, CRA is still the law of the land today. Fannie and Freddie were left out completely from any consideration of the Dodd Frank Law, which was supposedly passed as the response to the crisis. The answer of our banks of course to the continuing prospect of the mandates that say, if you lend money to anyone, you must lend also to people who will not be able to pay you back, is to simply not lend any money. Who can blame them?