Two of my sons who work in the financial sector say that the start of the current problems was the 
Community Reinvestment Act (CRA) of 1976. It was the bad loans mandated by CRA that were bundled together and sold as investments, involving Fannie Mae and Freddie Mac. As a consequence, there is no way to correctly value these bundles of loans. Closely related to the CRA are the Equal Credit Opportunity Act (ECOA), the Home Mortgage Disclosure Act (HMDA), and the Fair Housing Act (FHA).
The CRA was proposed during the Carter years by Sen Proxmire to eliminate redlining. The major justification for CRA was the perceived unfairness of using bank deposits in poorer areas to provide loans to people who lived outside of the depository's geographic area. The remedy was CRA which requires "geographic credit allocation" that has no relation to the market and little relation to the credit-worthiness of borrowers or the true value of collateral.
There is an in-depth 1994 article by a former employee of the Federal Deposit Insurance Corporation, the Federal Reserve Board and then-current (in 1994) employee at the Resolution Trust Corporation, analyzing the CRA and its history.
Included, among other things, are descriptions of the activities of community-based organizations and their attempts to regulate enforcement of CRA from below. Involved were groups such as Union Neighborhood Assistance Corporation (whose executive director described himself as an "urban terrorist"), and the Association of Community Organizations for Reform Now (ACORN) whose representative once said about its pressure tactics with big banks, "When you're taking a billion-dollar merger, every day of delay costs lots of money. It's cheaper to negotiate than to fight." The community group called Center for Community Change claimed that CRA has resulted (by 1994) in $30 billion in new lending.
The linked paper says, among other things, that the CRA is counter-productive - it makes it very difficult for more appropriate small financial instutions to function in low-income areas and discourages entrepeneurs in such areas.
Here's the conclusion of the 37 page analysis:
1) Remove Governmental Barriers to Low-Income and Minority Lending
Many governmental barriers exist that prevent lending in low-income and minority areas by discouraging the chartering of small financial institutions. These regulations are especially harmful to lower-income areas, because they place a greater weight on smaller institutions, the very type of institution most likely to open in such neighborhoods. Eliminating very small institutions leads to a large gap in size between non-regulated institutions (currency exchanges, pawn shops, and second mortgage operations) and the smallest of institutions existing in the current environment. These barriers have been increased over the past 5 years, as the regulatory pendulum has swung back with a vengeance. Among these barriers are: barriers to entry erected by the compliance costs imposed by laws such as CRA and fair-lending statutes; the administrative burden of organizing a bank or a thrist; dollar-denominated capital requirements that go well beyond the level dictated by safety and soundness concerns; and the recent aggressiveness and expanded powers utilized in pursuing suits against directors.
2) Repeal CRA
The CRA should be repealed. Altering the underlying regulations merely leaves the way open for future administrations to utilize the statute as a government credit allocation scheme. CRA has discouraged entrepreneurs who seek to open financial institutions in lower, middle income or minority communties; has led to criticism of minority institutions for targeting an underserved segment of their community (the very segment the creators of CRA had targeted); it has created incentives to bid away market share from institutions that specialize in low-income lending; and it has prevented institutions from asserting the business necessity defense when accused of implementing policies having a disparate impact upon borrowers [note the focus on outcomes and not on whether the rules in themselves are unethical or illegal]. Repealing CRA would level the playing field between those subject to and those not subject to its provisions by assuring that no institutions are required to follow a scheme of reinvestment rules.
CRA was established under the faulty economic premise that the equivalent of a wall should be built up around the ill-defined notion of a "community," preventing an outward flow of deposit dollars, and forcing inefficient and contrived reinvestment. The statute ultimately leads to an economic balkanization that is truly an anachronism in our complex, interrelated, global economy. Similar geographical barriers, such as state and interstate branching laws, have tumbled over the past decade because they have been recognized for what they are: arbitrary geographical limitations on the flow of financial resources from where they are available to where they are needed.
Meeting the convenience and needs of the community is more apprpriately left to market mechanisms. Financial institutions should strive to satisfy convenience and needs as defined by their customers and the marketplace around them, not community organizations or regulators.
You can find the entire article by Vern McKinley in the journal Regulation, 1994 Number 4.
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Here's an excerpt from a 1998 Janet Reno speech to the National Community Reinvestment Coalition about enforcing the Community Reinvestment Act (emphasis added). It was during the Clinton administration that the CRA began to be used aggressively by community groups.
You've noted that since the inception of our fair lending initiative in 1992 the Department has filed and settled 13 major fair lending lawsuits. . . . We will continue to focus on descrimination in underwriting, the process of evaluating the qualifications of credit applicants. This was the issue in our suits against Shawmut in Boston, Northern Trust Company in Chicago, and First national Bank of Donna Anna in New Mexico.
We have also focused on the problem of redlining by lenders and insurance companies. This past August we reached an agreement with Allbank of New York. We alleged that the bank had carved out and refused to make loans in urban minority enclaves within the bank's lending areas in Connecticut and Westchester County, New York. The settlement with Allbank requires it to make $55 million in loans at below-market rate in the areas previously redlined.
(Applause.)
A question from one of the the community activist attendees:
Ms. Martinez: I have one specific question. Yesterday a woman from Freddie Mac mentioned that your Department had done an assessment about credit scoring to determine whether or not there were discriminatory practices involved with credit scoring and that in fact your findings were that there was none. I'm seeking an opinion about that. This whole issue of credit scoring is an area that we have very little knowledge of, and if there was an assessment done I'd like to read about it or know about it.
Source: http://www.usdoj.gov/archive/ag/speeches/1998/0320_agcom.htm
These people who are wielding the CRA as a weapon are ignorant of the economic facts of life, and yet have the Attorney General of the US catering to them.
This is really complicated stuff that should have been straightened out a long time ago, but there has been no political will to do so. Many people have seen it coming, including George W. Bush and John McCain -who both have tried to get the legislature to act, to no avail. Maybe it had to take this really scarey melt-down to convince some legislators that you can't make silk out of a sow's ear. The market will not be mocked for long - the piper must be paid. Let's hope our representatives have the intestinal fortitude to do what it must do to prevent a total collapse.
Sorry for being pessimistic. I've been watching what's happening to my IRA.
Julia
