Sunday, October 02, 2016

Subprime causality

Did subprime mortgages forced on banks by the US Community Reinvestment Act (CRA) cause the Global Financial Crisis? Former US Senator Phil Gramm has repeatedly said that they did, and has repeatedly quoted Alan Greenspan as proof, using the Greenspan quote below which appears again in today's Wall Street Journal  --

"It's instructive to go back to the early stages of the subprime market, which has essentially emerged out of CRA."

But here is the full context for that quote to the House Oversight and Government Reform Committee in 2008  --

Mr. Greenspan. Well, you know, it is instructive to go back to the early stages of the subprime market, which has essentially emerged out of the CRA. The evidence now suggests, but only in retrospect, that this market evolved in a manner which if there were no securitization, it would have been a much smaller problem and indeed very unlikely to have taken on the dimensions that it did. It wasn't until the securitization became a significant factor, which doesn't occur until 2005, that you have this huge increase in demand for subprime loans, because remember that without securitization there would not have been a single subprime mortgage held outside of the United States; that it is the opening up of this market which created a huge demand from abroad for subprime mortgages as embodied in mortgage-backed securities. Now, we didn't know that the deterioration in the standards was occurring until 2005, because you look now at the outstanding subprime mortgages and it is very obvious that those that were made in 2004 and earlier have not turned out to be an incredibly difficult issue. In other words, the real toxic mortgages occur with the huge increase in securitization and largely the demand from abroad and to whatever extent Fannie and Freddie were involved, from them as well.

He's quite clear. He's not a huge fan of the CRA, but even with his view that it did lead to some marginal mortgages, on its own it was not a big factor. It was only the broader factors of securitized mortgages and the mid-2000s piling-in by foreign investors -- under no US pressure to buy anything -- that metastasized the market. But Gramm keeps using that single sentence quote, now to argue against institutional financing of public infrastructure investments. 

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