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HOW FEDS INVITED THE MORTGAGE MESS
... From the current hand-wringing, you'd think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job. In fact, it was the regulators who relaxed these standards - at the behest of community groups and "progressive" political forces.

In the 1980s, groups such as the activists at ACORN began pushing charges of "redlining" - claims that banks discriminated against minorities in mortgage lending. In 1989, sympathetic members of Congress got the Home Mortgage Disclosure Act amended to force banks to collect racial data on mortgage applicants; this allowed various studies to be ginned up that seemed to validate the original accusation.

In fact, minority mortgage applications were rejected more frequently than other applications - but the overwhelming reason wasn't racial discrimination, but simply that minorities tend to have weaker finances.

Yet a "landmark" 1992 study from the Boston Fed concluded that mortgage-lending discrimination was systemic.

That study was tremendously flawed - a colleague and I later showed that the data it had used contained thousands of egregious typos, such as loans with negative interest rates. Our study found no evidence of discrimination.

Yet the political agenda triumphed - with the president of the Boston Fed saying no new studies were needed, and the US comptroller of the currency seconding the motion.

No sooner had the ink dried on its discrimination study than the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: "discrimination may be observed when a lender's underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants."

Some of these "outdated" criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification. Instead, the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant's ability to manage debt.

Sound crazy? You bet. Those "outdated" standards existed to limit defaults. But bank regulators required the loosened underwriting standards, with approval by politicians and the chattering class. A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities. It also let community activists intervene at yearly bank reviews, shaking the banks down for large pots of money.

Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department. ...