February 1, 2009

The Community Reinvestment Act and the Rise and Fall of Washington Mutual

From my new VDARE.com column:

The mortgage fiasco devastating America’s big banks has many causes, but perhaps the least understood is the complex impact of the 1977 Community Reinvestment Act (CRA). There has been some hoopla over the CRA in recent months, but nobody seems to have noticed the subtle way the CRA actually exacerbated the disaster.

I’ll demonstrate using the meteoric rise and fall of Washington Mutual, Inc. (WaMu). Under CEO Kerry Killinger’s direction, WaMu went from being an obscure Seattle outfit to the sixth biggest bank in America. ...

I recently came upon this old Washington Mutual press release on Eric Falkenstein's Falkenblog dating back to WaMu’s $5.2 billion purchase of New York City’s Dime Bank:

“SEATTLE, Dec 21, 2001 … In connection with its merger with Dime [Bank], Washington Mutual recently established a ten-year, $375 billion community commitment which targets funding to low- and moderate-income borrowers, and minority borrowers … One of the largest community commitments of its kind, the ten-year pledge will be implemented with the assistance and support of a variety of non-profit community partners.”

On WaMu’s still-existent website, the bank explains that $375 billion pledge:

“These funds will provide loans and other financial support to communities consisting predominantly of people of color, to residents of low- to moderate-income (LMI) census tracts, and to people whose income is below 80 percent of median income. We will strive to create products and programs that increase our market share in low income and diverse communities, with a long-term goal of making our market share in these communities more closely mirror our market share overall. Using our Year 2000 production as a baseline, we have set our goal to double the number of loans made to borrowers of color by the end of the first year of this commitment. Thereafter, we will increase the number of loans made in these communities as quickly as possible.”

Not surprisingly, WaMu won the 2003 CRA Community Impact Award.

We now know that subprime foreclosures are centered among exactly the kind of people targeted in WaMu’s CRA agreement with racial activists. During the Housing Bubble of 2004-2007, minorities accounted for twice as many subprime dollars borrowed per capita than did whites. And the new report by the Boston Fed shows that, at least in Massachusetts, minorities defaulted on subprime loans at twice the white rate. All this suggests that minorities accounted for approaching two-thirds of subprime mortgage dollars lost.

For the GOP, the Community Reinvestment Act (CRA) was a more convenient example of government interference in the mortgage markets than, say, George W. Bush's 2002-2004 holy war on down payments in his effort to boost minority home ownership. That’s because the CRA was passed by a Democratic Congress and signed by a Democratic President.

Of course, the GOP’s claims about the CRA's centrality in the mortgage meltdown were obviously partisan. And more skepticism about the importance of the CRA seemed plausible, along these lines:

"How could the government hold a gun to the financial institutions' heads and force them to make hundreds of billions in stupid loans? Sure, giving out $375 million in stupid loans to get the government off your back, that would make sense. $3.75 billion, maybe. $37.5 billion, conceivably. But $375 billion, no way. Nobody would promise to give away $375 billion to dubious borrowers unless they thought it was a great idea. They’d leave the industry before they’d promise to hand out $375 billion to people whom they doubted would pay it back.”

In general, the government and its associated racket-runners can extort mid-level amounts of affirmative action booty. But when the demands get too great, businesses exit in one way or another. (Often with bad effects on general welfare, of course).

Obviously, it's a massive exaggeration to say the government and the ACORN clones forced WaMu to lend to likely deadbeats. Nobody promises to loan out $375 billion to low and moderate income and minority borrowers unless they actually want to lend out to low and moderate income and minority borrowers something approaching $375 billion.

Moreover, Washington Mutual sure didn’t act reluctant. They were positively exuberant about pouring money into the hands of minorities with weak histories of paying off debts. The relatively small number of big financial institutions that did a major fraction of subprime lending really seem to have drunk the same Kool-Aid as ACORN, Congress, Clinton, and Bush. They actually thought they were going to get rich off no-money-down, $400,000 loans to high school dropouts.

And they did, for a few years. CEO Killinger “earned” $88 million from 2001-2007.

WaMu's strategy was lending to deadbeats—the more minority the better. For years, WaMu ran a series of TV commercials where one cool black guy in a blue WaMu shirt, an actor who looked like a cross between Barack Obama and Don Cheadle, would humiliate dozens of old white bankers in suits.

Most advertisers would have put one token minority banker in the crowd of pompous empty suits. But WaMu didn't bother. They wanted to get their message across.

So it would seem that WaMu didn't need the CRA to blows billions.

And yet ... there's a more subtle point that I, and seemingly everybody else, missed in dismissing the CRA: the impact of the CRA's veto over bank acquisitions: the selection effect on who gets to get big.

For a full explanation of one nearly universally overlooked point about the the causes of the mortgage meltdown, continue reading here.

My published articles are archived at iSteve.com -- Steve Sailer


Anonymous said...


I have never seen "the rise and fall of WaMu" explained that way. It certainly sounds plausible.

However, short-term gains at any cost (and to hell with the long-term) seems to be the way "The Street" normally has operated, at least since the 1980's.

I don't think the CRA really did that much to change the culture of "big banking," except to provide yet another peverse incentive for wall street to follow.

Anonymous said...

I bet back then the NYT was beside itself how the CRA was not only the morally right thing to do, but how contradictory to white prejudice it was helping institutions make money.

Anonymous said...

If the government counts something, the government will eventually use the count to compel something. So the CRA is the still-growing fingernails on the corpse of the Carter Administration.

Anonymous said...

I thought Steve would go with the selection effect angle.

This from Russ Roberts fingers the blame on the CRA, and one Boston housing activist in particular.


Anonymous said...


Anonymous said...

This post presents the interesting but not entirely convincing theory that the CRA contributed to the banking crisis by inducing selection bias to bank mergers and acquisitions. If you didn't play ball with Jesse Jackson types, your bank couldn't merge or acquire.

On the surface, it's hard to believe. Do ethnic lobbies really have that much clout? Financial institutions are not usually pawns.

If this were really the case, wouldn't this criticism of the CLA already have been made? I'd need to see more evidence than the one Beverly Hills example that Scrooge banks really were being hindered in growth.

kurt9 said...

There were two parts to the business models the banks used during the mortgage bubble. The first one is where the mortgage lender, like WaMu, lent money as sub-prime and Alt-A mortgages, then sold them to Freddie, Fannie, and Wall Street institutions who, in turn, converted them into mortgage bonds, complete with AAA rating, which were then sold to investors.

The first business model did make sense for WaMu and the other mortgage lenders to pursue. Where they screwed up is that these same institutions that created these mortgages then had a second business model where they bought these "AAA" mortgage bonds as investment.

This is what I still don't understand. Since the mortgage lenders created these mortgages in the first place, they most certainly would have been aware of their dodgy nature. They should have been smart enough not to buy the resultant mortgage securities.

I have been aware that housing had been a bubble since the beginning of the decade. I was aware of the dodgy nature of these mortgages. I expected the housing bubble to crash but thought that the banks, especially the commercial banks, would sail right though it totally unscathed. I thought the banks were smart enough to make their money from the SALE of these mortgages and were smart enough not to buy any of the resultant mortgage-based bonds.

Obviously I was wrong.

Anonymous said...

The fuel of bank consolidation is consolidation of information technology budgets. Banks spend a lot of money to automate their systems. Consolidation of it means reducing the number of programmers and separate computer programs that they have to write and maintain. The savings come from firing IT professionals. Not pretty but true.
CRA would be a selection mechanism for deciding which banks get to capture these savings.
This is important going forward because there are still 8,000 or so banks in the country. So there is still pretty of incentive for consolidation going forward.

Anonymous said...

I don't know if it's his honesty or his intellect but Sailer is almost alone among writers in connsistently delivering this kind of meaty-goodness. No lame-stream-media reportage captures the what and more importantly the why of our ongoing economic insanity like an iSteve blog posting. Then again how can they compete when they can't even ask themselves the questions that would lead to the conclusions that Steve comes to?

Anonymous said...

Steve, you actually got a semi-favorable comment on http://www.ritholtz.com/blog/2009/02/the-rise-fall-of-wamu/#comments regarding on this!

Anonymous said...

"Do ethnic lobbies really have that much clout? Financial institutions are not usually pawns."

Who knows? But is (was) sure easy to pay the problem to go away. Path of least resistance and all that...

Anonymous said...

Brilliant. Absolutely on the razor's edge.

The only thing I don't fully understand is the mechanism whereby the CRA awards mergers to the bank that promises the greatest affirmative-action largesse. For example, does the CRA allow some agency to say "WaMu, even though you're paying the same or less in money for this bank's equity, you get to do the purchase because you pledged an additional $5 BB of minority loans." If that is the mechanism, do we know what agency has this veto power, and is the criterion so simple that whoever makes the biggest pledge wins?

Clearly the CRA does something, but I don't really understand its internal workings.

Anonymous said...

If that is the mechanism, do we know what agency has this veto power, and is the criterion so simple that whoever makes the biggest pledge wins?

Does CRA set explicit rules for which banks are in compliance and may do M&A or is it all subjective? To me this is like a board of cops getting together and deciding after you're pulled over what the speed limit should be. We avoid such laws in order to keep the law from being arbitrary and capricious.

Anonymous said...


I've been reading you since about 2002 because of your insight and this is by far one of the best and clearest articles you've ever written.


-Steve Johnson

Noumenon said...

For example, does the CRA allow some agency to say "WaMu, even though you're paying the same or less in money for this bank's equity, you get to do the purchase because you pledged an additional $5 BB of minority loans." If that is the mechanism, do we know what agency has this veto power, and is the criterion so simple that whoever makes the biggest pledge wins?

This is what's missing, Steve. An actual illustration of how ACORN can pressure a bank and torpedo their acquisition. I kept waiting for it and never got it.

Anonymous said...

Say a 45-year-old gets appointed CEO of a small bank, with a salary of $1 million per year. He could carefully steward his stockholders' investments, and continue to make roughly $1 million per year until he enters a comfortable but not lavish retirement in 20 years.

Or, he could try to grow the bank fast via risky bets. If he could increase the size radically, he would show the Board that CEOs of banks that big usually get paid $10 million per year

One of these bozos may be John Allison, former BB&T CEO and an Ayn Rander.

After 60 bank and thrift acquisitions,[...] the former eastern North Carolina farm bank has grown to become the nation's 14th largest financial holding company. Assets have increased from $4.8 billion, when Allison began his tenure as CEO [in 1989], to $137 billion today. Source.

So, was BB&T under Allison queer for subprime? Not excessively - and Allison himself denounced the CRA (and "the media's search for bad news"). But words and actions often differ - and the Federal Reserve Board (which, incidentally, seems to be the daddy regulator putting the CRA muscle on banks) has pronounced itself quite satisfied with BB&T subprime lending per CRA. See this enlightening pdf: a Federal Reserve Order of Approval of a BB&T merger in 2006 (esp. study pp. 8-12).

Allison hung it up at age 60, in December 2008, his 2007 compensation being $8 million. But not before BB&T swallowed $3.1 billion in bailout money, which it says it will use to acquire even more banks.

Maybe instead of reading Atlas Shrugged, all those university students should read Steve's post, eh? A little more practical...

Anonymous said...

"Noumenon said...

This is what's missing, Steve. An actual illustration of how ACORN can pressure a bank and torpedo their acquisition. I kept waiting for it and never got it."

It's possibly like this - the CRA gives "community groups" standing to sue banks in federal court so as to prevent mergers, unless of course the banks make money available for "low-income housing", and of course I'm not a good deal is also donated to groups like ACORN. This is, I believe, the way of lot of environmental legislation has worked (in gumming up productive activity, that is) - by legally empowering activists to get in the way through court action.